Aurora Cannabis Inc. (ACB) Q3 2019 Earnings Call Transcript

Then the last two key performance indicators I want you to focus on are kilograms produced and SG&A because they really tell the story of our pathway to profitability. We doubled our production. It’s up 99% quarter over quarter to over 15,000 kilograms. The other critical key performance indicator is our SG&A, up only 1%. This is further to the commitment that we made in January that we were shifting gears and focusing on disciplined execution and cost management to ensure that that pathway to profitability comes to reality.

So, I’m happy to say that we are still tracking for positive EBITDA in this quarter. So, the snapshot here before we move on to the formal comments is industry-leading production and production efficiency, industry-leading gross margins, industry-leading product quality, yield, and no crop loss, industry-leading global footprint and unparalleled technology. In this phase of the sector’s development, I would absolutely that the number one critical success factor is the ability to produce and sell an enormous volume of cannabis and we have got that in spades.

Now, on to the formal comments. Looking back at the first three quarters of our financial year, we’re very pleased at the progress we’ve made. We’ve consistently executed on our growth and expansion strategy, resulting in continued revenue growth, while improving efficiencies and scale to drive margin improvement. We’re proud of this progress and very pleased that while many in this sector are still trying to decide how to build their cannabis business, we have already successfully built a strong and thriving business with solid fundamentals positioned as a global leader.

Let’s look at our achievements in the third quarter. Our net revenue was $65.1 million, a 20% increase over $54.2 million in the second quarter. We produced almost 16,000 kilos of cannabis, double the volume compared to the previous quarter. With Aurora Sky ramping up very successfully, our cash cost to produce per gram fell by 26% while SG&A costs were relatively flat over the same period due to disciplined cost management.

In the quarter, Aurora continued to be a solid performer in the Canadian consumer market with leading market share and high brand awareness. Our consumer revenue has continued to exceed our expectations. We achieved 37% growth compared to Q2.

While increased production was a fundamental driver of growth, I think it’s important to understand how well our products perform in terms of brand resonance. An analysis of over 6,000 reviews on lift.com conducted by a covering analyst showed how well the Aurora brands perform in this respect. Two of the tip three most highly regarded brands were ours, with all our brands in the top 11. While in an undersupplied market, the ability to produce remains key. Longer term, we know the brand strength will play a key role in capturing and keeping market share. Going by these numbers, we’re very well-positioned in the consumer market.

We are also looking forward to an improved retail infrastructure across Canada, which will further increase consumer engagement. There are still many consumers that have yet to purchase their cannabis legally. Furthermore, people who do not transact in the illegal market but are interested in cannabis appear not to be engaged because the reported shortages and the underdeveloped physical retail infrastructure.

The launch of brick and mortar stores in Ontario is a great step forward in this regard and with increasing supply, we will see a growing network of retail stores. In this respect, I’d like to mention our partner, Alcanna, who recently opened another of its beautiful Nova Cannabis dispensaries at 499 Queen Street West in Toronto — sorry for the advertisement, not really. In general, in line with what has happened in other consumer jurisdictions, a well-developed physical retail network should result in strong growth.

While we perform very well in the consumer market, medical cannabis remains a cornerstone of Aurora’s identity. In the last quarter, we undertook many initiatives to strengthen our leadership position in this segment, both nationally and internationally. Some have suggested that legalization of consumer cannabis in Canada would result in a drop-off in the number of patients buying in the medical system, as people who head to stores to self-medicate.

In our experience, nothing is further from the truth. Every day, the number of global physicians prescribing cannabis to address real medical issues, from PTSD to palliative care, is growing. Many of these patients would only seek treatment through traditional channels, such as their trusted family doctor or clinic, rather than seeking advice in a dispensary.

In addition, through the medical channel, patients can seek reimbursement for their expenses through tax reduction and increasing number of companies, including medical cannabis, in their benefits policies. So, despite the introduction of consumer legalization, we continue to experience growth in our patient numbers, up 5% this quarter to over 77,000. As of yesterday, our patient numbers in Canada have increased even further to 82,745, in line with our production acceleration toward the end of the quarter and into Q4.

Additionally, three of our brands were included in the Shoppers Drug Mart online marketplace for medical cannabis, which opened this past January. In the quarter, we also introduced product identification numbers or PINs to 78 of our medical cannabis products to make it easier for patients to apply for reimbursement under health insurance plans.

We are recognized as the leader in medical cannabis. This is not just due to the high and consistent quality of our products provided by our three medical brands, but also because as an organization, we are integrated throughout the value chain to advance medical knowledge, to support physicians and other health practitioners, and to service our patients with excellent products, customer care, and information.

To our knowledge, we have the broadest medical research program in the industry, with over 40 clinical trials and medical case studies under way and completed. This creates incredible brand strength with physicians worldwide who are still the key drivers of growth for the medical sectors.

We own Cannabis-Rx, which provides critical services to both patients and physicians looking to understand medical cannabis and its uses, we engaged with health authorities internationally, with physician networks, and with pharmacies. It is this rigor in our medical cannabis program that has enabled us to grow our presence in the medical cannabis markets, both domestically and globally.

Currently, we are present in 24 countries on five continents. This past February, we added to our European presence with the purchase of a 51% ownership interested in Gaia Pharma. Renamed Aurora Portugal, this new division has received permission from the Portuguese Health Ministry to construct an EUGMP, European Union Good Manufacturing Practices-compliant cannabis cultivation facility.

The first phase of the facility is expected to be complete in Q3 2020 and will have a capacity of 2,000 kilograms per year with a further 2,000 kilos coming on when the second phase is complete.

Another significant advancement in Europe was our win in the recent public tender competition in Germany to cultivate and distribute medical cannabis. Aurora was one of the three winners in the competition, which was judged based on the design, quality, security, and logistics of the growing facility.

On the 79 applicants, we received the highest ranking and won the maximum number of lots in the tender. The lots will allow us to provide a minimum supply of 4,000 kilograms of medical cannabis over a four-year period. We will start constructing this month and expect to ship cannabis from the facility starting October 2020.

We are very pleased with this win, which solidifies our leadership position in Germany and reflects our industry-leading facility design. This was an important scale that we developed early on with our acquisition of the facility design business Larssen in 2017.

While the quantities of the tender are very much smaller than what we anticipate the size of the German medical cannabis will grow to, it is a critical win that will strengthen our brand in the local market as well as throughout the rest of Europe. Another development strengthening our brand in Germany is the introduction of full spectrum extracts. Hereto, we’ve established early mover advantage and are developing the market.

As an aside, using the Canadian medical market as a proxy for how other international markets will develop, this provides a good indication of the scale of the opportunity we’re pursuing. In Canada, we already have over 1% of the population registered in the medical system. Translating this to the international markets in which we have very strong first and early mover advantage, it’s clear to see that very substantial additional capacity is needed. Hence, our upscaling of Aurora Sun in Medicine Hat, and the construction of Aurora Nordic in Denmark.

With scientific studies increasingly augmenting word of mouth and anecdotal evidence, we think it’s fair to assume that destigmatization of cannabis and adoption by physicians will follow an accelerated curve in comparison to Canada. Work is to be done to develop these markets obviously. For now, they remain supply restricted, but the opportunity is there and we are executing extremely well in this regard.

In terms of our production facilities, in the third quarter, both MedReleaf Bradford and Aurora Sky in Edmonton were fully licensed by Health Canada. Bradford is now fully planted and provides a production capacity of 28,000 kilos of premium hang-dry and hand-manicured cannabis. Aurora Sky is, we believe, the single most advanced cannabis cultivation facility in the world. The 800,000-square foot facility has a production capacity in excess of 100,000 kilos annually.

