Earnings Call: Q4 2019

Jun 21, 2019

Good morning, and welcome to Canopy Growth's 4th Quarter and Fiscal Year 2019 Financial Results Conference Call. On June 20, 2019, after the close of the financial markets, Canopy Growth issued a news release announcing its financial results for the Q4 fiscal year ended March 31, 2019. This news release is available on Canopy Growth's website and on SEDAR. On this call this morning, we have Bruce Linton, Canopy Growth's Founder, Chairman and Co Chief Executive Officer and Mike Lee, Canopy Growth's Executive Vice President and Chief Financial Officer. At this time, all participants are in a listen only mode. Certain matters discussed in today's conference call or answers that may be given to questions could constitute forward looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect results are detailed in the company's annual information form and other public filings that are made available on SEDAR. During this conference call, Canopy Growth will refer to supplemental non GAAP measure, adjusted EBITDA. This measure does not have any standardized meaning prescribed by IFRS. Adjusted EBITDA is defined in the press release issued yesterday as well as in this period's management's discussion and analysis document that will be filed on SEDAR. Please note that all financial information is provided in Canadian dollars unless otherwise specified. Following prepared remarks by Mr. Linton and Mr. Lee, the company will conduct a question and answer session during which questions will be taken from analysts. I would now like to turn our meeting over to Bruce Linton. Mr. Linton, please go ahead. Great. Thank you. And welcome, Mike, to your first call. So the platform was busy last year. We were expanding globally, delivering multiple market platforms from rec to medical, investing quite a lot of capital. And the net effect is revenues on a 12 month basis were $226,000,000 190 percent year over year growth. We saw gross revenue in Canada with the rec market 140,000,000 dollars about 24,000 kilograms in the fiscal year compared to 8,700 kilograms in the prior fiscal year. And we shipped over 5,000,000 units in the fiscal year compared to about 1,000,000 in the prior year. So you have very active business on that level. But really what was it about? Well, today we sit with IP of 90 patents that were either acquired or issued. And it's our view that intellectual property, the containment of novel outcomes, creating, unique brands based on science is going to be the future and we're heavily invested. So there's a portfolio growing day on day. We announced approximately 2 weeks ago, 60 trials that are either ongoing or near term ready to get going. And what you're going to see is a shift globally from a discussion of medical marijuana to cannabinoid therapies. Our positioning of Spectrum is about that. Our acquisition of C3 expands that. It's a major theme. And so we expect that while year on year, if you look at the total number of patients we had in the medical sales, it's taken a bit of a step back, which was anticipated. We've gone to about 70,000 patients, but that's in part when you migrate products such as LBS could also be known as Lease by Snoop and DNA products from the medical platform to the recreational platform. We've just readjusted our portfolio, and we expect to see growth year on year in medical. This is not something that we didn't expect, and we are well prepared to ramp it up. U. S. Hemp, we announced our plan and we're in full ramp up mode. Contracts for farmers, announced sites, RFPs out for construction works that we can begin refitting buildings, working on multiple states so that they take a pattern and follow a process that's very similar to New York State, developing brands, creating and testing products and getting a production ramp that while there's no absolute certainty, we certainly are aiming to have a Q4 in channel product set. Acreage, yesterday before yesterday, we had our mutual votes with great shareholder support. Yesterday, you saw some activity in the U. S. System of making decisions on what is going to be permissible where it certainly looks like the House of Representatives supports on a cross party basis the notion that the DOJ should not be using funds to go and pursue states that have made a decision to act in certain ways whether it's recreational or medical. And so we continue to believe that the 20 states that acreage has and our soon ability to license our IP, our brands and our products into them should accelerate their ability to be very dominant in those states. And we believe that the alignment between Canopy and Acreage is excellent now and will continue to benefit from what we've learned on scale. So what did we learn on scale? If you look at Q3 fiscal 2018, Canopy had about 600,000 square feet of licensed facility and we understood and did and delivered a margin, a gross margin greater than 50%. And we could have stayed there and we would have been a nice tidy little company, probably quite profitable. But what we thought was important is when you acquire a bigger supporting partner and they bring CAD5 billion and there's a global opportunity which we are in our opinion the best position for. What you need to do is use that capital to build scale and we did. And so you've seen I think the bottom of our margin trough which is about 16% this quarter and it's because as you build out from 600,000 square feet license in Canada to 4,800,000 square feet over about a 5 quarter period, you end up with a lot of assets that are coming on stream, but are not on stream. And they carry burden that doesn't show up in benefit. But the point of the exercise is not benefit in a quarter or in a day or a week. It's that by the time we exit this year, we're moving up the margin model back to where we were and we'd like to do that well or better. And how you get there is events that will happen in December of this year and carry on into the future, which is the platform that will regulate the sale of higher margin products because they move up the finished good value chain. Things like chocolates or vapes. Our facilities for producing chocolates and producing vapes are licensed platform right now where we could be producing cannabis products. We can't yet produce chocolates or vapes, but the actual platform as far as the medical marijuana and recreational marijuana licensing schemes in Canada has been approved in those areas. So we're not chasing approvals. We're waiting for regulations to say that we're permissible to produce. We've had a lot of talk about beverages. Our beverage platform, the photos necessary to submit to Health Canada are scheduled to be prepared and could be submitted on or about June 28. That would follow where we will start to see tanks arriving early July, processing skids mid late July, things like piping equipment and consumables early August, qualification of equipment August to September, so that we're looking at a mid September finished construction. And I give you that detail on that. There's a bit more spend to go, but the finish line will be products measured in 2 to 10 milligrams in a beverage that will be unique, differentiable, we believe highly brandable. We think we're in the leading position globally to create these products that are differentiated and that the margins that we'll yield off of them are going to be rewarded to you as an investor and to us as a company because we've really put our focus on how do we get to the front, how do we get to scale. And this has sort of been the line where we got to. Finally, we don't want you to just focus on Canada, but we expect by the time we get to the end of the year, this is going to be a country in which we can show you a product set, a margin set and a breakout of R and D and core spend. So you will understand this is a business that could go global. Global is now starting to be a very significant part of our spend. We acquired C3 in Europe, which is Europe's largest cannabinoid based pharmaceutical manufacturer, 5 approved cannabinoid therapies, and they had sales of $40 plus 1,000,000 in 2018. That is a key piece. Acquired This Works, it's a global leader in natural skincare and sleep solutions. It's going to strengthen our ability to enter markets and bring CBD based offerings that align with a well established 34 plus country channel. So these are the sorts of actions that we've taken. I'm going to hand it over to Mike because I would like him to take the time to walk through the model and we can move to questions. But this is the framework we're operating in. Mike? Thank you, Bruce. Good morning, everybody. First allow me to introduce myself. I joined Canopy Growth Corporation in February of this year as Executive Vice President of Finance, working with Tim Saunders. My background is largely in the beverage alcohol industry, having spent over 20 years in this space. 