Q2 2020 Earnings Call
Team under this release announcing its financial results for the second quarter fiscal 2020 ended September Thirtyth 2019th. This news release is available on cannot be girls sweat fight and has been filed on SEDAR.
On the call. This morning, we have mark the cooling canopy girls, Chief <unk>, Chief Executive Officer, Mike Leigh cannot be growth executive Vice President and Chief Financial Officer, and ready Kovacevich cannot be girls president.
At this time all participants are in listen only mode certain matters discussed in todays conference call or answers that maybe given to questions asked could constitute forward looking statements actual results could differ materially from those anticipated risk factors that could affect results are detailed in the coffee that annual information form another public filings that are made available on SEDAR.
During this conference call kind of P. growth refer to supplemental non-GAAP measure adjusted EBITDA. These measures do not have any standardized meaning prescribed by our FRS adjusted EBITDA as defined in the press release issued this morning, as well and that's what was in this period management's discussion and analyst document filed on SEDAR. Please note that all financial.
Formation is provided in Canadian dollars unless otherwise specified.
<unk> prepared remarks by Mr. Colin it Mr leaves the company will conduct a question answer session Dream wish questions will be taken from analysts if you'd like to ask a question. Please press star one on your telephone keypad.
I'd now like to turn the meeting over to Mr.. It's a cooling it's just the cooling. Please go ahead.
Thank you Gerry and good morning, everyone. Thanks for joining us so a little bit of Oh, I guess housekeeping before we start or you know last last quarter. We I guess I took the time to I have a well likely introduction to go over our strategy.
Ill remind people what it wasn't had confirmed yeah. We're thing thing to do it so.
I I give you my word we won't do the same likely a summary, this time, Mike and I between US, we'll we'll stick to probably under half an hour loyalty partner for questions and then though what it but to get back to the date.
Second thing just to let you know there are four slides that we have put up on our website.
Which speaks to <unk>.
As a complicated quarter, we decide to put information down on paper about you adjusted EBITDA inventory levels working up to normalized margin. So those are there Mike will use though does he speaks a little bit later on.
With that said.
You know I think it it's fair to say, it's been a challenging couple of quarters in the Cabot sector.
So I would like to first address that head on.
Second speak to what we as a company have done this quarter to adjust some of the short term challenges.
And third reinforced our view that over the medium term and despite the current climate, we feel exceptionally bullish on how can it be it's set up to win.
Diversity the big picture.
To be clear there is still an emerging global Kansas opportunity, where hundreds of billions of dollars across medical pharmaceutical CBD and recreational campus.
However, we know the bellwether remains what is happening in the Canadian recreational market.
The first national but really legal large scale market opportunity for the sector execute upon.
And the market opportunity today, it's simply not living up to.
Your expectations.
And the risk of over simplifying the inability of the Ontario government to license retail stores right off the bat has resulted in half of the expected market in Canada simply not existing.
Ontario represents 40% of the country's population has one retail can distort per 600000 people.
When one year end of the market the addressable market is nearly half.
What is expected there's going to be meaningful short term problems.
So as a company we're pleased to see the recent announcements that Ontario has made a commitment to move towards an open allocation of retail licenses with a number of stores will only be limited by market Tibet <unk>.
This is a big deal, but it cannot come soon enough.
There is sufficient supply for an orderly store rollout to happen now as it did numbered over the past year and until this happened the canvas sector cannot reach its fulfilled potential it cannot convert consumers from the elicit market into the legal market.
Having said that the stores will open.
Canvas to boil product launches will come.
And the size of price will still materialize for canopy, because we have to strike resources and build out whether the short term store.
We've said it before we'll say it again this is and always has been.
Long term game and there was no company better position to when it today then Kennedy.
So store decide let's look a bit closer at the first your Canadian recreational candidates and can be performance this past quarter.
Got it be continues to hold the strongest marketshare and the Canadian recreational market.
It's still over one in every $4 spend at the tail being spent on academy product in our estimation.
Kathy is number one of the killing Ontario number one in Nova Scotia number one and P.I. and number one in Alberta the countries most adult market out over a 35% marketshare.
They go back and your number two only behind Ekso.
Our products are performing customer affinity is growing and we're consistently delivering our flower oil in soft gel product to market.
And we have the inventory and breadth of few variety to maintain increase that share at the market grows.
No I just been covered by many of you on this call we have witnessed the slowdown by potential buyers and the recreational channel that's the rightsized their own inventory level after significant inventory accumulation.
Despite this headwind.
Solid product image right helped drive strong shipments of dry flower and people join across our Canadian recreation channel in the last half of the second quarter.
This health can be end of quarter with dry bulk shipments up 12% quarter over quarter.
Signaling that Canadian and consumer demand for recreational canvas is growing.
Those revenue from cannot be owned same store retail sales grew 17% in the second quarter.
Accounting for same store sales as well as the opening of additional stores.
Gross revenue from recreational canvas retail sales increased by 24% to $13.1 billion.
Additionally, gross revenues before accounting for a return to provision increased sequentially by 6% to $118.3 million across the company.
So considering the challenging dynamics that have existed in Canada. We are pleased overall with how the second quarter unfolded.