Sky, a massive closed system indoor facility with a glass roof deploys state of the art technology that produces cannabis of high and consistent quality while benefiting from a high degree of automation to increase efficiency. This means target production costs of less than $1.00 per gram. Sky is now fully planted and successfully ramping up to maximum capacity. The increase in production seen in Q3 over Q2 will continue with increased product availability for sale in Q4.

At Aurora Sun in Medicine Hat, our newest and most evolved Sky class facility, construction is progressing very well, with the erection of the metal structure and glass installation almost completed. The design of Aurora Sun includes a number of technology advances as compared even to Aurora Sky and will further improve our economic efficiencies. As I mentioned, we announced an upscaling of Aurora Sun in the quarter. The facility will now measure 1.6 million square feet and with Sky class efficiencies is targeted to produce over 230,000 kilograms per anum.

Sun also represents an advance in our production process, with the facility focused solely on high efficient production, with the dry cannabis shipped to other facilities for further processing. In February, we announced a new facility, Aurora Polaris, that will focus on post-harvest processing. Strategically located adjacent to Aurora Sky in Edmonton, Polaris will be EUGMP compliant and serve as our center of excellent for the production of high-margin value added product such as edibles.

Our product development team in collaboration with our market development specialist and internal market forecasters have identified those products that we anticipate will sell best and have the best margins. These projects include edibles, such as hard baked goods, chocolates, mints, as well as vape products, cosmetics, and soft gels that we will produce at Polaris. Products such as infused beverages are also under development. Considering the anticipated relatively low market share of these products, we’re not rushing this, as we’d rather get it right than get there fast, launching a product with limited market resonance.

Leveraging its proximity to the Edmonton International Airport, Polaris will also serve as a domestic and international logistics and warehousing hub. Polaris is expected to be completed by the end of thus year. In the interim, in anticipation of new regulations permitting these new products, we are installing production lines at our other license facilities to ensure that we will exceed market demand with a broad complement of products and not have the level of shortages that the industry experienced on October 17th of last year.

Polaris demonstrates the scale that we’ve achieved in our operations. We’re not a cottage industry, but rather a pharmaceutical level industrialized operation that requires complex systems to drive operational efficiencies, consistent, high-quality output, and product innovation.

You’ve heard today the advances that we’ve achieved in the consumer and medical business both domestically and internationally. Polaris will help us institutionalize our innovation and our innovation culture and maintain our global leadership.

Now, Glen will discuss the financial highlights of the third quarter. I’ll hand it over to you, Glen.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Glen Ibbott&nbsp;— Chief Financial Officer” data-reactid=”84″>Glen Ibbott — Chief Financial Officer

Thanks, Cam and good morning, everyone. Aurora’s financial performance in the third quarter of fiscal 2019 reflected our continued robust execution across all market segments, as Cam just described. Our net revenue increased to $65.1 million for the quarter compared to $54.2 million in the second quarter of fiscal 2019 and just $16.1 million in the comparative period last year.

Of this, cannabis revenue was $58.7 million, 23% sequential growth across all three market segments, driven largely by a 37% increase in consumer market cannabis sales. Underlying this growth was the increased production that Cam discussed from Aurora Sky and our Bradford facility.

Medical cannabis sales in Canada grew by 8% or $1.9 million as a result of continued growth of our patient base. As Cam indicated, we continued to support the growth of the Canadian medical market and in line with our patient first culture, have increased availability of the medication that patients need.

We continued to take the position that medical cannabis, like all prescription drugs, should not be subject to excise tax. For that reason, we continue to absorb the cost of the tax for our patients. This negatively affected our revenue in the quarter by $3 million or 5%. Extracts represented about 18% of cannabis revenue in Q3 compared to 22% last quarter. Our oil extraction facilities have been operating at a maximum capacity for the past two quarters and as a consequence, the relative contribution from extracts fell slightly as our total revenues grew.

During the quarter, we installed additional extraction capacity at some of our facilities and that capacity is now online. Furthermore, our extraction partner, Radiant Technologies, has now entered commercial operations, which we anticipate will start making a noticeable contribution from the end of Q4 onward.

Finally, installation of EnWave’s rapid low-temperature drying technology at our Aurora Sky and Sun facilities will increase speed of extraction in future quarters, taking it from a matter of weeks down to a day.

The average net selling price of cannabis decreased to $6.40 in Q3. This was partially a result of product mix as recorded a 48% increase of dried cannabis sales in the consumer market which has a lower wholesale pricing structure. The ASP was also impacted by the first full quarter of excise taxes on medical cannabis, which Aurora absorbs. And finally, and most importantly, the relative decrease in contribution to revenues from extracts impacted the average selling price as well.

Going forward with significant additional extraction capacity coming online internally as well as from Radiant, we anticipate the relative contribution from higher selling price products to increase toward the end of the current quarter.

A significant improvement in our cash cost to produce cannabis more than offset the decrease in average selling price. As Cam noted, it’s a key driver of our financial performance and the cost to produce was down $0.50 from last quarter, 26%, to $1.42 per gram in Q3. The result of increased production coming out of Sky and Bradford creating significant economies of scale was also a result of a reduction in the temporary labor that we had employed to prepare for the commencement of consumer sales in Canada.

We expect production costs to continue to go down as Aurora Sky produces at full capacity in Q4 2019 and Q1 2020 and reiterate our expectation that production cost will be well below $1.00 per gram.

So, tying all of this together, in Q3, our consolidated gross margin was 56%, up slightly from Q2 of this year. This reflected the improvement in our cash costs, offset by a lower percentage of extract sales and the increase in the consumer market sales. We expect gross margins will continue to improve as we introduce new product lines, expand our extraction capacity, and increase international sales. All of that combined with our continued improvement in production efficiency.

Cannabis production in the quarter increased by almost 100% to 15,590 kilograms, driven mainly by the ramp up in production at Sky and Bradford. Much of this production increase came toward the end of the quarter. At March 31st, we had WHIP inventory exceeding $45 million in fair value, which reflects the significant harvests during March.

A few more words on our ramp up at Sky — in order to reach the 100,000-kilogram production capacity, two parameters are critical, the frequency of harvest and the yield per harvest. I’m pleased to note the frequency is nearing our target rate. Sky is reaching a real cadence in production.

This means that we will comfortably reach the stated capacity of more than 100,000 kilograms per anum harvest rate in the first quarter of the new fiscal year. I should also note that the yield per harvest has actually been substantially above target. The average of the last ten harvests there has been more than 20% above our targeted yields.

With the successful ramp-up of Bradford and increasing production yields across our other facilities, we anticipate harvesting at a rate in excess of 150,000 kilograms per anum by the first quarter of our fiscal 2020. On a planted rooms basis, our capacity already exceeds 150,000 kilograms per anum.

For Q4, we expect to have over 25,000 kilograms of cannabis harvested and dried. With the implementation of new regulations permitting the sale of a broader portfolio of derivative products later this year, we are planning to allocate a sizable fraction of this production to inventory for further processing to ensure we’ll have a broad portfolio of new products in sufficient quantities available for sale when the higher margin products will be permissible in Canada.

Over the past several quarters, we have invested significantly in building out the talent and the infrastructure to lead the Canadian in the international cannabis industry. Now, much of that infrastructure is in place and ready to support our growth. In Q3, SG&A costs grew by 1% compared to Q2 of this year. Within SG&A, sales and marketing actually decreased 28% as the reduction in pre-cannabis spending was partially offset by higher shipping costs, which are related to our increased sales volumes, and an increase in sales representative headcount.