15 of that was with E and J Gallo Winery, working in a finance capacity for most of my tenure, notably spending my time partnering with various commercial teams across the business. That is where I really cut my teeth as a commercial finance leader. After Gallo, I went on to work for PepsiCo where I was division CFO in their beverage business, spending most of my time on revenue management, pricing architecture and operations finance, again partnering closely with the business throughout. A few years later, I joined Constellation Brands and was quickly promoted to division CFO of Wine and Spirits where I spent most of my time. As for my pathway leading to Canopy, I would say I became very enamored with this company back in 2017 when Constellation made their first investment in Canopy. And when the 2nd larger investment was made in 2018, I was offered the opportunity to join the Canopy team. Flash forward a few months and I'm now working as acting CFO, awaiting my security clearance from Health Canada, which we expect to receive in the near future. Before I move to my review of fiscal 2019 results, I would like to formally thank Tim Saunders for his support during the last several months. Tim has been committed to my success from the day we met, and I appreciate everything that he's done to ensure a smooth transition. Tim is really a class act and I'm thrilled that he will continue to serve Canopy Growth in a new capacity. Now on to our fiscal 2019 results. This has been a historic year for Canopy Growth. We spent years preparing for the launch of the recreational channel in Canada and our leadership position since this historic day last October is evidence that our strategy is working. We generated net revenue of $226,300,000 representing an increase of 191% over fiscal 2018. We sold 24,300 kilograms and kilogram equivalents in fiscal 2019, up 180% over fiscal 2018. Gross revenue in the Canadian rec channel totaled $140,500,000 in fiscal 2019, including $117,400,000 in the product wholesale to the provinces and territories. Gross medical sales generated $78,900,000 in fiscal 2019, up 6% versus last year. Further expanding on medical, our international medical business grew to $10,000,000 up 170% versus year ago. Medical sales in Canada experienced a modest decrease of 3% during the fiscal year. Our online medical store in Canada saw a period of major transformation during the year with established brands Tweed, DNA Genetics, LBS and certain craft grow partners largely transitioning to the rec channel. This product transition along with supply challenges in specific product categories, which have since been remedied, led to a decline in the medical channel in the second half of fiscal 2019. We also had other revenue of $34,000,000 which includes revenue from our clinics, merchandise and our medical device company Storz and Bickel. Moving beyond the top line, cultivation and post harvest processing capacity has been a top investment more than double the amount we harvested last year. But more more than double the amount we harvested last year. But more importantly, our current quarter referring to Q1 of fiscal 2020, harvest is on track to achieve 34,000 kilograms, which is more than double what we harvested in Q4 and nearly quadruple what we harvested in Q3. We're expecting to see further capacity increases as we shift from build and license to operate and optimize across each of our facilities. Turning for a moment to cash flows during fiscal 2019, there are 3 themes that speak to our priorities. Number 1, we're building capacity in Canada, the U. S. And beyond. In fiscal 2019, we invested 6.40 $4,000,000 in fixed assets. And although our initial wave of investments in Canada infrastructure is nearing completion, we are continuing to invest in various extraction and advanced manufacturing capabilities to further automate our processes and prepare for the next wave of product platforms later this calendar year. We continue to invest internationally and this is expected to accelerate into the upcoming fiscal year as we build out our CBD platform in the U. S. And increase our investment beyond North America. Number 2, we're building organizational scale. We will continue to see investments in our organization for the foreseeable future as we complete the build out of our Canadian team, expand our global organizational footprint and invest in scalable corporate capabilities including finance, operations, engineering and information technology. In addition, we will continue to invest in the development of new cannabis products, including clinical research activities being undertaken by Spectrum Therapeutics to prove the science and safety of new cannabis based medical therapies. As a result of building organizational scale and investing in the development of future products ahead of revenue, we incurred $666,000,000 in operating expenses during the year, of which $283,000,000 is non cash expenses related to stock based compensation for both employees and acquisition milestones. Number 3, M and A continues to be a priority. We invested $380,000,000 in acquisitions in fiscal 'nineteen, including the acquisitions of AgriNext USA, Colombian Cannabis, Ebbu, HIKU Brands and Storz and Bickel, as well as the outstanding shares of Canopy Health Innovations and BC Tweed. And it can be expected that we will make additional acquisitions in the future. The $5,000,000,000 investment from Constellation Brands continues to serve as a critical war chest that will fuel our expansion plans in coming years and has enabled Canopy Growth to exit the fiscal year with the strongest balance sheet in the industry. Let's briefly review adjusted EBITDA, our supplemental non GAAP measure for fiscal 2019. Adjusted EBITDA is defined as earnings from operations as reported before interest, tax, depreciation, adjusted for other non cash items such as stock based compensation and accounting for biological assets and inventory as well as acquisition costs. We report adjusted EBITDA believing it's a useful financial metric that will help investors assess the operating performance of our business before the impact of investments, acquisitions, income taxes and non cash fair value measurements. Adjusted EBITDA amounted to a loss of $257,000,000 in fiscal 2019 as compared to a loss of $36,000,000 in fiscal 2018. The increased losses are directly tied to my earlier commentary about investing ahead of revenue to build scale. To further illustrate, our investments in sales and marketing increased from $38,000,000 to $154,000,000 as we're hiring sales and marketing teams across Canada, staffing 20 company owned retail stores across the country, investing in brand building for the first time and building systems and processes to analyze the business and study consumers. In G and A, our investments increased from $44,000,000 to $168,000,000 as we've built out our global team, our back office functions including finance, technology, human resources