However, detracting from these successes.
After a detailed business review, we have concluded that it is appropriate to reflect returns turn provision and inventory adjustments, which Mike will expand upon later.
Management believes that these are extraordinary measures, but now taken will not occur again and that inventory and production levels across all products are now with an appropriate range as we look ahead to future quarters.
Obviously, these abnormal restructuring items, how distorting impact on our gross margin to the tune of $40.4 million.
<unk> for more specifics related to the charges against gross margin later in the call.
Using those handy cheeks, we talked about.
Jumping ahead to the medium term.
We're also very excited for the launch of cannabis 2.0 products, which we believe will further differentiate our offering and bring new customers into the market.
Many years investments in market research product development and product marketing has prepared but we believe will be the highest quality most differentiated they beverage and edible products available on the market.
On October 29, we hosted a media that during which media toured our chocolate in beverage production facilities were introduced to our distilled Kansas concept and the given the opportunity to take not diversion of beverages and chocolate products that we plan to bring to market.
The beverages will range from spirit alternative products to ready to drink Tweed branded beverages, refreshing sparkling waters and citrus favorite beverages.
Over the coming month, we will conduct various trade shows the retailers stakeholders across the country to familiarize seminar offering and will also revealed our vapor product portfolio at that time.
All of our extraction evaluate facilities are fully license and ready to go with the exception of our Babbage facility, which we hope to have licensed by Health, Canada Imminently.
Well I have focused thus far on the dynamics of the Canadian recreational Kansas market. It is important to recognize that the global medical cannabis and cannabinoid markets. Our car core part of our business and are all performing strongly.
Our Canadian medical canvas business grew 8% last quarter, while our international medical canvas business grew by 72%.
Combined total organic global sales and our medical business was up an impressive 23%.
And notably oil and soft gel now represent over 50% of our global medical business.
We continue to focus internationally on physician education at international markets expand.
And accredited physician Education program is now lots in Australia, where the market continues to grow at a rapid rate.
In Europe , our Danish greenhouse has received GMP certification and we expect that facility to serve our European production need by fiscal Q1 2021.
And then I forgot we've now completed our first sale spectrum products in South Africa.
These first sales are always the most complex and they test logistics system and bureaucracies, new to can't Miss laying framework for greater sales overtime.
We're also focused on launching CBD sales in South Africa in the coming months.
In the United States I focus on the CBD market opportunity has continued this past quarter.
As you May recall, we made significant investments and you attempt cultivation. This past season, I think thousands of acres of have largely by a contract with American farmers.
The harvest of our 2019 have crop is nearing completion and we're pleased with the overall yields and crop quality.
This harvest puts canopy and a strong position to meet anticipated high growth of consumer demand for CBD in the U.S. and abroad.
As our large scale Canadian construction projects are coming to a close we're aiming are focused on building out our best in class production facilities across the United States.
Those efforts remain on track at our previously announced facility and Kirkwood, New York and that other sites not yet publicly disclose.
We are deploying all the learnings scale and sophistication of our Canadian production environment to the U.S. market.
We continue to build a pipeline of new CVD products, including skincare and cosmetics therapeutic <unk> beverages beat product oil and soft gel.
Our team remains on track to launch a selection of the new TV product in the U.S. before the end of this fiscal year.
The first Dave with new products is currently being manufactured and our U.S. marketing efforts are scaling up in anticipation of the watch.
Our acquisition of a 76% stake in bio fuel sports nutrition was the strategic investment into a truly authentic brand whose products are used by the likes of Wayne Gretzky book Anderson Condiment, David and as you get all hit to name a few.
During the close that deal and shortly thereafter biofuel, that's already expanded into the United States with over 6000 points of distribution with national retailers across the country.
Biofuels in the process of formulating the world's first better view CBD sports nutrition offerings.
To be on shelf in the United States early in the new year with over a dozen new product.
Our partnership with acreage holdings continues to progress.
And they are well to plans to roll out actually branded cannabis and multiple U.S. States then the fiscal year.
They are also we're finding plant opened tweet and told you smoke branded dispensary inflect metro locations across the U.S.
And finally, they continued to build out their own set of Brad and intellectual property portfolio.
So stepping back.
Last quarter, we talk about our path to success for long term shareholder value creation.
We discuss developing intellectual property building brand.
Building internationally.
And then drink scale production.
For current and future products.
We continue to do all of those things.
We continue to make a meaningful shift from builders to operators in Canada with our entire infrastructure platform now substantially built out.
While there are headwinds the Canadian market, we are well capitalized.
Yes, we built out.
We continue to execute in Canada and globally to ensure we are leaders in the global market, whether that market be medical CBD.
Well recreational.
Last quarter provisions and returns this side, we saw increases in our retail store revenues, our Canadian medical canvas revenues, both organic and inorganic international Kansas revenues companies other revenues as well overall gross revenues. We also saw total canvas shipments out the door improved quarter over quarter.
We believe these fundamental allpoint and the right direction for our company.
Now let's call. We also discussed the goal of achieving net revenues of $250 million in the fourth quarter fiscal 2020, where the growth margin of 40%.