For G&A, while we saw 16% increase, greater than 6% of this was due to a new Health Canada cost recovery fee, which was calculated at 2.3% of sales. Q3 2019 G&A also reflected the first full quarter of ICC integration and a partial quarter of Whistler costs. Going forward, we anticipate SG&A to show increases in line with the growth of the organization, but certainly at a rate significantly lower than our anticipated revenue growth.

In Q3, 2019, our adjusted EBITDA loss decreased by 20% in the quarter to $36.6 million from the $45.5 million in Q2. I should note that we have defined adjusted EBITDA in our Q3 2019 MDNA.

Through the combination of substantial revenue growth, a decline in unit cost of production, increased availability of higher margin derivative products, increased shipments to the EU, and ongoing disciplined operating cost management, Aurora continues to track toward achieving positive EBITDA beginning in this current fiscal Q4 2019.

Our financial position remains solid. At March 31st, we had almost $350 million in accessible cash and over $70 million in accounts receivable. This compares to both $75 million in cash and $15 million of AR at June 30th, 2018. The increases are largely due to draws on the BMO-led credit facility, the issuance of senior secured notes in January 2019, and the increased level of sales in our business.

In addition, we recently completed the filing of a base shelf prospectus, an ATM supplement, a long-term strategic measure that provides the flexibility to access growth capital if or when required to provide the gas to continue executing on our global expansion and partnering strategy. We implemented this base shelf prospectus and ATM supplement as part of a prudent, maturing capital structure, a normal part of housecleaning as we filed our Q3 results.

In conclusion, I’m very proud of the team at Aurora. Kudos to all for delivering yet another strong quarter. We continue to boast stronger fundamentals each quarter, expect significant growth, and our financially healthy. We are executing our growth strategy and consequently, I believe we are very well positioned to further strengthen our position as a clear leader in the global cannabis industry. I’ll now pass the call back to Cam.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”108″>Cam Battley — Chief Corporate Officer 

Thank you, Glen. As you’ve heard today, we’ve built an extremely strong platform for growth that’s generating continued solid results. We have several initiatives in place that will drive further growth and further secure our leadership globally. Let’s look at a few.

One exciting development has been the appointment of Nelson Peltz as our strategic advisor. Nelson has a decades-long track record of building businesses and generating exceptional shareholder value and has deep experience in the consumer products business. We are working with him on multiple initiatives, including our partnership strategy. As we communicated at the time, our partnership strategy is differentiated. We do not believe that a change of control transaction at this point with so much growth still to come is in the best interest of our shareholders. Rather, we are well-positioned to explore the benefits of multiple partnerships across a variety of industry verticals.

Nelson’s experience and his connections in these areas will prove, we believe, very value in this respect. We are excited about the opportunities in the cannabis and also the hemp space globally and we continue to explore multiple opportunities with Nelson. We don’t want to put a timeline on things right now, but I want to stress that we are approaching this very strategically, methodically, and thoroughly.

One important area of attention is the US, which appears to be moving toward a more open legalization, particularly in the areas of industrial hemp and CBD. We are assessing where in the value chain we’ll be able to generate the most value. We’re well-positioned to pursue multiple angles through our deep research and product development capabilities, our regulatory expertise, as well as our extensive global hemp infrastructure, which we intend to expand through acquiring the shares in Hempco not already owned by Aurora.

CBD for both medical and wellness applications has incredible potential and we intend to fully leverage our capabilities, our infrastructure, and our partnership potential to maximize shareholder value creation.

You can also look to us to continue to build on our leadership in Europe. In addition to our entry into Portugal and our recent tender wins in Germany, we recently have been selected as the exclusive supplier to the Luxembourg Health Ministry for medical cannabis. While this is admittedly a small country, Luxembourg has demonstrated that it is an innovator in cannabis legislation within Europe.

For example, it’s the first country in the European Union to propose legislation that would allow the consumer use of cannabis. Our association with the Ministry of Health will help us be on the forefront of opportunities with them that could translate into further growth in other European countries as the market matures.

As I said off the top of the call, while many in the industry are still evaluating how best to build their cannabis business, we have built a solid and rapidly growing business that is exceptional well-positioned to capitalize on the enormous global opportunities in cannabis. In fact, we’ve built a global leader. Our fundamentals are improving rapidly and we have the know-how, the scale, the credibility, and the reach to execute.

That concludes our prepared remarks and now, I’d like to ask our operator Chris to open the call for questions.

Questions and Answers:

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”119″>Operator

Certainly. At this time, in order to ask a question, press * followed by the number 1 on your telephone keypad. Again, that’s *1. I’ll pause for just a moment to compile the Q&A roster.

Your first comes from Vivien Azer with Cowen and Company. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Viven Azer — Cowen and Company — Managing Director” data-reactid=”122″>Viven Azer — Cowen and Company — Managing Director

Hi, good morning. So, as we think about the capacity ramp and the expansion on Sun, Cam, I think it might be helpful just to revisit the rationale for laying down so much capacity, certainly in the near-term. The market is clearly very tight. One of your competitors extended their view of the supply and demand imbalance last night, saying 18 to 24 months. So, a two-part question — number one, the longer-term rationale around building out all this capacity when ultimately we will go into an oversupply situation and number two, if you can comment on your expectation on the switch to oversupply from a broader market perspective. Thanks.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”124″>Cam Battley — Chief Corporate Officer 

Sure. I’ll start this off and then maybe hand off to Terry and Glen. Looking at our view for the need for capacity, the first thing is that you’re right. The market is undersupplied in Canada. We see continued strong demand. We also were not necessarily in line with some people’s expectations as to what max capacity will be, particularly given the advent of new products as per the new regulations that will be coming out this year. So, there’s that.

The second thing is — and we’ve said this before — the central fact of the global cannabis sector is a massive excess of demand over supply. We know that we’re going to have to supply a lot of international markets with product that we’ve cultivated in Canada. So, that’s why we’re doing this.

Also, we have a massive cost advantage here. There are a lot of companies that are promising to have x-capacity available in 12 or 18 or 24 months. We’re delivering it now, but we’re also delivering it incredibly economically. So, we’re going to have massive capacity to supply the Canadian market, supply international markets. We don’t see any shortage any time soon. Terry or Glen, did you want to weigh in and add to that?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”128″>Terry Booth — Chief Executive Officer

Sure. Thanks, Cam. I think I said last quarter that if there’s one thing I lose sleep about, it’s our ability to supply the global demand for cannabis. I now lose a little bit more sleep because my 2-week old baby, but it is definitely something that is at the top of our agenda, increasing our capacity to feed the globe’s need.

It took Canada five years to meet its demand with a population of 33 million. If you put that into perspective with the EU, Australia, Mexico and other countries coming online, it would take 50 years to meet that demand, but we’re not going to take that long because of the scale we’re now able to build upon. The market is moving at a very fast pace. You’re seeing what’s happening in the United States with the Bank Safe Act, the Farm Act, the number of states that are now stepping over to medical and also taking on adult usage.