and legal. Moving beyond operating expenses, other expenses in fiscal 'nineteen included a non cash expense of $203,000,000 related to fair value changes in our senior convertible notes, which have been recorded through the consolidated statement of operations. And these fair value changes are due to the increase in Canopy Growth stock price from the issuance of the senior convertible notes in June of 2018 through March 31, 2019. Our net loss on a reported basis, which includes all fair value adjustments for biological asset accounting as well as many other non cash items such as stock based compensation was $670,000,000 as compared to a net loss of $54,000,000 in fiscal 2018. I would like to take a moment to review select financial operational metrics for the Q4 of fiscal 2019. Canopy Growth generated net revenue in the Q4 of $94,000,000 Total quantity of cannabis sold during the Q4 of fiscal 2019 was 9,000 100 kilograms, up 2 70 percent from last year. At the same time, average price per gram decreased from $8.43 per gram to $7.49 per gram as the recreational channel opened up and the business model shifted more toward business to business with the wholesale tier at the provincial level. Oil and softgel capsules accounted for 40% of gross revenue in the 4th quarter of fiscal 2019, up from 21% in the Q4 of fiscal 2018. Gross recreational revenue in the Q4 of fiscal 2019 was $69,000,000 Gross medical sales totaled $13,000,000 in the 4th quarter and Canadian medical revenue was $12,000,000 Medical sales in the 4th quarter included international sales of $1,800,000 down from $2,400,000 in the prior year period and this decrease is due primarily to supply constraints. We believe the supply constraints that limited medical sales in Q4 have been resolved by higher finished product inventory levels and we expect finished product inventories to increase further in Q2 fiscal 2020 as a result of the large harvest in the current quarter. Other revenues generated in the Q4 of fiscal 2019 accounted for $24,000,000 up from $900,000 in the prior year. Turning my attention to gross margin. As a reminder, the cost of sales includes the impact of operating costs of cannabis cultivation subsidiaries not fully utilized, including specific zones of Aldergrove and Mirabel Greenhouses as well as costs associated with developing and laboratory testing edible and beverage products for which markets will be available later in calendar 2019. Gross margin in the Q4 of fiscal 2019 before the IFRS fair value impacts was $15,000,000 or 16% of net revenue. Comparatively, gross margin in the Q4 of fiscal 2018 was $7,700,000 or 34% of net revenue. The lower gross margin percentage in the Q4 of fiscal 2019 was primarily attributed to $24,000,000 of operating expenses for facilities not yet cultivating or facilities that had underutilized capacity. In addition, in the Q4, we incurred some non recurring costs, including costs related to unusual weather event in BC. Excluding these costs associated with underutilized assets and non recurring expenses, the gross margin before the fair value impacts and cost of sales and other inventory charges was $39,000,000 or 41% of sales. With utilization increasing in these facilities, we expect our operating costs to normalize in the next several months as we work through seed to sale. However, as a reminder, start up costs related to advanced manufacturing and our new bottling plant will continue to serve as a slight headwind, but will become less material as our revenue increases. We believe we are on a path for reported gross margins to be above 40% by the end of the fiscal year and will increase further in the future with higher efficiencies and increased sales of value added products as we approach full utilization of the new production capabilities. Finally, to recap, Q4 adjusted EBITDA amounted to a loss of $98,000,000 as compared to a loss of $22,000,000 in the Q4 of fiscal 2018. The increase in the loss is largely reflective of the investments made through fiscal 2019 in the areas of sales and marketing and general and administration expenses as well as research and development. Total other expense was $135,000,000 in the Q4 of fiscal 2019 as compared to $11,000,000 in the prior year quarter. The increased expense is partially due to a non cash expense of $163,000,000 related to fair value changes on our senior convertible notes, which have been recorded through our consolidated statement of operations. These fair value changes are due to the increase in Canopy Growth stock from December 31, 2018 through March 31, 2019. Our net loss in Q4 fiscal 2019 inclusive of fair value impacts of biological asset accounting as well as other non cash items was $323,000,000 as compared to a net loss of $54,000,000 in fiscal 2018 Q4. Moving beyond fiscal year 2019 and into the Q1 of fiscal 2020, I wanted to highlight 2 items. Number 1, as previously addressed in our shareholder circular related to the Acreage deal, we agreed to a modification to the investor rights agreement with Constellation Brands. The new investor rights agreement has 2 modifications related to the exercise price of their warrants as well as the expiration date of their warrants, both of which are subject to fair value adjustments, which will be recorded in Q1. As a result, we expect to record a material non cash charge in Q1 related to these adjustments, which will contribute to a material net loss in the period. Number 2, our harvest continues to increase quarter on quarter, which will support our view on revenue growth in coming quarters. But our Q1 harvest, although substantial, will largely be sold in Q2 and Q3 due to the timing of post harvest processing, value add product manufacturing and the timing of laboratory testing and the associated quality assurance lot release process. For my remaining remarks today, I would like to take a moment to speak about the priorities I have established for myself, my team and by extension Canopy. We are passionate about driving performance improvement and executing on our mission statement with a commitment to operational excellence. And as successful as we've been, we need to continue to challenge ourselves as a company to build out our success and to enable a truly global platform that will fuel growth as we chart our course over the next several years. So let me share my top three priorities for building on these capabilities. Number 1, we're going to review our global ERP strategy. Having just rolled out our new ERP world class solution to support our business end to end, not just for today, but for tomorrow and beyond. Number 2, we're going to strengthen financial reporting and controls. To be a global leader, we must operate around the world seamlessly. We plan to design and implement a set of fully integrated capabilities that will allow us to manage risk, provide improved controls to our business, all while meeting our SOX compliance obligations. As our business evolves, so too will our financial reporting. We are already reengineering our financial reporting processes. We are in the early stages of planning for what is an eventual conversion to U. S. GAAP reporting, anticipating that we will no longer qualify as a foreign private issuer in the future. We are also evaluating our reporting methodology, which could lead to changes in how we communicate our performance to investors. Number 3, we're going to accelerate acquisition integration. Central to our growth plan is our ability to acquire companies that enhance our reach into global and vertical markets. In our industry, many of these target companies have relatively nascent or immature capabilities from a business and technology perspective. Having a turnkey M and A playbook will improve our ability to acquire and integrate, which will improve our deal synergies, reduce our costs and fuel our growth more effectively. In summary, this plan allows us to create a platform that supports