Well Kathy is geared up with product inventories production capability and sales efforts to deliver on the 250 million dollar objective. We do not believe at this time, but there will be sufficient points of retail sale in the near term to unlock the necessary Q4 demand.
As a result management believes that achieving our Q4 milestones of $250 million is increasingly unlikely.
Finally, as you all know on July 3rd we announced the leadership change that's up Bruce went and leave the company myself moved from my role as President and co CEO to salt deal and radical batch rich become president.
Additionally, we announced but they also made the decision to leave cannot be after assisting during this transition period with the expectation that this would occur within this calendar year.
Well the search is not yet complete I can confirm that the company is continuing to explore a very short list of exceptional candidates that we expect to make a further announcement within the coming weeks.
This concludes my remarks, and I will pass the call over to Mike to review, our second quarter fiscal year 2020 financial results in greater detail I think already.
Alright, Thanks, Mark good morning, everyone.
Let me first we get my remarks with a brief review of our topline performance.
Total gross revenue on product shift during the second quarter fiscal 20 before charges of 32.7 million was 118.3 million, which is up 6% versus Q1.
First quarter.
And a few minutes I will break down the 32.7 million and charges, which primarily relate to the restructuring of our recreational oil and soft gel business.
Inclusive of these charges cannot be generated net revenue of 76.6 million on net cannabis revenue of 53 million and sales of 10913 kilogram and kilogram equivalents.
[noise] drilling further into the cannabis net revenue of 53 million. There are four trends that I would like to know.
First our Canadian retail business, which is the best bellwether of consumer demand performed extremely well during the quarter growing to 13.1 billion, which is up 24% and versus Q1, it up 17% on a same store sales basis.
Second overall Canadian recreational flower sales continue to perform well and gross revenue on recreational flower was $59 billion, which is down a modest 3% versus Q1.
Third the Canadian Medical Channel continues its growth trajectory with gross revenue of 14.1 billion, which is up 8% versus Q1.
And for the International Medical Channel achieved record level gross revenue of 18.1 million benefiting from a full quarter of gross revenue from C. But also delivering 138% organic growth and our international medical business, reaching 4.1 million in Q2.
Now that we've covered our core channels of business. Let me now focus on the restructuring costs related to oil and Sop gels.
You may recall that in Q1, we evaluated what was at that point. The most recent provincial and territorial inventory levels related to sales observed and direct channel and we concluded that a risk of oversupply of certain oils and soft gels existed in certain markets due to under the.
Developed retail markets and several provinces.
Based on that assessment, we reported in our Q1 results variable consideration that may result from rates of return and the amount of $8 million a gross revenue and in Q2, we continued to see a disconnect between inventory levels and the rate of sale for certain products in the market.
Hence, we recently modified our retail pricing architecture, and our package assortment to allow us to focus on a smaller portfolio products at more competitive price points, while we continue to educate recreational consumers about the benefits of these formats.
And following the shift in this strategy, we reviewed all remaining inventories.
For both product on hand, as well as product in the provinces to determine which product would be returned which product would remain with the provinces and be subject to buy down.
And which product would be on affected.
And the result of this evaluation is $32.7 million and revenue provisions broken down into three categories of charges.
Number one pricing actions that are required to establish this new pricing architecture.
Number two.
Returns from provinces for discontinued or slow moving product and number three inventories pair impairments for excess or obsolete on hand inventories. So I'd like to run you through this west and I'll start with number one which is pricing.
Recreational oil and soft gel pricing adjustments of $10.3 million are required to establish our new pricing architecture and up. This 5.9 million has already been process and 4.4 million will be processed soon these charges fully account for a full reset.
Pricing at the provincial level, however, new retail prices will take some time to flow through the market as inventory at retail is sold and replenished with new product.
Pricing has been reset at cannot be owned retail locations, but as a reminder, regulations do not allow the l. piece to buy down third party retail inventory and most provinces.
[noise] incidentally in conjunction with oil and soft sales pricing review, we also looked at dry flour and concluded there is $3.5 million of additional provisions warranted for potential by downs on certain mid level th.
The CBD strange, but none of this pricing was processed at the end of Q2 and vast remains as a general provision on our balance sheet.
Moving onto number two returns to date, we've taken actual returns of 20.5 million from the provinces and we expect another 6.4 million to be returned in coming weeks for a total of $26.9 million and product returns and also.
Note that these charges are netted against the $8 million provision from Q1, leaving a net charge up 18.9 million for the court.
Moving onto number three inventory provisions.
With the new retail pricing set within our own retail stores, we used the new sales velocity is that we're experiencing as well as those seen within markets, where we have already implemented pricing to determine our expected days of supply. Once this new pricing flows through to broad retail and we also used our.
Latest projections on store openings to help calculate our forward looking demand and in doing this we identified $15.9 million of products that have been deemed excess we're obsolete and this charge has been recorded in cost of sales.
So in summary, the restructuring charges just highlighted results in their revenue impact of $32.7 million.
And in determining the impact to gross margin, we incorporated the recovery of Cogs for products return to inventory. We included the recovery of excise taxes.