There is no doubt in my mind that the US will be legalized completely over the next three to five years, albeit at a state level. Those types of demand are there. The East Coast of the USA does not have the growth capacity at this point that the West Coast has. Add them all up. The demand will be significant for the product for many, many years to come.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Viven Azer — Cowen and Company — Managing Director” data-reactid=”132″>Viven Azer — Cowen and Company — Managing Director

That’s helpful. To follow-up — any view on when the Canadian marketplace might be able to produce enough supply to meet demand?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”134″>Cam Battley — Chief Corporate Officer 

I’ll answer that. That’s a bit of a mugs game is putting those investments out there. Anybody who tells you they know when the market will be properly supplied is probably pulling your leg. We’ve seen a lot of predictions not be correct. From our perspective, all we need to do is keep executing the way we are and that’s the way we look at it.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”136″>Operator

Your next question is from Chris Carey with Bank of America Merrill Lynch. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Christopher Carey — Bank of America Merrill Lynch — Analyst” data-reactid=”138″>Christopher Carey — Bank of America Merrill Lynch — Analyst

Hi, thanks very much. I just wanted to start off — I have a near-term question and then a more longer-term philosophical question. On the near-term, I think you said you would anticipate the 25,000 kilos that you would have available for sale would go for value-added product forms potentially later in the year. Would you anticipate growing sequentially from a kilogram sold standpoint in fiscal Q4 relative to fiscal Q3?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”140″>Cam Battley — Chief Corporate Officer 

The answer is yes. I’m going to let Glen go into more detail on this.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Glen Ibbott&nbsp;— Chief Financial Officer” data-reactid=”142″>Glen Ibbott — Chief Financial Officer

Yeah. I think what we said — we said that we would allocate a portion of that for the value add products. What we’re trying to do is learn from the challenges of the industry last year and the initial launch of consumer legalization and we absolutely have to have a sufficient inventory to launch these products properly. That means taking a little bit of revenue out of Q4 and putting it into inventory in new products, that’s what we’ll do.

The other part of this, Chris, is we have today and in the past, we are tracking EBITDA positive in Q4. There has to be a significant increase in our sales and volumes from Q3 to Q4. So, we’re going to trade those off and make sure we’re making the right decisions for the long-term future and the long-term value of the company. So, you would expect to see continued significant growth on the revenue and volume sold by Q4.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Christopher Carey — Bank of America Merrill Lynch — Analyst” data-reactid=”145″>Christopher Carey — Bank of America Merrill Lynch — Analyst

Okay. Makes sense. And then longer-term and somewhat connected to the prior question — based on what you’ve put out there, you’re going to get to roughly 400,000 kilos capacity in Canada over the next few years, potentially 40% plus-minus of the total market, but when you think about that 400,000 kilos capacity, how do you think about the evolution of the ability to use international exports as a lever if you can’t find a home for that much supply in Canada? Said another way, how quickly will some of these markets open like Europe? Even this quarter, kilos sold to Europe are still very small. How do you see that evolution over time?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”147″>Cam Battley — Chief Corporate Officer 

The first thing to remember is that Germany, for example, where most of our international medical cannabis sales have gone thus far, that market has been constrained by supply. We’re just at the point now, we’re ramping up at the point where we’ll have a lot more to sell into Europe. How quickly will these markets develop?

That’s an interesting question. We’re actually actively involved in sharing best practices with governments around the world so that we see truly accessible systems for patients and help them accelerate development. I think it will happen very fast, some markets more than others. If you look at Germany, for example, that’s a really exciting market. We talked about Canada having more than 1% of the population with a script for medical cannabis.

If we assume that’s going to happen in Europe and probably faster because most patients are getting insurance reimbursement, you’re talking about very short-term to like 850,000 patients in that one country alone. These markets are opening up so fast. I’ll recall what Terry said. Our biggest nightmare is we just want to produce more cannabis and be able to supply these opportunities.

Remember, we emphasized we’ll have about 400,000 kilograms of production in Canada. We don’t see any constraints for years and years on the ability to export. A lot of those export markets are premium-priced. Europe, for example, we get the benefits of the currency differences.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”152″>Terry Booth — Chief Executive Officer

Just to add to that, Cam — the German market is one thing. We know that’s going to start to take traction as we are able to send pharmaceutical reps around physicians and having seminars. But countries like Australia, where Cam did a great job in working with the government in cutting some red tape. It literally went from less than 500 patients last year at this time to well over 5,000 now. So, that’s a country that will be importing for some time.

They have no production facilities. Canada has had production facilities for over 15 years. So, as these countries scale up — we know the medicine is true. We believe in the medicine 100% in different product forms and different means of administration. That’s all coming online as this industry matures. This wave of cannabis required globally for medical purposes is significant and getting into these countries as first mover medically will set us up excellent for any adult usage planned with any other countries.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”155″>Cam Battley — Chief Corporate Officer 

Something that’s really important about Aurora is from the very beginning, we’ve taken an approach of emphasizing purpose-built, highly economical facilities. There are a lot of companies that are producing or trying to produce cannabis in Canada. Not everybody is able to do so economically. We’re doing so more and more so economically. So, low-cost and premium quality is a very neat trick to pull off. We’re doing that. I like where that positions us in the Canadian market as well on a go-forward basis.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Christopher Carey — Bank of America Merrill Lynch — Analyst” data-reactid=”157″>Christopher Carey — Bank of America Merrill Lynch — Analyst

Got it. Thank you very much.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”159″>Operator

Your next question is from Tammy Chen with BMO Capital. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Tammy Chen — BMO Capital Markets — Analyst” data-reactid=”161″>Tammy Chen — BMO Capital Markets — Analyst

Thanks. Hi, everyone. My first question is on this new potential accounting change, the IFRS 16, I’m just wondering — do you have a view that will have a material impact on the way you recognize your operating leases and the way that can effect the potential change in how you would report your EBITDA going forward?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Glen Ibbott&nbsp;— Chief Financial Officer” data-reactid=”163″>Glen Ibbott — Chief Financial Officer

Yeah, Tammy. Of course, I’m not sure if everybody on the call is aware, but under IFRS, there is a new standard coming out for us in the next fiscal year, Q1 2020, that will require essentially most leases to be capitalized and then amortized or depreciated over time. That will effectively move some operating costs off the P&L and into depreciation. Tammy, we own pretty much all our facilities.

We do have some lease costs for some land at the Edmonton International Airport and we do have office leases and those are likely to end up as capital assets. There will be some sort of impact to EBITDA. I don’t think it’s as significant for us as it might be for some others that are leasing a lot of their facilities. We’ll see. That analysis is ongoing. It’s a big project, as you might expect.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Tammy Chen — BMO Capital Markets — Analyst” data-reactid=”166″>Tammy Chen — BMO Capital Markets — Analyst

Okay. So, that would happen in your new fiscal year. It wouldn’t happen next quarter?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Glen Ibbott&nbsp;— Chief Financial Officer” data-reactid=”168″>Glen Ibbott — Chief Financial Officer

That’s right.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Tammy Chen — BMO Capital Markets — Analyst” data-reactid=”170″>Tammy Chen — BMO Capital Markets — Analyst

And my second question — I wanted to touch on the more near-term revenue outlook in the Canadian market. From what you’re seeing there, is there the ability to sell materially into the current distribution channels in Canada as long as you’ve got the supply or would you need to see a material ramp of new retail store openings across the country to absorb the level that you’re speaking to in the fiscal Q4 quarter?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”172″>Cam Battley — Chief Corporate Officer 

The current infrastructure everybody knows is too small. But in addition to that, there hasn’t been consistent supply. What we’ve heard from some stores is in different parts of the country is that regular consumers know the day that new inventory is delivered and they all descend on those stores at that time with great big lineups. As a result, the most in-demand products sometimes sell out in an hour or two. What that shows is even within the current infrastructure, there is not the consistency of supply of the most desired products yet.