scalable growth, fuels our expansion into the U. S. And beyond. It empowers our employees with the advanced tools and capabilities to develop business insights that allow us to seize market opportunities and provides a continue and repeatable basis for reporting to our shareholders and the financial community. I will provide updates on future calls as we progress toward this agenda. This concludes our review of the financials for the Q4 fiscal year ended March 31, 2019. I would now like to turn the call back to Bruce for some closing remarks. Thank you, Mike. Excellent summary. So where we are now midway through near the end of Q1, we continue to look at the world quite optimistically. We're seeing indications of change in so many countries and we feel we're the best physician company to pursue them. So please, if you have questions, queue them in, and we look forward to responding. Your first question comes from Chris Carey with Bank of America. Hi, good morning. Good morning, Chris. So I just want to start with a bigger picture question, then have a follow-up on near term dynamics. So on the big picture, just I guess taking a step back on the results this quarter, Clearly Canopy continues to invest globally to establish these long term competitive advantages. And I think that makes a lot of sense, especially given peers don't really have anywhere near the same capability given your scale and balance sheet, right? But I guess as you continue to enter new markets, you will of course need to keep investing. So in that context, I think maybe it'd be helpful to get your perspective on this natural tension between investing into the long term versus the need to have some of the near term discipline and how you think that strategy impacts your financial model over the next 3 to 5 years? Yes. So it's a good question. So part of the reason, Mike put out as one of his reporting priorities is to be able to give some segmented reporting because we do need to be able to show you Exhibit A, which is going to be Canada. How is it running on medical? How is it doing on rec? What's it look like on a total business? Back out some of the costs which aren't really directly related to campus income, medical programs, expenses of that nature. And then as we go to other geographies, we mentioned, I think, in our press release earlier this week about an approach in Colombia where we have a partner who will be producing our gel caps because as we get more IP, we can move up the value chain, use other parties' manufacturing capabilities and really put together our differentiated outcomes in the research. Maybe the final part is we've signaled to the market that we're quite interested in some form of instrument which will allow us to take and rotate the invested capital in Canada, call it $1,000,000,000 plus and turn that into some form of an instrument which under the right scenario should also become a schedule type instrument. So that if we got a federal permission in a foreign geography for another license that we'd actually be able to take that asset put it on and have the cash rotate back in. And we've advanced through quite a few of the models on that. I don't think it's something you'll see turned up instantly, but there's quite a lot of interest in how we could actually get that capital back into rotation versus stranded. Okay. And then just on the follow-up. So your ability to kind of hit this $1,000,000,000 annualized run rate revenue by your fiscal Q4 2020, how much of that is dependent on the launch of new product forms in Canada? And maybe how much will you need from revenues outside of Canada to help you get to that number? Yes. So that is a figure that was put out by Constellation, which we certainly feel is achievable. It's principally a domestic driven opportunity. It doesn't our growth and revenue plans, we haven't built a material sum coming out of, say, hemp derived products in America. We're looking at Canada as a market that principally drives the biggest number top line growth over the next three quarters. And what we see in the market, the biggest risk and uncertainty we have was when is the launch date. So we now know that. And then our ongoing continuous risk assessment is approvals by the regulator. So long as Health Canada continues to approve the platform necessary to produce the products, we think we have the technology and the platform created. But with those things together, we think there's a substantial business in Canada with a little support from other geographies. Okay, great. Thank you very much. Next question comes from Vivien Azer with Cowen. Good morning, Bruce and Mike. Good morning. So, Mike, my first question to you please. I really appreciate the detail on the gross margin. Given the commentary around the shift in kind of revenue into 2Q and 3Q based on what you've cultivated in 1Q and the target to get back to north of 40 percent. Can you offer any kind of incremental color on the cadence of that over the course of the year? It sounds to me that our expectations should be reset materially lower for the Q1 as we kind of push out gross margin improvement. If you comment on that, that would be great. Yes. Thanks for the question, Vivien. So so there's been a lot of activity going on at our big anchor facilities out in BC, Tweed as well as Mirabel and we are on the tail end of the renovation retrofitting of those facilities and given the growth time it takes time to kind of claw your way back. So we would expect that as we get into Q3, Q4 that you start to see those normalized margins that we've been talking about for some time now. There will be a bit of a headwind, albeit relatively smaller than the headwind we've seen on the grow houses. But as the bottling capabilities are stood up, there will be some fixed costs that will hit ahead of production, ahead of revenue. But all things being equal, I think it's going to be a much more modest impact than what we've experienced in the last two quarters with the grow houses. So we remain very optimistic that we'll get to the 40% by Q4. And as we start to see the benefits of the new platforms, in my view, that's where we get the runway to that high 40s that we've talked about for quite some time. Perfect. That's really helpful. And then, for both of you, Bruce and Mike, just as a follow-up to that. Can you comment on how that like influences your view on EBITDA and getting to positive EBITDA? Obviously, the story has changed pretty materially in the 2.5 years that Bruce has been covering the stock, but there was a time when you guys were talking about getting the EBITDA positive once you had adult use revenues hitting the P and L. Now I fully appreciate that with the incremental capital that you've gotten from Constellation Brands, you've made some adjustments to your investment priorities that are impacting EBITDA. But the magnitude of the increase in your EBITDA losses really dwarfs anything we're seeing from your peers. And you guys aren't the only one trying to scale up both domestically and internationally. So any help on kind of the glide path to EBITDA profitability would be great. Thanks. Yes. Yes. And you're right. It does dwarf our peers and it all comes back to the war chest that we talk about, which we think is going to turn into a competitive advantage over time as we're building this global scale. But I'll bring it back to Canada. Our focus in the near term is to demonstrate Canada performs as a standalone model that we can take around the world. And in FY 2021, we believe we're on a path to show EBIT dot positive performance. And with the announcements with the new regulations coming out with the platforms and the capabilities that we've stood up from a production perspective, we're confident that as we get into fiscal 2021, you'll start to see that positive EBITDA performance for Canada as a standalone business. Perfect. Thanks very much. Next question comes from Peter