And we factored return product into our days on hand calculations to ensure that returns were factored into our excess and obsolete calculations and the some of these impacts on a gross margin basis is $40.4 million.
With these charges recorded there is now less than $10 billion of oils and soft gel in canopies inventory on hand.
There is approximately $2 million of inventory across Alberta in Ontario provinces. So we believe this issue is fully behind us.
With this lets move onto a full analysis of gross margin for the quarter.
Gross margin in the second quarter fiscal 24 of the IRS fair value impact was a loss of $9.7 million or negative 13% of net revenue, which is a reduction from 19% reported gross margin in Q1, and well off of our target of achieving 40% in the near term.
The lower gross margin was primarily driven by the previously mentioned restructuring charges of $40.4 million, but it also includes 10.5 million of operating costs related to facilities, not yet cultivating ore processing can't how to best or facilities with under utilized.
It is capacity and it's worth noting that the impact of facilities not fully utilize has decreased from $24 million in Q4 of last year to $16 million in Q1 of this year to 10.5 million in Q2.
And we expect this cost to continue to cycle downward as the infrastructure Buildout in Canada, and Denmark approaches completion and as the manufacturing facilities for rack 2.0 products begin production.
Excluding both the restructuring costs as well as the costs associated with underutilized assets results in a normalized gross margin, but for the fair value and pacsun cost of sales and other inventory charges is $29.2 million worth 38.2% of net revenue.
And as Mark highlighted this is summarized in a Q2 2020 supplemental information presentation. That's located on our Investor Relations section of our company website.
Taking a step back gross margin is an extremely important metric for our company and as we continue to work toward the 40% Mark margin goal highlighted previously it's an important to note that every cannot be employee that participate in our bonus program has this goal Inc.
Included in their annual incentive so we can assure you that this is a priority for the entire organization.
Now speaking briefly about operating expenses, our sales and marketing expenses were $60.5 million in the quarter, representing an increased in staffing as we build out our network of tweet in Tokyo store retail locations, but we're also making investments ahead of revenue to prepare for the second phase.
Recreational cannabis as well as CBD prospects in the U.S. all of which are expected to launch later this year.
Our DNA expenses grew to $87.9 million, primarily due to onetime nonrecurring costs of $19.6 million.
Up to 19.6 million 10.8 million pertains to a legal dispute with a third party HAMP farmer in the United States for which we are seeking remedy for breach of contract.
The remaining 8.8 million pertains to estimated exit costs for retail locations that were leased ahead of Rex 1.0, but for the full set of regulatory and permitting rules. We're now.
Share based compensation expense was $92.9 million and is up 5.6 billion from Q1 of fiscal 20. The increase is primarily attributable to accelerated vesting due to the executive transition announced in July .
Separately management has restructured its share based compensation program that will lead to reduce expenses and share based compensation and upcoming fiscal year.
Moving beyond operating results I'd like to spend a few minutes on other income and expense total other expenses are $109.3 million during the quarter, primarily driven by fair value adjustments.
First we recognize the noncash unrealized gain of 164 million driven by fair value changes related to senior convertible notes, which is due to the decrease in canopies gross stock price from June Thirtyth of this year through.
September Thirtyth of this year second we recognized a noncash expense of 235 million related to that fair value change and that acreage call option.
Now as a reminder, the acreage arrangement provides cannot be with the option to acquire 100% of the shares of acreage with a requirement to do so once you asked cannabis production and sale is federally legal and the U.S. and in exchange for this option cannot be made an upfront payment to acreage shareholders.
Third million dollars and Usdtwo.
Which is now recognized as a financial asset on canopies balance sheet with the subsequent changes and the fair value of this option recognized on our consolidated statement of operations.
And the fair value of this instrument is driven by many factors, including the relative value of the two companies.
And because the stock price of acreage is influenced by the fixed exchange rate of 8.5818 shares we cannot rely solely on acreage is stock price to determine the relative value of the two companies. Hence we must also evaluate the entire sector of them.
So Andy you asked to help derive the value of acreage and because the multi state operator sectors valuations decreased in Q2, the relative value of acreage is implied to have decreased more than cat canopy and therefore, a loss was recognized.
Now, let's briefly cover adjusted EBITDA, our supplemental non IRS measure for Q2 fiscal 20.
Adjusted EBITDA in Q2 amounted to a loss of $155.7 million as compared to a loss of 92 million in Q1.
The adjusted EBITDA loss includes the full impact of the restructuring charge of 40.4 million as well as the 19.6 million of onetime nonrecurring costs included in GSK for the third party disputes as well as the provision for onerous leases. The remaining decline was 3.6 million.
And was driven by increased operating expenses.
Our net loss on a reported basis, which includes all fair value adjustments for biological asset accounting was 374.6 million or one dollar an eight cents per basic and fully diluted share.
Turning to the balance sheet as as of September Thirtyth, we had cash and cash equivalents available as well as market marketable securities on hand, totaling 2.7 billion.
Representing a decrease of approximately 400 million since June Thirtyth 2019, and the primary uses of cash during the quarter was 228.3 million for infrastructure with the balance related to ongoing debt servicing and funding for operational losses.