We also know that provinces are allowing for ramp-up of brick and mortar stores. That’s great. We also know that the regulations will be in place this year to allow for the new product forms. You put that all together and we’re very confident that we’ll continue to perform exceedingly well in the consumer system and we think the consumer system will start to pick up speed and accelerate its growth.

Then also, let’s not forget the medical side. We anticipate continued demand in Canada for Aurora products and MedReleaf and CanniMed products in the medical system. The picture all together, I think, for us is very favorable.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Tammy Chen — BMO Capital Markets — Analyst” data-reactid=”176″>Tammy Chen — BMO Capital Markets — Analyst

Okay. Got it. On that consistent supply point, what sort of products are you seeing that are most in demand? How is Aurora’s product offering in comparison to that?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”178″>Cam Battley — Chief Corporate Officer 

You heard earlier in the call that our products are exceedingly highly ranked, all of them in the top 11. It’s everything from certain kinds of dried flour — connoisseurs really like certain flowers — to oils. It’s also across not just high THC, but also CBD products are very much in demand. It’s a pretty consistent picture across the board. We anticipate we’ll see the same thing for concentrates and edibles as well.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Tammy Chen — BMO Capital Markets — Analyst” data-reactid=”180″>Tammy Chen — BMO Capital Markets — Analyst

Okay. Thank you.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”182″>Operator

Your next question is from Brett Hundley with Seaport Global. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Luke Perda — Seaport Global Securities — Analyst” data-reactid=”184″>Luke Perda — Seaport Global Securities — Analyst

Hi, this is Luke Perda on for Brett Hundley. First question — as we approach the legalization of value-added products inside Canada later this year, there seems to be an overwhelming focus on the beverage side of the market as you’ve noted, in part given the strategic partners that are in place for a number of the Canadian LPs. It’s interesting because if you look at certain parts of the US market, beverages have lagged behind considerably relative to vapes.

Part of this is because the American beverage products don’t have the R&D and marketing support that we presume Canadian beverage products will have, but we’re also wondering if common consumer desires are being overlooked here and whether or not the Canadian LPs and their partners are trying to force a square peg into a round hole. Can you talk a bit about your own views on how the value-added product market might develop inside Canada and what kind of opportunity you see on the vape side?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”187″>Cam Battley — Chief Corporate Officer 

Yes. I’ll start and then I’d like to hear from Terry on this as well. I don’t want to be too much of a negative on beverages. It’s just that we’ve made what we think is a pretty rational decision to focus our priorities in terms of the new product forms in areas where we know that there’s strong demand, in part based on the model that we’ve seen in the US consumer legal state and where we believe that we can deliver something that’s highly differentiated and good for consumers and also where we think that we can generate the highest margins.

Now, we said before with respect to beverages, that may turn out to be a great market segment. It’s not yet in the US consumer legal states. As you point out, it’s something like 2% or under of the market. There are some good products out there that are well-formulated. It’s just that perhaps it’s going to take a little bit of time and some marketing and some experience to change consumer tastes, whereas as you noted, vapes, vape pens are exceedingly popular and have rapid and high uptake.

We think that’s going to be a terrific market segment that doesn’t need a lot of market development that will be pretty much ready-made. They’re so discreet. You can stick them in your pocket, your purse. They don’t create smell, just a little bit of vapor. I think that will be very attractive to new consumers who just want to try it out. What’s all the fuss about? Let me try one of these vapes.

So, we’re focusing on what we think will be the best sectors or market segments for us but with the highest margin and where the demand is already clear.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”192″>Terry Booth — Chief Executive Officer

The proven market is certainly not in beverage. There are some players in the United States. Heineken, for example, did have some brands in California. It’s a very different effect when you drink an intoxicating cannabis beverage. It’s not like alcohol. It doesn’t lead to another and another. It’s actually the more you have, the less you want in a very short amount of time once it starts taking effect. It also has the potential if it doesn’t have the rapid onset to have adverse effects over time.

There are not going to be any cannabis bars like there are alcohol bars anytime soon. You mentioned marketing in Canada. That’s still not allowed and it won’t be allowed for beverages either. The gummies and the vapes, they’re the best sellers. They’re the best margins in the states. If we’re leaning toward any beverage, it would be on the wellness side, which we think there’s tremendous market potential there.

On the intoxication side of the fence with respect to cannabis drinks, the market is just not there and it’s not proven to be a popular item anywhere. It’s not able to market like typical beer companies or booze companies are allowed to market. So, it’s a small step for us. Certainly, we’re going to be focused on what we feel sells best and provides the best margin.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Luke Perda — Seaport Global Securities — Analyst” data-reactid=”196″>Luke Perda — Seaport Global Securities — Analyst

Thank you. Just one more for me — you’ve gone out and purchased Whistler. You also have an investment in TGOD. It seems that you really believe in the forward market opportunity for organic cannabis. Do you see Aurora becoming a big player on this side of the market and can you talk about the forward market opportunity overall in your view?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”198″>Cam Battley — Chief Corporate Officer 

I’ll start and then pass this to Terry. We see it obviously as a part of the picture. So, yes, there’s going to be a segment of the market of consumers and patients who prefer an organic product. It’s not necessarily the be all and end all. Organic has advantages and disadvantages. It’s just another piece of the market to us. Terry?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”200″>Terry Booth — Chief Executive Officer

Yeah. The organic market in cannabis is a popular one, as is the organic market in hemp. We have the largest organic producer of hemp under our wing now in Lithuania, Agropro and Borela. So, we know that there continues to be a move toward organic products in the cannabis space and Whistler has the very best for sure in the Canadian license producer space. We’ll wait and see how TGOD executes on growing organic at scale. It is a difficult thing to do. We wish them the best of luck. We do still have a right to 20% of their production supply.

Where you run into some problems with organic is microbial. You have to watch the dirt very close. It’s a growing and living breeding minimum that if it gets out of control even a little bit you can have crop loss. Whistler has been doing it for five years. They’ve eliminated crop loss over the years completely and know what they’re doing with respect to organic.

It also demands the highest price. They’ve done a tremendous job with the provinces and maintaining they’re not going to drop the prices of their cannabis and if you don’t want it, you don’t have to take it, but it flies off the shelf before everything else. That will continue to increase organic supply if indeed organics are the way to go.

On the food and beverage side, on the edibles, I think that may be even a bigger picture for organic cannabis making organic edibles, sugar-free edibles. I think the organic supply of cannabis is an important piece of the puzzle and it’s just a matter of if we can grow it at scale, much like the organic vegetable market.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”205″>Cam Battley — Chief Corporate Officer 

You’ve heard me say before that on important strategic questions, we like to measure twice and cut once. As Terry indicated, if we find there’s an increasing appetite for organic cannabis products, we’ll be there. But we don’t want to over-commit to that until we see the demand is there. We think it’s a prudent way to operate.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”207″>Operator

Your next question is from Michael Lavery with Piper Jaffray. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Michael Lavery — Piper Jaffray — Analyst” data-reactid=”209″>Michael Lavery — Piper Jaffray — Analyst

I just wanted to touch on the US. You expect legalization federally in a few years like roughly everybody. Can you give us a sense of how you envision entering the market and would I be hearing you right that some of the capacity you already have planned would be available for export to the US and if that’s the case, what would be needed from a regulatory perspective to allow for that?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”211″>Cam Battley — Chief Corporate Officer 

The first thing I want to do here is emphasize that we are not making any news on that point today. Then I want to reiterate what we said before — we obviously will be in the US and we’ll be in the US in a big way at some point in the future. It will always be in a way that is consistent with US federal law. We will enter when it is permissible on a federal level in the US. There are some ways to enter earlier. We’ll also do this in a way that is consistent with the requirements of our exchanges. But Terry I know wants to speak to this.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”213″>Terry Booth — Chief Executive Officer

Sure. The US is an interesting country, to say the least, with respect to cannabis. The states all have much different regulation, varying regulation from state to state. I feel Nevada is probably the best state for Canadian companies to enter into. The regulatory changes that are forthcoming, we don’t know what they’ll look like. If they don’t erase the state to state line in the cannabis space, once legalized, then it’s a very difficult market to operate at scale in.