Sklar with BMO Capital Markets. Mike, there was a number you a harvest number you threw out there 34,000 kilograms. I didn't quite catch that in the pace of your commentary. Can you just talk a little bit about what that represents and when that will sell through? Sure. So 34,000 kilograms is our current forecast for Q1 harvest and this is really driven by the fit out of all of our grow houses. Recall, if you go back and look at the last couple of quarters of harvest, I think in Q2, we had about 15,000 kilograms. In Q3, we harvested around 7,500 kilograms. Q4, 14,400 kilograms. You sort of get a sense of the dip that incurred as we were putting those facilities through the retrofitting. So 34,000 kilograms is, I would say, the beginning of what I would consider to be our new normal of harvest capacity. And I would also say that our operations teams are committed to progressing that number even further. And that's going back to my remarks of transitioning from establishing these facilities and getting everything up and running to really focusing on optimization. We've got a lot of runway in front of us to further optimize these facilities. And going back to Vivien's question and earlier questions around gross margin and EBITDA, getting these facilities optimized is going to be a critical value lever for driving that bottom line because as the throughput increases, your fixed costs are relatively fixed. You might have some marginal costs on that higher throughput with some additional hourly labor. But as you guys know, these facilities are highly fixed cost in nature. So that's really where the power of that leverage is going to come through. And Peter, sort of in the modeling of it, typically, the way I look at it is like 2 thirds of the sales in the next quarter come from the harvest in the prior quarter. So when you see that number, you can start to work it into if we've got the right product mix and the stores are opening up that harvest number from this quarter is a big key factor for the next quarter. Okay. So really just putting it all together, it's this now they've achieved this higher level of harvest. That's why you're optimistic about the margin improvement in Q3 and Q4. Is that would that be correct? Yes. Well, it's utilization of the platform. So as the building fills, we get the yield off the building. And as the product formats become more sophisticated, you sell a lot less. When you measure everything in milligrams, you sell less cannabis with more adjacent ingredients to create more value and then you get to put it into the form factors of vapes to beverages to chocolates. That mix combined with our platform utilization turns into a great outcome. And what I like is like what we observed in the last 5 years is the creation of opportunity that I don't think we're ever going to lifetime window. And so this model that we've developed and how we're deploying it globally with tuning it in Canada, I think we're very well positioned and the capitalization we have allow us to have multiple years of advantage if we spend properly now, which we are. And so that's kind of the path we're driving. Okay. And my other question is, I believe your recreational sales, if you look in kilograms, not revenues, but kilograms, declined Q4 versus Q3. And is that because like you just didn't have the production in Q4 or rather it's just that the retail flow like the retail demand isn't out there because Ontario and Alberta just haven't been building their store base? That's one of those questions. It's a bit of both. We're talking that it's a couple of percent down, but it's really been about product mix that we had, because this is a second quarter. We had about 2 quarters or 3 quarters to get ready for the 1st launch quarter, And we had to keep supplying through. So that's that whole half product and why the prior question, the available product for Q3 matters or Q2 matters. But obviously when Alberta needed to pause in their opinion the additional licensing of stores in Ontario got going in April, That kind of made the platform static. What we're seeing is a lot more stores opening up, obviously, in Alberta. There's quite a bit of discussion and rumor about will Ontario do some more sooner. So the channel is growing and we're pretty upbeat that that channel is going to have more and more interesting products and it's going to be a big channel by the time we get to Q3, Q4. So a little bit of a blend. Okay. Thank you. Next question comes from Oliver Rowe with Scotia Capital. Thanks for taking my question. So your international sales this quarter were pretty low and I know that that business is a bit lumpy by nature, but it seems apparent that we haven't hit inflection point for growth in these markets yet. Many countries prescribe cannabis as a last resort and only for very serious indications And for that to relax, we need to see regulatory change. So from your seat, I'm just wondering how quickly you see that change happening and sort of what we could expect to see in the next couple of years in your international segment? Yes. So it's a bit textured in that the U. K. Is still at that stage where they're making extremely challenging for patients typically very ill young children to gain access and then it's extremely costly. And so, what they're effectively doing is fighting in the media with sick children and that obviously won't work for a long time, so it starts to open up. If you move across the opportunity, you will get to Germany as the most available. And frankly, in the period we're reviewing, it was a function of not having the product to export because you can't just say I'm going to send this to Germany. It needs to be actually the product which has been fined and registered. And we didn't have sufficient. We think that we do now and that we're in a position where that should grow because the demand was there. We also have places like Denmark coming online, which means the export potential will be from a Denmark production facility into say Germany or the Czech Republic. And so our transiting of cannabis will become a bit more textured and not just Canadian. And I expect to see that over the next quarter or so. But really the markets seem to be growing. It really has been our ability to keep up with the right product mix. And now we're further working to have things like gel caps and oils approved as exportable products, not done yet, but it has been an aggressive project to get there. So I think you might see the mix of products improve, not just the available product. That makes sense. Just as a follow-up, I know you just mentioned there that you have to get certain products availability for export. I know the export markets are offering you about 2x better price than the recreational market. So why are you not just focusing on getting products through that channel to realize those prices? Yes. It was a bit of a juggling act. I would say that the regulators probably were a little bit more supportive recently of approving things from Canada over our ability to grow and target that amount has been improved because of the platforms items we described. It was a small window where we were probably juggling 8 balls. And I would say that we didn't get to sort of utilize everything the way you would optimize for cash, but I think we're pretty much there right now. On our receiving side in Germany, it's an interesting thing in that we have a capacity constraint to some extent where what we can receive has to sell through before we can put more in. We don't have like a 10 ton vault there. We have a limited capacity vault. So we're always adjusting the choke point, but I think the choke point will be more that than it will be product mix or available product. That's helpful. Thank you. Next question comes from Graeme Kreindler with 8 Capital. Hi, good morning and thanks for taking my questions. I just wanted to go back quickly to the 40% gross margin target