Our biological and ask an inventory on hand.
Ended the quarter at $572 million, which is up from 496 million in Q1.
And this includes $219 million a fair value adjustments.
Along with the $353 million of inventory at cost and of the $353 million of inventory at cost 65 million pertains to markets outside of Canada, which leaves us with $288 million of inventory at cost related to our Cana.
Operations.
So let me now address our dry flower inventory, which comprises a portion of the 288 million looking at our current demand projections, which includes estimates for new store openings, we estimate our supply and demand for dry flower will reach equilibrium and.
Summer or fall of next year and these demand projections assume 40, new stores opening per month in Ontario, starting in January which is informed by the pace of new store openings that were experienced in Alberta hits. We believe we are well positioned on our flower inventory levels and we will.
We continue to monitor the situation closely and we've illustrated the supply imbalance of dry flour and the supplementary information package referenced earlier.
It's also worth noting that the balance of our inventory, which includes extraction oil and islands' as well as other raw material inputs is in line with demand and in many cases has an extended shelf life. The provides us with lots of flexibility.
Next I would like to provide a brief update on our foreign private issuer test that was completed at the end of Q2.
As part of our us financial reporting requirements. We have confirmed that as of September Thirtyth 2019 cannot be growth no longer meets the criteria for qualification is a foreign private issuer, hence as of April Onest 2020 can be growth will be considered a united states domestic issuer and a large.
Accelerated filer and with this we will transition to us gap and our new reporting will impact certain elements of our financial reporting and we will provide an overview of the financial reporting changes at our upcoming Q3 financial results Conference call.
Finally, I would like to provide a brief update on the priorities that I covered during our last call.
We are making tremendous progress and reengineering, our financial close and reporting processes and we expect to achieve the accelerated close timelines at year end.
We continue to make tremendous progress in improving our control environment and are working to remediate our material weaknesses with end user can meet computing by the end of this fiscal year.
And we recently launched a project to implement Sep across the enterprise, starting with the U.S. market and having a tier one ERP solution in place will give us a platform needed to scale our business in coming years and provide us with the capabilities to truly make us a digital company.
So suffice it to say, it's a very exciting time for cannot be the investments, we're making in people and process and technology will position us for global leadership and despite some of the short term headwinds that we're facing we're confident that we will continue to be the steady hand of this industry going forward.
This concludes my review of the cannot be gross financials for Q2, 2020, and operating we'd be happy to field any questions at this time.
To ask a question. Please press star one on your telephone keypad to ensure inefficient call that gets to the questions have as many analysts as possible analysts I request to limit to one question and should it be necessary. One question follow up question any event analysts have an additional questions. They are welcome to answer the question Q.
First question comes from his Vivien Azer with Cowen.
Hi, good morning. Thank you so much the question on appreciate.
Color on that.
Certainly.
Or not.
In calling out the challenges.
Retail distribution standpoint, limiting the revenue opportunity, but Mike can you offer any more clarity in terms of what we should expect from a revenue perspective now that you 50.
Okay.
Yes, so thanks again and.
Mark I'll I'll take this one I think we have seen there are a lot of variables out there we know what we can do.
But if we just look they'll short term about what's happening and we're waiting to see canvas 2.0 products get to market.
Waiting to see.
Whether there are delays over Christmas for how that happened, obviously, we're waiting to see the store rollout and frankly relating to.
We think we've seen the provinces rightsize a lot of the inventory levels that they're holding which a lot of analysts that talked about.
Encino touching on my so we are feeling bullish but on the other had I think there are just too many variables for us to try to give direct guidance on on what the upcoming quarters look like.
Okay. That's fair, maybe just a follow up then.
On the U.S.
Opportunity can you offer a little color on how we should think about shipments impacting your fiscal third quarter of 20, seemingly you'll you'll be pushing some product into the market.
Sorry business up are you actually Q3 year Q4.
Well I thought you were going to you would have recognized some revenue in threeq.
For Q.
Any commentary in the back half on revenue generation expectations for you asked the CBD. Please.
Yes, I think you know our target remains Q4 of of this fits goal.
It is potential some of that might.
Creep into Q3, I don't think we'll be adding material and Q3 to be quite honestly.
And where I'd say on we are hemp operations are are now completing we have the.
Contract manufacturers in place we have actual manufacturing underway. The team is ramping up we have probably around 100 people in the US now and a lot of head office resources going towards that.
But like all weekend, but nothing is easy the conversations with retailers aren't easy.
Basics of setting up an online store.
More challenging and selling the widget. So we work through all those things and are confident to see product in Q4.
Okay. That's helpful. Thank you.
Next question comes from Tommy Chen with BMO capital markets.
Yeah. Thanks first question just wondering on your assumption.
About Ontario, 40 stores them on starting in January so you're looking at Albert as the President I'm just wondering.
In a sense from the current Ontario provincial governments are they ready to do something like that starting in January .
Yes, so great great question, So I'd say two things.
What we put out in that.
Slide deck is there was an illustrative Kate so you can assume that going into that are our tons of assumptions about our market share you know the sales per store.