Right now, they have multiple state operators, multi-state operators that have small facilities in their various states. That’s not really the Aurora way of doing things. If we do go to the states, we’ll be focusing on large populations that are not fully established that we’re able to operate with profit.

If they erase the state lines, that changes. If you’re able to cross the state lines, then it becomes a massive cannabis market. As far as the export into the states, again, we don’t know when that will happen. We’re allowed to export to a number of countries now. I don’t know why we wouldn’t be allowed to export to the United States. The demand will certainly be there if indeed we’re allowed to export. We look forward to getting that going sooner rather than later.

The hemp industry in the United States, the Farm Act, allows for CBD derived from hemp with 0.00 THC. That’s a limited market at this point, as it only includes topicals, if you really want to go to the letter of the law of federal legislation. The FDA is looking at ingestible CBDs. Yes, I know, many states already sell it. They’re selling it is federally illegal as the states that have legal cannabis selling statewide are selling federally legal. It is something we have to figure very, very closely.

You have to understand Aurora is not being blind to what’s going on in the United States. [Inaudible] is doing well for a start-up company. It’s done four or five deals. It’s our little brother. We have back end rights and more to come on that later. It’s something we feel very confident as do most that it will be legalized. It’s how it’s legalized is the question. Is it going to be legalized medically state to state or adult usage state to state all at once? Nobody knows. I don’t think the government knows. That’s a ways away. One step at a time and we are taking the steps necessarily to do that in an organized fashion. As Cam said, measure twice, cut once.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Michael Lavery — Piper Jaffray — Analyst” data-reactid=”219″>Michael Lavery — Piper Jaffray — Analyst

Just to follow-up on the flip side of the question — to what extent do you have any of your capacity plans even sort of vaguely earmarked for the US and have the opportunity to export there, would you have to rethink a little bit how that gets put to use?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”221″>Terry Booth — Chief Executive Officer

Again, we don’t know. That’s not in our capacity plans at this point. We have a strategy of entering into the US. That strategy is obviously confidential. I would expect if we have an over-capacity in Canada and the rest of the world, we would love to ship to the US, but I don’t think we’ll have that capacity depending upon the timing. Even if they announced they’re going to have a legal system, it would take years to get the regulations in place and proper capacity in place.

Valuing these MSOs based on their retail doors is, in my opinion, a mistake because states can always open the door to more retail. We’re seeing that in Canada. We’re seeing the value of the retail stores that had gotten lottery wins drop significantly. We’re quite happy we didn’t jump into that fray. Does that answer your question? We don’t have any plans to export anything into the United States. It’s not our future yet.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”224″>Cam Battley — Chief Corporate Officer 

I think that’s the key point. If I understood you correctly, you asked if we’re counting on supplying the US from Canada. Absolutely not — we have not built that into our plans. The other thing to emphasize is once the opportunity exists to build production in the US for us, we build the best cannabis production facilities in the world.

I think we’ve demonstrated that with the highest efficiency, use of automation and technology that nobody else has been able to touch and the result of it is premium product at a real economical cost. So, once the opportunity exists, you can expect that we’re going to be looking at using our technology lead to build that capacity ourselves in countries around the world.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”227″>Operator

Your next question is from Jason Zandberg with PI Financial. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Jason Zandberg — PI Financial — Analyst” data-reactid=”229″>Jason Zandberg — PI Financial — Analyst

Hey, guys. I wanted to drill down a little bit on your medical cannabis sales. As an industry, we’re starting to see medical sales decline and that’s typical in other regions that have adopted an adult use program that medical sales tended to trail off a little bit. You guys have seen a growth in your medical — not a huge number, but growth. What do you attribute that to? Is it your coverage of the excise tax? Is it providing product identification numbers? Can you give your opinion as to why you’re bucking that trend?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”231″>Cam Battley — Chief Corporate Officer 

It starts with the fact that we make great medical cannabis and everyone knows it. It only increased about 5% in terms of patient count in the last quarter, 8% increase in Canadian medical cannabis revenue sequentially. But let me emphasize — that was our choosing. We wanted to make sure we had exactly the right product allocation for each of our distribution channels, Canadian medical, Canadian consumer, and international medical. So, we actually could have turned on the taps and brought in more patients.

I’m not kidding when I say we produce great medical cannabis product. We also have an extremely good reputation across all of our brands, Aurora, MedReleaf, and CanniMed among physicians. So, our credibility, supported by our clinical program, in the medical community is outstanding.

Let’s get to where medical can go in Canada. Obviously, for us, we see increased demand and increased patient counts and increased Canadian medical cannabis sales, which is great because medical cannabis patients tend to be sticky. Consumers, you never know, but with a medical patient, they’re likely to stay with you as long as you keep them happy.

The other thing that would be a wild card to keep your eyes on would be the possibility that the excise tax, which, as you point out, we’ve been absorbing for our patients, could be eliminated. I’ll remind everybody that we had a press conference not that long ago in Ottawa along with a patient advocacy group called Canadians for Fair Access to Medical Marijuana. Also, on the stage with us were members of parliament from the conservatives, the liberals, and the New Democratic Party and there is strong support in all three caucuses to start to treat medical cannabis the same as other prescription medicines.

If we get that excise tax and ultimately the GSD and HSD removed from medical cannabis, it will be, first of all, justice, but it will also be an appropriate reason for patients to stay in the medical system. Before we stop on this point, I want to emphasize that patients who are using medical cannabis to manage the symptoms of a chronic health condition should be getting their medication by prescription and consulting with their physician. Physicians and pharmacists should know about all of the medications that patients are consuming. There are good reasons for patients to patient and certainly good reasons for patients to come to Aurora.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Jason Zandberg — PI Financial — Analyst” data-reactid=”237″>Jason Zandberg — PI Financial — Analyst

That’s a great answer. Looking forward in upcoming quarters, would you expect to see that trend continue in terms of continued growth on your medical cannabis? Obviously, the rec market will continue to grow, but do you expect that to happen continually with your medical sales?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”239″>Cam Battley — Chief Corporate Officer 

I don’t want to predict the whole market, although I think it will be good. On an Aurora basis, we expect our patient count and Canadian medical cannabis revenue to continue to grow.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”241″>Terry Booth — Chief Executive Officer

Was your question global or a Canadian question? The other 22 countries we’re operating in do not have [inaudible] systems and those medical systems are just starting out.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Jason Zandberg — PI Financial — Analyst” data-reactid=”243″>Jason Zandberg — PI Financial — Analyst

Yeah, I was referring to the Canadian market.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”245″>Terry Booth — Chief Executive Officer

I understand the question because we’ve seen differential results across different companies in the sector. But we’ve always emphasized medical cannabis. We supported that with a great clinical program. We are really, really good to our patients as customers and so yes, we do anticipate continued growth on the Canadian medical side.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”247″>Operator

Your next question is from John Chu with Desjardins Capital Markets. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="John Chu — Desjardins Capital Markets — Analyst” data-reactid=”249″>John Chu — Desjardins Capital Markets — Analyst

Good morning. Maybe just a quick question on Europe and how you plan to allocate your increased production between Europe and the value-added market. How would you try to prioritize the two and maybe just talk about the margins you get? Which ones are higher?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”251″>Cam Battley — Chief Corporate Officer 

Sure. Let me start and I know Terry will want to weigh in on this. Let me start by telling you how much we love Europe. Europe is a market where there is very little competition. There’s only one producer in Europe right now and it actually is one of eight that are EU GMP-certified. Of the remaining EU GMP-certified facilities, we’ve got two, two out of seven. We’re undergoing audits right now to add additional facilities, so very limited competition. It’s a supply constrained market and we are really ramping up now to be able to supply that market.