you're expecting by the 4th quarter optimistic to reaching that. You've had some competitors mentioned on recent calls the expectation that there could be some significant downward pricing pressure on the flower side of the market with more capacity coming online, especially from smaller producers. So I was just wondering if that target there takes into consideration any headwinds on the flower side considering they'll probably remain a significant part of the market in the near to medium term? Yes, it does. Our expectation of how much and how quickly it comes on stream, I think might be informed by our experience. I would also say that there's a very different big difference between growing some bud quality versus producing an API extract kind of level and giving things into a form factor that actually rely on a bottling plant or vape technologies we've created or the chocolate factory area that's licensed. So I think if you're going to be measuring things on grams, there may be some pressure and I don't think it's in the time period you've described on grams, but that when you start measuring things in milligrams, I think the milligram formatted products Medical Direct are actually going to have a very solid opportunity for margin increase. Okay. Thanks. And to follow-up on the subject of higher margin products and to follow-up from the last set of questions there on the export. The press release mentioned a pretty lengthy process to get export approval. So I was wondering if the regulator has started to streamline any of those processes or they're taking any input from you or other producers in order to help that go a bit faster? Yes. I think the regulator's objective is to make sure that every patient in Canada has full access to product and that the provinces have what's necessary. And then exports have to go where the receiving country requests and Canada issues an export. I think it's becoming smoother, but it isn't I don't think it's ever going to be something in our short term window, maybe the next several years, where it's automatic. We'll see where we get with CBD. But if you start including the ingredient THC, it does become a complicated process. Really what you can do now, there was as we have scale production, the quantities which we can put through, it doesn't matter if you're doing 2 50 kilograms or 25 kilograms, essentially the overhead rate is about the same. And so I think we're finding ways to just put a little bigger volume through each approval. Okay, very helpful. Thank you very much for that. Your next question comes from Doug Miehm with RBC Capital Markets. Yes. Excuse me. Good morning. Couple of questions. Just with respect to the rollout later this year, how would you say that the provinces are set up relative to what we saw last year in terms of value add products and their capabilities in that regard? Good question. And well, in a word much better, right? Like last year at this time, we were still trying to talk about what's the start date. Now we're talking about whether or not they've wired their buildings to have fridge plugs. So for example, when you go to New Brunswick, those stores run by the provinces actually put in the capital so that they've contemplated the ability to have chilled fridges. They have more storage capacity. When you look across the private sector ones, I think they'll react quite quickly. So I wouldn't say it's even, but I would think that there's probably half the provinces in which we'll be able to launch quite quickly with the full range of products and the others which will be catching up based on the fact that they could be making a lot more rate of return on their buildings if they had all the products in. And so not uniform, but way better than where we were. And I think the products that they're talking about are critical to be in a store. If you look at the e commerce rate for liquor sales, it's not super high. But if we have a beverage on a store floor and say Nova Scotia liquor, which I've mentioned it many times when I was down there in the last few months, you essentially walk in the front door of the liquor store and then at the back of the store as sort of a semi separate areas where they sell the cannabis. If you pick up a bottle of wine and walk through to the cash at the back, you can pick up cannabis and pay for both at the same spot. And so we're quite optimistic that some of those platforms are going to be able to show substitution effect and accelerated sales. But overall, I think half or more are going to be quite quick to launch. Okay. And then the other question I had is just with respect to the testing process, which I think you briefly mentioned. Are the hurdles in your mind different as it relates to the value add products and edibles, etcetera, versus what we've seen before? And do you believe there are any different implications for that process versus what we saw last year? And I'll do it there. Thanks. Yes. So I think like you, we're still waiting to see what the final criteria and testing process will be, but it's narrowing in. And that's we're frankly, I think when they're looking at this, it's going to be part of what we've observed in the U. S. Where we tested a great range of CBD products and about 80% of them were more than 10% of the spec. So I think the regulators are going to be looking very, very carefully that you can actually confirm both the cannabis dosage and the quality of the product that you're mixing with whether it's a food type product or a food testing platform. It certainly doesn't feel like it's going to be a stretch to deliver, but it isn't nailed down yet as a final step. Perfect. Thank you. Next question comes from Michael Lavery with Piper Jaffray. Thank you. Good morning. Good morning. Just wanted to touch on a couple of your newer platforms coming and understand some of the timing there. First for the U. S, for the CBD initiatives and hemp products, likely by the end of fiscal 2020. Can you just give us a sense of how that builds and maybe why it's not something sooner? And then 2nd on the 2nd wave of products coming in Canada, Obviously, there's some regulatory issues around all the timing, but how much should we expect pipeline fill in calendar Q4, even if there's mid December dates that are really sort of the green light? How should we think about how that looks in terms of you getting product out the door? Yes. So there's a certain amount of stuff that I'm going to keep a little bit close to the vest in that we think there's some competitive advantage in what we're doing. But take New York, for example. In Kirkwood, we've assembled the property and the facility we're going to go in. We've issued the RFPs where we're focusing on local trades and contractors and engineers so that we can actually implement the platform that we already know how to implement. So that site will then become a processing of CBD. We've contracted hemp in several states across the U. S. For production. We've defined all of our brand launch lines, think health and wellness principally. And we have found and are finding a variety of contract manufacturers who are putting the form factors together for us. Where we want to launch though is we don't want to have SKUs run out. We don't want to have anybody have a fear of what's in the product and we want certainty that it's controlled. So even meetings with the USDA, what's permissible spray? When do they test it? How do we make sure that the product when it's harvested from the field doesn't contain things that downstream are going to become viewed negatively in a state. And so what we're doing is assembling a scale reliable platform that is not going to leave any big box or C store operators with an embarrassment, but rather an ongoing sellable SKU. And so it takes a little bit of time to do that at scale. But typically, we try to push and deliver things a little earlier than our schedule rather than promise and