New products all of that sort of stuff, but the big variable is how many stores it rolled out and multi that Ontario. So I think the first point I'd make is we've modeled less stores more stores and you know it shifts from maybe shift from equilibrium in June to go to August and maybe that shift inventory on hand from Florida.
Months to six months or the other way around but you know in virtually all of those models, where we see.
Any sort of.
Interior rollout, we still feel good about about where we are.
To answer the question directly.
I think the entire sector is putting a lot of pressure on the Ontario government you've seen.
Ill offer that we've done together to depression, and there certainly saying that they're going to do all those things that we haven't seen reaction.
I think it's important to note that they have announced essentially roughly another 70 to 75 stores that will come regardless to the lottery system. So in some ways that speaks to some of those early a month or are these stores in the pros that even if they don't do anything else.
But we are we are confident we'll see in the next couple of months that they will will make a move to sort of ensure that that that number continues into the at months.
Okay, Thanks, and second question.
Mike So I just want to comes from when you talked about the new pricing architecture with that specifically or only to the oil fields and the rack market or does that pertain to flower too because what I'm getting at here as I noticed by my math your average selling price match for rack on flower.
Still is higher than some of the other peers that we've seen and I'm just wondering could there be potential downside there because we are seeing a number of LP is becoming more aggressive on flour pricing in the rock Mark.
Yes. Good question. So the ASP that you look at for dry flower quarter to quarter was down and product mix was the driver as we get our tw de brand end market in earnest we.
Our filling the supply chain if you recall earlier in the year that was one of the brands that were holding back as we were filling our flower channel.
So now that that's out there we expect that Tds TWB will play a role but the mix in Q2 of our dry bulk shipments was weighted more toward that as we feel that pipeline. The pricing architecture changes that we talked about for soft sales and oils does pertain to soft shells and oils across Canada, and I would think about it is a 5% to 7%.
Price reduction on average depending on the province is there some variation across the provinces, but I think 5% to 7% would be a good proxy of the architecture changes that we're making.
Okay. Thank you.
Next question comes from Chris carry with Bank of America.
Hi, good morning.
Hi, Chris.
Hi.
So I guess.
I'm trying to get a sense here for.
You know if things have really bottom here.
Right or or if there is potential.
I suppose cliffs ahead right because.
And certainly what the stock is doing pre market I think would indicate that the investment community is really looking for what actually is fundamental trough and I think the decision to take the provision on on oil.
Makes sense right, but then.
Im kind of scratching my head about this assumption for.
40 stores per month in.
Ontario, and Ontario's revenue per store is just so much higher than the rest of Canada, which so it's a pretty significant driver of inventory depletion.
And I guess I'm just trying to.
Frame in my head.
What happens if.
It doesn't occur right because.
Production was.
40000, kilos again, this month or this quarter.
And I'm just trying to frame in my head what happens if you don't get these 40 stores right because do you have to.
Do you have this is like slow down your production.
Do you have to shut down some facilities.
What are what are the implications for gross margins and obviously you have more mix coming to you equation and so so so really all that together, but the sort of philosophical.
Dynamic that I'm trying to get out here is when we can get comfortable that things have sort of.
You know bottomed and maybe I'm just.
I'm, just trying to kind of walk through that analysis, and maybe I'm just not quite there yet. So so anything you can do to help me would be appreciated.
Yes.
Total and and Great question, you know I would say.
No if we.
If we park. The question first second and we look at everything else going on in the business right.
Our recreational market share is sitting north of 25% no across the country in our view gross revenues prior to adjustments up 6% to $118 million Canadian medical sales up global medical sales up retail sales up fifth largest retail network overall kind of shipments up so you know we feel.
Provision to side, we feel very strong about the quarter actually.
I just speak to the stores you again, we put one illustrated case in there of the store openings and today, we are out a bit of that perfect storm or provinces are working down inventories canvas 2.0 is still yet to come and we have 60% of the population with only 10% of the stores in Canada.
I think you up we if we look positively on that last one it is such a big deal and it's actually such an easy solution right. The government has has recognized the need to have more stores. They they recognize that they want to explore their distribution model that recognize that they want to move to an open market system. So.
I think for sure you hit on the point.
There is still a 6 billion dollar.
Canadian market when you convert the elicit market that is all there.
We are waiting for stores we cannot.
To your point, if Ontario doesn't open source for another year, we all have a problem I don't think weekend.
Right.
Try to.
Look that.
But theres no reason to expect that will happen they've indicated we're going to open stores everybody's pressuring them open stores hopefully the within the calls like this and considering.
The impact is having on our sector and I think we'll we'll see that happen.
Okay.
Okay. Okay. Then then maybe the other element, which I just wanted to dig into a little bit.
It.
As you know I fully appreciate.
The pre revenue investments and I think you know, we all understand what's in place here and it's a very large market with huge Tam.
And and you guys are one of the few companies that actually has capital to make investments and so it makes a lot of sense it to do that but I guess on the other end.
There is this dynamic of.
Markets are coming together, maybe a little bit slower from a legal standpoint, and we all get that they're there and that revenue is there to be had but with.
The the quarter over quarter deterioration in free cash flow.