The bigger picture here is a question of product allocation. We’ve developed a very sophisticated product allocation protocol and team that we’re very proud of that works on demand planning so we know where the demand is going to be and helps us calculate where we’re going to generate the highest margin.

It’s no secret the Canadian consumer system is a lower margin distribution channel for us than Canadian medical and international medical. The margins in Germany, for example, are extremely good, in part because of currency differences, but not completely. You will see us allocating more of our product to Europe and other jurisdictions around the world as those markets open up. We’re going to be a big part of that by removing supply constraints. We make a constant series of decisions with respect to product allocation.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”255″>Terry Booth — Chief Executive Officer

The product allocation team, I’ve felt sorry for them for the last year because we didn’t have the products to allocate. We’re starting to have that product allocate. In the Canadian consumer usage market, it is lower. The provinces underestimated the demand. We underestimated the demand and it continues to go up. We don’t know what the demand is until it’s met.

The European market — we have boots on the ground now in Italy, Germany, Malta, Portugal, the UK, Netherlands. These are not small contracts or pieces of companies. We distribute cannabis ourselves. Getting that contract, only three LPs of the 79 applicants were awarded that contract. The demand in that contract is going to go up. The first movers that successfully execute will have first crack at the expansion of facilities. That’s when the dirt will hit the road. The fall of 2020 — I lose sleep over being able to supply this global market.

The European market is going to go nowhere but up. We’ll start shipping in bulk to Europe before too long. We’re the first to sell high-value derivatives in Germany, which are now starting to get some traction with the doctors. We are going to educate the entire EU the best we can with our team of physicians and PhDs and thought leaders in the cannabis space. It’s waiting to be cracked. It’s not scratched the surface in Europe. They still will take whatever we can give them.

We have to take care of our medical patients in Canada and we have to have a presence in the adult usage market in Canada. We’re Canadians. It’s Canadian medical patients first, European patients second, and it’s the adult usage market third. But we will dominate in the adult usage market as well because of the quality of cannabis that we grow, the cost per gram of cannabis that we have, and because the increased capacity we continue to bring online.

Everybody remember, we are building a Sky class facility in Denmark as we speak. We are growing cannabis in Denmark quite well in our phase one of Aurora Nordic. Once we can start supplying Europe from there, it will help with our international initiatives.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”261″>Cam Battley — Chief Corporate Officer 

In terms of helping you understand another reason we love Europe so much, that’s a population including the UK of 500 million. It’s larger than the US. But in the US, with its patchwork regulatory system, there are thousands of producers, in Europe, there’s one and us and a handful of other Canadian companies with high barriers to entry because they believe in tight regulation. We’ll be in the US, obviously, as soon as that’s permissible. We’re also prepared to operate in two very different markets. The US and Europe appear to be very, very different. So, we want to be set up to succeed and win in Europe. We’re already building the infrastructure for that right now. We’re very pleased with the direction Europe is going.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="John Chu — Desjardins Capital Markets — Analyst” data-reactid=”263″>John Chu — Desjardins Capital Markets — Analyst

Maybe just a quick update on EnWave — when do you think that’s going to get integrated and make a meaningful impact. Finally, on the Radient — you received your first shipment, are you happy with what you got? When can we see a more meaningful impact?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”265″>Cam Battley — Chief Corporate Officer 

Glen, we haven’t heard from you in a bit. Do you want to address that one?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Glen Ibbott&nbsp;— Chief Financial Officer” data-reactid=”267″>Glen Ibbott — Chief Financial Officer

So, Radient has just been recently licensed and we’ve received our first commercial batch back from them, still relatively small volumes. We expect to see that actually impacting our ability to produce derivative products toward the end of this quarter. So, we’re in the last six weeks now. So, June, we’ll start to see some of our product making it into our production chain. Most of that extraction goes into products that take time to show up on the shelf toward the end of the quarter. EnWave will shorten the drying time, allow us to speed of extraction, which does accelerate our capacity still being implemented. We won’t see that in Q4.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”269″>Terry Booth — Chief Executive Officer

The other point I’ll add with EnWave is they also reduce the risk of crop failure or production failure with a very short timeframe. There is risk in drying systems where molds can come in and more people are around it. When you shorten that time, it de-risks the process of the production of cannabis.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”271″>Cam Battley — Chief Corporate Officer 

We haven’t had that problem, but we know it exists. What we’ve just talked about here — you’ve got two great examples, RTI and EnWave — those are really consistent with our overall business strategy, which is to reduce all risks as much as possible and also to accelerate the entire process from cultivation through to production, getting it to market. That is consistently across the board our strategy. So, you picked two really good ones to focus on. They are entirely in line with our global strategy.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”273″>Operator

Your next question is from Doug Miehm with RBC Capital Markets. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Doug Miehm — RBC Capital Markets — Analyst” data-reactid=”275″>Doug Miehm — RBC Capital Markets — Analyst

Good morning. With respect to how we’re thinking about the Q4, I know you’ve indicated you’re going to show some positive EBITDA, how important is it you do that? Is it more important you have enough product for the value-add launch or is what you’re going to do for producing that EBITDA in Q4 the most important thing? Then with respect to the recent acquisitions, Whistler, HempCo, and Chemi, are they contributing to you guys having positive EBITDA in Q4?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”277″>Cam Battley — Chief Corporate Officer 

So, actually, I would say one of the most important things we did when we put out that guidance in January that we were targeting positive EBITDA in the June quarter was we signaled our discipline. If you look at our revenue growth compared to SG&A growth, it’s showing we’ve been focusing on that disciplined execution. Setting that target on its own has been remarkably beneficial to us. We’ve been getting that feedback from institutions as well.

It is important to differentiate by showing a clear path to profitability. It’s something that we’ve made a commitment to that differentiates us from a lot of peers. So, it is very important to us. The nice thing is with where our production has gone, we can kind of have our cake and eat it too. We can continue to attract toward positive EBTIDA in this current quarter and have sufficient product supply to have the inventory to produce those new higher value-added products that will be allowed by regulation. It’s a great, great situation to be in and it’s happing at exactly the right time for us.

The second question you had was with respect to the recent acquisitions and whether they’re expected to contribute to achieving positive EBITDA. I’ll defer to Glen on that but not substantially. We were tracking that way before these. Glen?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Glen Ibbott&nbsp;— Chief Financial Officer” data-reactid=”281″>Glen Ibbott — Chief Financial Officer

The first part of your question — they’re not running negative. They’re running positive. They’ll contribute but not substantially, as Cam said. We based our EBTIDA positive forecast on our core cannabis business. We do have this quarter about $6.5 million of revenue from other business lines that are non-core cannabis and they do contribute at least a 50% or greater margin on average. That will help, but we’re really trying to drive the discipline and the growth in the core cannabis piece of this.