fail. So I think we're operating in that mode right now. And on the Canadian products coming in later this year? So on those, it feels like we're landing finally where we want to be, right? Like we've been talking about beverages for 3 or 4 years. And I think if you look back in the decks we've been using, we've had a treated tonic with a clear bottle and a cap on it for a long time. We have a chocolate factory operating in what used to be a chocolate factory that became a marijuana factory that has both now. We have done a lot of work on brands, form factors and launch. So I think you're going to like what we have for everything from how baked products work and how our margin model has been thought through on that to every other form factor. We are I think well ahead in terms of the facility, the space, the license for cannabis to be present. All we need is the final agreement that we can launch. And typically that's going to be 60 days from the time the regs hit, so mid December. The principal challenge in Q4 is mid December also has a late December event, which can be Christmas or Hanukkah depending who you are. And so there's a shipping window that's going to be limited and how much can get into stores. So our logistics will contemplate how maybe we can direct ship to stores that can take it versus warehouses that have to inventory it and then crank it up in Q4 Q4 for us calendar Q1. But those are sort of the things that we're already mapping out and here it is only June. Next question comes from Brett Hundley with Seaport Global. Hey, good morning, gentlemen. If I could just package 2 quick questions together. The first is, if the U. S. Senate follows House passage of the spending bill for the forward year, Would your lawyers consider that a triggering event for the acreage deal? And then separately, New York State has been really wet this spring. Do you have a sense for how CBD or hemp plant yields are impacted during late plantings? And can you share with us kind of what the situation is with regards to your company or I guess partner farms? Thank you. Two good questions. 1, I would say is actually, so recent news, we're still trying to figure out exactly where that came from, right? Like it was yesterday's vote, I think is the one you're referencing with regard to the DOJ budgets? That's exactly correct. Yes. So that was last night's reading and discussion and calls around 9 at night because it does need to be supported by the Senate. But I don't know that that makes it federally permissible. I think what it makes it is federally unenforceable. And so we will see where we get, but I think it's just a progression towards where we wish to be. But, yes, this is one of those things that we are monitoring closely and we have people living in all the right zip codes so that they can be on that for us. As far as the second one, we're still getting the green light that the harvest will occur. Yes, it has been ridiculously East Coast rainy. We do have hemp that we've acquired from prior years that is into a processing step and we do have contracts in other geographies. Obviously, New York wants to see product produced in New York, so it can process to New York and branded as CBD in New York. But we certainly don't have any flags to throw yet at this time. Thanks, Bruce. Next question comes from Ryan Macdonell with GMP Securities. Yes. Hi, good morning, guys. Thanks for taking the questions and Mike, welcome to the conference call. Thank you. So my first one is maybe for you, Mike. You talked about how global and ex Canada is really starting to be a large portion of your spend. Could you share with us in the quarter approximately what proportion of SG and A was attributed to outside of Canadian operations? Was it on the order 20% as much as 50%? I'll let Mike see if he can dig around and get you a specific breakout on that because we haven't covered off. But I'll link it back to an earlier question on things like exports. And I mentioned how it gets textured. Someone was asking, is the export process from Canada to Germany accelerating? And it is what it is. But maybe in a quarter or 2, our export process for Germany in some proportion relies on a Denmark authority. And so we do have fully competent resources in Europe to handle that kind of transaction where we grow it, we certify it, we execute the legal framework paperwork and move it where it doesn't rely unnecessarily on a function at head office. So Mike, I don't know if you have any more breakdown. Yes. I would say when you think about our infrastructure outside of Canada, our SG and A, I'd put at the 10% to 15% range, but clearly an area of investment. The difficult thing in unpacking that is we are adding infrastructure in Canada to support the build out of the global business for things like shared services, legal, finance, etcetera. But in the coming months and quarters, you'll see more investment going into the U. S, going into Latin America, going into Europe as we build out those functions. Excellent. Thank you very much for that color there. And maybe kind of following up on that, on staying in international. With regard to the U. S, you talked about the rollout of CBD products there. Maybe can you share with us what sort of categories you find are interesting? And also any comments you have around ingestible CBD products in south of the border? So turn a little bit sideways. What we really like are states that step in so we don't have to wait for FDA to govern the dosage. You'll see many products out there that are full spectrum hemp and they'll say 25 milligrams or they won't say CBD. And they don't get into the details. So what we like is in New York State, we think we're going to have everything from the potential of a beverage to certainly skincare products and moving along that could in fact become ingestibles because at the state level we expect them to regulate and they appear ready to regulate before FDA so long as we don't make health claims. And so I think you're going to find 6 or 7 states are going to govern very well that will allow companies like Canopy to put up infrastructure, process to finish goods that can be topical through ingestible, drinkable as well and have the dosage on them. And so long as we do that, we'll be in compliance with the state license and not offset with the FDA. So we don't think you're stuck in the topical swim lane only, but we think it's a good category. Okay. Thank you very much. Next question comes from Owen Bennett with Jefferies. Good morning, guys. Hope all are well. First question, I just wanted to come back to the U. S. Hemp CBD. So you spoke about the $1,000,000,000 sales run rate at the end of the year being largely Canadian driven. So U. S. Hemp CBD obviously offers possible upside to that should it come online in 4Q. So I was just curious in terms of how much of a contribution can we expect U. S. Hemp CBD to make in its 1st full year even in a very conservative scenario? So in the first part of your question, you're correct that we are not leaning on revenue or sales from that category in order to actually see a high growth company. We're investing a few $100,000,000 into U. S. Processing assets that are great for hemp, but they'll also be functional and I think scalable for cannabis should that become permissible activity. As far as the forward look, CBD doesn't resolve everything that's on the planet. So that perspective that you just say the letter CBD and everything's good. So whatever that's that really off the top number is, we don't buy into that. But I have seen analyst reports that this is a substantial healthcare product set and we think with what we're doing we should end up with a leading market share. And I don't want to lean to a number, but we're building for scale and trust. And if you're running a big box chain, a corner chain, you do not want another supplier who's going to embarrass you. Cool. Thanks. And then just a