I mean is there is there an element here, where you kind of say, okay. We get the importance of pre revenue investments, but we also get this other dynamic that.
The market is coming together at a certain pace and maybe we need to be more dialed about the money that we're putting to work.
And maybe if you could comment on how you see free cash flow trends going forward, so any anything there.
I would also be very helpful [noise].
Yes.
Thanks, and I'll, let Mike speak to the free cash flow going forward.
I think it's fair to say.
We have built this company for the long term as you say those long term markets are all there there are short term challenges in Canada and even other places as we look for more certainty in the U.S. and while we built for long term our folks on the long term if we're not naive to the short term either so over the last several quarters, we have actually been making tough decisions.
To limit certain research expenditures limit certain hires to keep within the reality of what's happening.
And I think the other keeping focused on his infrastructure and M&A right. I mean, we are in the fortunate position of having over $2 billion in the bank with our Canadian infrastructure essentially fully built out.
With.
Our European infrastructure, essentially fully built out with our global M&A program largely completed there will always be.
You know opportunistic focuses that we filled all the holds we have so the big things that draw on our capital.
Our our minimize right now we are being very prudent to make sure we.
We look at current events, but we're also not taking drastic steps that will undermine our successes the long term because you know speaking to cash flow, we don't need to do that.
I would just add that when you think about opex, taking that that part of the question first Chris from an Opex perspective, there has been investment and back office capabilities over the last six to nine months and we are on the tail end of that back office investment.
The Genie increases that you saw in the quarter are largely driven by one time events nonrecurring events that will normalize in the next quarter.
But our back office is largely in place.
With respect to other operating expenses, we continue to balance investments in long term strategy versus short term results and we recognize that the Canadian market is six to 12 months behind where we thought it would be given the store open.
Thanks.
And we are continuing to challenge ourselves to make sure that we're scaling our organization appropriately keeping that in mind, but we are not sacrificing into that longer term investments that are multi year investments but.
Any interruption to that would be highly disruptive to our strategy.
So set that aside and when you look more broadly across our international markets. The U.S. continues to be our number one investment for.
Operating expenses and Weve built a team of just north of 100 people on the ground and there.
There will be continued investment over the next 12 to 18 months as the CBD scales.
More broadly looking at free cash flow, we've put objectives and the public domain around expectations on Canada, and how it's going to perform over the next year in terms of adjusted EBITDA. When do we expect to get the entire enterprise to adjusted EBITDA positive and all of that but.
With that thinking about free cash flow in the capital spending investments that were made we're coming off of a major phase of investment from Canada, and we are literally in the final stages of.
Of that and paying bills on the last part of it and then our next wave of investment will be in the U.S., but it's a much smaller wave initially so our capital spending will be muted over the next 12 to 18 months relative to the last 12 to 18 months that you've seen so we would expect that are fat our free cash flow will continue to improve.
Over the next year to.
Yes.
Okay. Thanks for those and I'll pass it on.
Next question comes from Andrew Carter with Stifel.
Thanks, Good morning.
Part of the issue in the first wave that's kind of manifest in this quarter's results has been really a lack of visibility into the market just new and evolving so what kind of wanted to first start give a sense of where you think your capabilities are now versus throughout kind of the first way the into into kind of making adjust adjustments in understanding that and then also kind of how much is.
Last year can customers, both the provincial and retail stores and then regarding kind of your visibility I think what does or does your ability to make changes in the second wave increase significantly now. So you can kind of respond to customer customer demands more quickly.
Yes so.
Got it here.
So I think several points on its I think firstly last year at the rollout of legalization.
We had little to no data, we're looking at what you asked markets had done, but we had nothing within the Canadian regulatory contacts for recreational legalization, when making production decisions and so we looked at things such as soft as an oil is forecast to them to be up 15% in the market and panda around 5% I think the big change that we've had over last 12 months.
Is we now have data right. You took you know about four to eight months press. The star came provincial opt until data service rather than simply to be to be sales, but seeing what did selling through the customers.
So we could change our product portfolio and our mixing skew rationalized to make sure. We had the right just use in place that we're having pull through and being able to have that continuous supply to build customer affinity.
I think the other thing we've done while is working with the provinces in terms of.
Team meetings to make sure we're producing products that meet their demand so going back to average selling price and rack one day, good examples where I've been very successful.
Hi, GC products, 20%, plus TCM flower, we've been able to do very well take advantage of a gap in the sector on supply and that ends.
And execute prudently I think as we move into Cabot 2.0, what we've been able to do is take the demand, we've seen and leverage that into our supply and demand planning for new products, such as based beverages, and chocolates and I think our ability to scale advanced manufacturing products and to your point on an agile basis, where since.
Wanted to how we deal with excise stamping the automation up this manufacturing procedures allows us to allocate products leader in the process lean to shorter lead times and ensuring that we can change our portfolio mix.
Quite quickly to meet market demand. So overall I think we're confident we're taking prudent approach I know the of course, if these are new products and with any innovation products to always be risk.
But we feel pretty strongly about our ability to execute going forward.
Okay, and you mentioned the second wave on the products theres been quite a bit of investment there at both internal M&A the partnership with constellation in your initial kind of discussions with with the problem with your customers prevention and private operators.