The allocation decision, there are some really healthy debates internally, but as you would expect, a lot of this is dependent on when Health Canada is going to allow the introduction of these new products into the market. You see various signals at times from the regulators as to when LPs will actually be able to start shipping products.

So, should that happen toward the end of the year, should we get clarity that those sales won’t start toward the end of the calendar year, we may have more product to allocate into revenue in Q4 and Q1. Should it be available earlier, then we’ll have some decisions to make. How much of that goes into inventory as opposed to revenue? As Cam said, at least we’ve got the production coming to make those decisions.

The EBITDA piece is very important to us, not only because of the commitments we’ve made to the markets but also as internal guidance to our priorities. We still have a focus on the long-term value we’re creating and it’s very important to launch properly into those product segments we want to capture toward the end of the year.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Doug Miehm — RBC Capital Markets — Analyst” data-reactid=”286″>Doug Miehm — RBC Capital Markets — Analyst

Then just my follow-up question — Cam, with respect to the capabilities you’re putting in place outside of Aurora Polaris in anticipation of the launch of the value-add product, could you give us a little bit more detail? As I think about this marketplace and the problems that we observed in Q4 of 2018, I just want to make sure you guys are following the proper steps to ensure you’re going to have products.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”288″>Cam Battley — Chief Corporate Officer 

So, you asked for a little bit more detail. We can give you a little bit, not a lot. What I can tell you is that all of the capabilities for the market segments that we prioritize, it’s all in place. As Glen indicated in his comments, we wanted to make sure that from an Aurora perspective, we won’t be seeing some of the challenges that the entire industry faced not being ready for consumer legalization in October of last year.

We have across multiple facilities, we’ve got the capabilities in place to produce those products. Polaris is going to be amazing. It will be world class and there will be nothing like it once it’s opened up. We do not need to wait for it to be online for us to deliver those product forms.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”291″>Operator

Your next question comes from Rob Wertheimer with Melius Research. Your line is open.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Rob Wertheimer — Melius Research — Analyst” data-reactid=”293″>Rob Wertheimer — Melius Research — Analyst

Hi, everybody. Your production ramp has been impressive so far with no real material hiccups and stumbles and so forth. The question is a little bit, if you can give us anymore background on how you do it, but other people in the industry have had crop failures and the product hasn’t grown as well as yours. How to evaluate the risk of that? Do you see little issues pop up and quickly mitigate them and fix them so there’s no risk of a larger issue? I wonder if you can just expand on that a bit.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”295″>Cam Battley — Chief Corporate Officer 

I really want to speak to this. I’m going to start by making Terry blush. The first and greatest credit for this is Terry’s vision. Terry went in a different direction from every other founder and CEO in this sector when he decided that cannabis production should be purpose-built. North of Calgary, our mountain facility, that’s the first purpose-built cannabis production facility in the world, to our knowledge.

What that does is give you GMP standard, everything from the cultivation rooms to the airflow inside and the ability to manage all of the environmental variables — the lighting, temperature, humidity, CO2, nutrients. Every other peer of ours that is producing at mass scale has done something different as we’ve all scaled up. Whereas we’ve gone with these massive indoor facilities with a glass roof, all of our peers producing at mass scale are doing it in retrofitted greenhouses.

You can argue there are advantages and disadvantages to each approach. We like our approach because as you heard me say earlier, at this phase in the sector’s development, the number one critical success factor is the ability to consistently produce and move and sell a large amount of cannabis. Our entire business strategy is set up to do exactly that. You control the environment, that reduces the risk of pathogens and pests and therefore crop loss. Touch wood, we’ve never had a crop loss and I hope we never do.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”299″>Terry Booth — Chief Executive Officer

You nailed it on the head. To most respects, environmental control — CO2, micro mold, humidity temperature, all of those factors in and you have to stay within a certain band or you will lose control of your facility. One thing affects the other. With a typical greenhouse, you have environmental risks, with the roofs opening to cool them down. You have risks with the variable temperatures, raining or snowing or hot and sunny. So, environmental control is a very, very difficult thing to do right.

Secondly, you mentioned automation and you nailed it on the head a bit there because automation takes the human out of the picture with direct contact to the plants. That is one of your highest risks of disease are the human beings. The last one is GMP. GMP is the direction of the product flow. You never go backwards. You never go from a dirty room to a clean room. It’s a pharmaceutical process. It’s highly repetitive and recognized in the pharma industry. Those three factors along with the top QH team in the world and some very experienced horticulturists and growers equate to no crop loss.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”302″>Cam Battley — Chief Corporate Officer 

By the way, before we wrap up, we truly believe we’ve invented 21st Century cannabis cultivation and we also believe — this is central to our business strategy — that you have to do that if you want to build a global enterprise. You’ve got to add that consistency. You’ve got to mitigate risk. You’ve got to do it economically. It’s got to be scalable and replicable on a global basis. That’s what we set out to do from the beginning. Now, at Aurora Sky, we think we’ve validated that Sky class concept to do exactly what we’ve planned to do from the beginning.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”304″>Operator

This concludes the Q&A portion of today’s call. I will now turn things back to Cam Battley for closing remarks.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”306″>Cam Battley — Chief Corporate Officer 

I want to thank everybody for joining us for the call. Obviously, we’re really looking forward to the next one as well for our year end. Take care and everybody have a great rest of the day.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Operator” data-reactid=”308″>Operator

This concludes today’s conference call. You may now disconnect.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Duration: 90 minutes” data-reactid=”310″>Duration: 90 minutes

Call participants:

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cam Battley — Chief Corporate Officer&nbsp;” data-reactid=”312″>Cam Battley — Chief Corporate Officer 

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terry Booth — Chief Executive Officer” data-reactid=”313″>Terry Booth — Chief Executive Officer

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Glen Ibbott&nbsp;— Chief Financial Officer” data-reactid=”314″>Glen Ibbott — Chief Financial Officer

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Viven Azer — Cowen and Company — Managing Director” data-reactid=”315″>Viven Azer — Cowen and Company — Managing Director

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Christopher Carey — Bank of America Merrill Lynch — Analyst” data-reactid=”316″>Christopher Carey — Bank of America Merrill Lynch — Analyst

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Tammy Chen — BMO Capital Markets — Analyst” data-reactid=”317″>Tammy Chen — BMO Capital Markets — Analyst

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Luke Perda — Seaport Global Securities — Analyst” data-reactid=”318″>Luke Perda — Seaport Global Securities — Analyst

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Michael Lavery — Piper Jaffray — Analyst” data-reactid=”319″>Michael Lavery — Piper Jaffray — Analyst

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Jason Zandberg — PI Financial — Analyst” data-reactid=”320″>Jason Zandberg — PI Financial — Analyst

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="John Chu — Desjardins Capital Markets — Analyst” data-reactid=”321″>John Chu — Desjardins Capital Markets — Analyst

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Doug Miehm — RBC Capital Markets — Analyst” data-reactid=”322″>Doug Miehm — RBC Capital Markets — Analyst

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Rob Wertheimer — Melius Research — Analyst” data-reactid=”323″>Rob Wertheimer — Melius Research — Analyst

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="More ACB analysis” data-reactid=”324″>More ACB analysis

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="All earnings call transcripts” data-reactid=”325″>All earnings call transcripts

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