follow-up. Could you please give some more details on the unusual weather event and other one time activities impacting margins in the quarter? And how confident are you these one time activities won't need to be repeated as we move through the year and obviously trying to get to that 40%? Yes. So a couple of things there, Mike will chime in on some. When you're retrofitting and securitizing greenhouses, you're not operating them. So if you get a heavy snow load on a sudden basis, it can actually become a problem. It did. We had to get heat cranked up and things done. But when the greenhouses are full and operating, their design with a snow load doesn't become a topic because it actually continuously melts off. Check that box good there. As far as the other ones, Mike, I don't know if you want to comment. There was some specific things related to leases and such, which I would say are functions of startup or recreational when you're trying to figure out who, what, where, when fast and have options? That's right, Bruce. I don't think anything is material in nature, but I would just say just as we're working through that retrofit, it's a challenge to grow and operate at the same time that you're retrofitting. So we just had a number of small unusual activities occur during the quarter. Nothing systemic, nothing to be concerned about. Okay. Thanks very much guys. Appreciate it. Next question comes from John Zamparo with CIBC. Hi. This is actually Krishna Ratnam on for John. I just wanted to follow-up with regards to the pet CBD market, something that you've mentioned in the past, just to see whether you have an update on when products will be available and whether that will be in this calendar year? So we're looking at a couple of launch locations. Certainly for the ones we wish to launch in the U. S, we want to make sure that they're safe for the animal and valuable for the owner who pays for them. With that criteria and brands like Martha Stewart associated, I would say our cautious window for launch is as late as Q1 calendar Q4 our fiscal. There may be other products in Canada that could come out sooner. And again, what we're trying to do is make sure that what we launch is easily supported by very large industrial players in the pet food space. So that we have brands and we have colleagues who could play with us that would see what we're doing as the best way. And that appears to be the path we're on. It's been a we're dealing with how do we interact with the veterinarian and tech care areas in both Health Canada and the FDA. We're trying to follow those kind of rules and platforms and tell you that it's calendar Q4, it's more likely calendar Q1, Q4 for our fiscal for the pets. Okay. Thanks for that. And I just wanted to follow-up a little bit further on just your thoughts on the initial sort of rules around derivative products. And then whether you feel you have a competitive advantage relative to the other LPs in Canada? Yes. The rules, they work. There's going to be some unusual aspects like people are accustomed to an ABV equivalent so that when you have a volume of something you associate it with the strength, I think there's going to be a bit of room for improvement there. Because of when they're coming out, I think you're going to see canned products rolling off sooner than glass bottle products or clear bottle products just because of timing on those consumables. So I think the launch will come out. Part of the way that we end up with an advantage is we've been using our balance sheet and our visibility and views. And so we began building our bottling plant, for example, before there was a certainty that you're going to have drinkable product, which is why it's going to be ready to make beverages in the launch window. And if you have what we think are really well thought out beverages with great brands And if they're on the shelf and available and people try them first and like them the best, this can become kind of a lifetime category. And so we feel very good about it. I did mention earlier in the call we have zones for vape filling and chocolate making that are already licensed for cannabis. They exist and have been constructed. And they built to us food grade standard that meets Health Canada criteria for controls. So I think being ready, having products early and having research is going to give us a serious shot at being globally relevant. And what others do, I guess that's what they'll do. Next question comes from Bill Papinasteshu with Canaccord. Hi, guys. Thanks for taking my call. I just had a question in regards to the top line. It looks like core cannabis revenues were down quarter over quarter. However, your direct to consumer sales were slightly up. I was wondering how should we look at this line given the Ontario market coming online? And maybe you can share some color on the magnitude of it in Q1 2020? Yes. I think these things aren't instant on off. We expect that the top line for cannabis has an opportunity to start climbing as the stores are there and they go, but it's not like a rocket ship. The rocket ship is as more and more stores open, more and more medical opportunities come, as more and more proof arrives, and as we get into Q3 fiscal for us and Q4. So just this feels like it's now on to a bit like it's picking up momentum business and building up margin business, but it's not flip switch and they both go to the top. Okay, great. That's all the questions I have for now. Thanks. Next question comes from Aaron Grey with Alliance Global Partners. Hi, thanks for the question. So I just have one quick one on the medical market. So you mentioned before that the patient count was down to about 70,000 from 83. You talked about the transition in terms of brands and I think you also mentioned some supply chain issues. So could you just kind of talk about your confidence in kind of bouncing back there? And then also what you're kind of seeing overall in the medical market and whether or not those kind of patients are being serviced just given the allocation of product that you're seeing within yourselves and other kind of peers with the medical with the adult use market now being online? Thank you. Yes. So, no, good question. I feel actually quite confident that we're going to see growth in medical. And I think it's going to happen because we had it obviously when you move brands like Tweed and Leased by Snoop out of your medical store and into the rec store that will migrate 10000 ish of our customers. But we've been putting a large push on what I'll call is onboarding patients, acquisition through clinics. And in the background, we're running these clinical trials. And I think that if we start reading data that shows that this works, a lot of people are going to jump up. And so when we just take that at a high level. And if you take our Spectrum brands, so there's been a lot of push to that. The actual Spectrum branded product is growing like it is moving up as a medically selected product. So this to me feels like do the research, do the blocking and tackling. The brand portfolio is now well established. It's going to grow is our expectation fully. Okay, great. Thanks. Good. I think we have time. 2 minutes left, if there's any others. Otherwise, thank you everyone for your time. This is another quarter, another year, and it's only a once in a lifetime opportunity that we see. So we're certainly not tracking on the Amazon model, but you see the value investing when people transform their behaviors and we're at the front of that. So thank you for it and look forward to next quarter. This concludes Canopy Growth's 4th quarter fiscal year 2019 financial results conference call. A replay of this conference call will be available until September 21, 2019, and can be accessed following the instructions provided in the company's press release issued earlier today. Thank you for attending today's call and enjoy the rest of your day. Goodbye.