Do you get a sense like on the pricing side are they starting at where kind of the supplier pool for dry flower prices or are you getting kind of kind of a kind of credits or kind of for years, but for the capabilities you bring to bear getting getting now a higher kind of I guess share share the value chain, what's your second wave products.
Yes, So I think it's fair to say, it's not feeds off flour pricing.
We're introducing over 30 plus products.
Canvas 2.0, with another 20, plus Prost coming over six to 12 months thereafter, we've had great meetings with the province as most of them at this point pretty close to having us finalized their listing process.
And we've had great reception I think good example would be on the beverage front.
Our strategy as everyone knows from day, one has been to disrupt beverage alcohol and so pricing our beverage products out a slight premium to beverage alcohol is important if it's going to be a direct trade off and province have been very receptive to approach and we're very happy at the outcomes on that front.
On the vaporizer side.
I think it's more looking at a number of occasion uses and so forth in terms of pricing.
Hi to I think the work that we've done to make sure that our products are serialized that their tempur evidence.
That there are rojas, meaning no heavy metals in the.
Equipment, and you all certifications and so forth hi, all that work we did over past two to three years to our.
R&D team is really coming out to pay dividends at this point to ensure that we have leading products that may customers.
In both provinces and retailers feel comfortable carrying our products and so on the whole I think we're really happy with where our canvas 2.0 products have landed we're happy with the price points in gross margin that we'll be able to bring forward with these.
And.
Certainly we're also happy with the ability to scale in reaction to market demand as more stores come online and these products start to gain market share.
Thanks I'll pass on.
Next question comes from Doug Miehm with RBC capital markets.
Yeah. Thanks, I just want to go back to I know Theres a lot of questions around those stores in inventory and that sort of thing, but maybe I can ask the question. If you get the go ahead from the province in Ontario.
Many of those 40 stores per month could carry.
Your banner and then I guess the other question really has to do with inventory.
And a half months for dried flowers, along time do you think you're gonna have to start to write off inventory anyway.
Yes, so first I'll take the discussion of new store openings, So we've talked about having.
Trademark licensing agreements in place.
Which is how we've had stores on dry banners in Ontario, and I think it's a few important parts that come with that but namely the brand recognition the ability of.
Consumer to go into a store half a brand experience and leave that star, saying.
I really enjoy shopping at Tokyo smoke. It leaves laughing brand of Sandy that's a strong value add on top of the products we distribute.
And so the.
Trademark licensing agreements we have in place have been very successful. You'll note you know we're wanting to talk by brand you'll see in Ontario today, and I don't see any reason that would change going forward in terms of the inventory I think the important thing to remember is that.
Under Health, Canada is regulations, there is a lengthy quality assurance proceso, which of course is super important and we have over 300 quality checkpoints in our release process.
For product to make to market. So from the time you start harvesting a crop to actually is released and available for sale is about 45 to 60 days. So one after two months.
Points, we then have to offer to the provinces. They placed peos. It gets excise stamping goes out the door. So in a perfect world. It takes two to two and a half months have finished goods ready to go out the door to retailers of course.
Our potential partners are looking for inventory consistency and so often they're looking for us to half of four to eight weeks of supply any finished goods in our warehouse. So they can feel confident that when the product is doing well that there'll be able to have consistent access. So so we see four to five months inventory as the ideal.
Length, the period for dry flower I'm to make sure we have continuity of availability and so from that perspective, what we're trying to highlight in the supplemental is given that floor has approximately six to eight months lead time to market.
That we feel very happy with our inventory levels today, another saying suffer success. Both in terms of if there was a slower store rollouts.
That we have the right inventory levels, but that it's Ontario does hit that 40 per month, Mark that we're able to scale quick enough and respond and really I continue to dominate market share through that held problem.
Okay great.
The question follow up I just have to.
Has to do with the new CEO .
Typically when new Ceos come in that cleared the decks and make a bunch of changes and those sorts of things now.
Fully you've gone out and Youve taken charges and made provisions and that sort of thing but.
Are there any places in your business, where a new CEO you think could come in.
Thank you.
Significant changes and I'll leave it there thanks.
Yeah.
So I think what has set can be apart over these six years that has allowed us to grow into the leader in this sector.
Is the team we have right so.
A new CEO will come in they'll have to assess.
Everything Ano they'll run things in a different way and all those sort of thing, but at the end of the day, we have built.
An incredible team an incredible company and have full confidence that we have all the right people in place from the other people on this call to people running IP to sales and marketing to our international team.
So I think but what we're trying to do and make sure in fact that the new seal comes in as time to understand a very complicated sector, knowing that he or she has the support of incredible team.
And I am I getting the.
The the the hook year from from Tyler, suggesting we're.
Got it 30 minutes I think.
Good so thank you.
Everybody. Thank you for for the question.
And I know, we have a number of calls with with people on this call.
For the rest today. So thank you very much and we'll talk to you said.
This concludes canopy girls second quarter fiscal year 2020 financial results Conference call. A replay of this conference call will be available until February 14, 2020, and can be accessed following the instruction is 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.