Aurora Cannabis - Earnings Call - Q2 2021

Transcript

Operator (participant)

Greetings and welcome to the Aurora Cannabis Second Quarter 2021 Results Conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ananth Krishnan, Vice President, Corporate Development and Investor Relations.

Ananth Krishnan (VP, Corporate Development and Investor Relations)

Thanks, Maria, and good afternoon, everyone. Thank you for joining us for the Aurora Cannabis Second Quarter Fiscal 2021 Conference call for the three months ended December 31st, 2020. This call is being recorded today, Thursday, February 11th, 2021. With me are Aurora CEO, Miguel Martin, and CFO, Glen Ibbott. After the close of markets today, Aurora issued a news release announcing our financial results for the fiscal second quarter. This news release and the accompanying financial statements and management discussion and analysis are available on our website or on our SEDAR and EDGAR profiles. Listeners are reminded that certain matters discussed in today's conference call or answers that may be given to questions asked could constitute forward-looking statements that are subject to the risks and uncertainties relating to Aurora's future financial or business performance. Actual results could differ materially from those anticipated in these forward-looking statements.

The risk factors that may affect results are detailed in Aurora's annual information form and other periodic filings and registration statements. These documents may be accessed via the SEDAR and EDGAR databases. Since we are conducting today's call from our respective remote locations, there may be brief delays, cross-talk, or other minor technical issues during the call. We thank you in advance for your patience and understanding. Following the prepared remarks by Miguel and Glen, we will conduct a question-and-answer session. To ensure we get as many questions as possible, we ask the analysts to limit themselves to one question. With that, I'd like to turn the call over to Miguel. Please go ahead, Miguel.

Miguel Martin (CEO)

Thank you, Ananth, and good afternoon. Let me begin with some high-level comments about the quarter. I will then turn the call over to Glen for his financial review, after which I'll come back to discuss our progress to date and why we believe we're very well positioned to take advantage of the massive global cannabis opportunity ahead of us. In short, we had an excellent second quarter, and we're pleased to be tracking to the strategic plan laid out in September when I became CEO. We are now executing a proven, regulated CPG strategy that I know very well, one that we are confident will give us maximum flexibility to drive growth, cash flow, and shareholder value in the coming quarters. Our fiscal second quarter represents a pivot for Aurora from a full year of tough but shareholder-friendly decisions that will ultimately lay the foundation for the future.

We essentially reorganized the business, reset strategy, and mobilized our entire team. Where they are now organized behind our strategic plan, we're squarely on offense. Early progress is already reflected in our financial statements and market share data. But beyond our financial statements, we've made significant strides pursuing margin accretive initiatives. Rest assured that in the coming quarters, Aurora's intents are continuing this trend. As you know, our core business has four parts. First, high-margin Canadian medical, where we are number one by revenue. Second, international medical, where we continue to see strong growth. In fact, we just recently announced a strategic relationship that should accelerate the business. Three, our US CBD business, Reliva, which is the number one Nielsen-ranked CBD brand and continues to be a platform that provides us with significant optionality in the US.

Four, our Canadian rec business, where we've seen the market react positively to both our Generation One and Gen Two products and our ability to enhance quality across both efforts. We're pleased that for the second quarter, our total cannabis net revenue, excluding provisions, was CAD 70.3 million, an increase of 11% versus the year-ago period. Adjusted gross margin was impacted slightly, but relatively steady in the low 40s. It's important to note that margins would have been 52% had we not applied the full fixed cost of the Aurora Sky facility during a time when we significantly reduced production and initiated targeted product returns in order to open the channel to higher velocity products. Fortunately, this was mostly offset by steady margins in our medical markets in Canada, Europe, and U.S. CBD. Combined, the margin in these businesses is generally 60% or higher on a run rate basis.

SG&A was CAD 42.3 million, excluding a one-time charge associated with our strategic plan. This represents a dramatic decrease of 55% from last year's second quarter. Finally, as it relates to Q2, we materially improved our year-over-year adjusted EBITDA loss with a CAD 58 million swing to CAD 12.1 million, excluding restructuring and revenue provisions. Another big positive for the quarter was the improvement in our cash use by more than 74% versus Q2 2020, and our cash on hand as of yesterday was CAD 565 million. The reduced cash burn, plus our newfound balance sheet strength and flexibility, allows us to act quickly should an opportunity arise to take market share. The bottom line is we feel great about the quarter and our strategic progress.

We're building momentum as we execute our plan, and we firmly believe we have the team, the tools, and the strategy in place to take advantage of a dynamic and exciting market. I'll now turn it over to Glen to walk through the financial details.

Glen Ibbott (CFO)

Thanks, Miguel. Good afternoon, everyone. Please note that the figures I'll be going over today are all in Canadian dollars and can be found in the press release we issued this afternoon. We'd also note that the comparative period for our analysis today is Q2 2020. We believe this best represents the measure of the company's transformation and improved performance. If appropriate, I will also note the sequential period comparisons. For our second quarter fiscal 2021, the three-month period ended December 31st, 2020. We saw a strong performance in our medical business, especially international sales, and we continued to transform our consumer business with a shift to higher quality, higher margin products. We also made the decision to significantly reduce production volumes to align with demand.

We expect our sales-to-production ratio in Q3 to be in the 90% range, and we initiated targeted product returns in order to open provincial sales channels to premium product. Yes, these actions impacted reported revenues and gross margins for Q2, but they provide a sturdy foundation to support higher margins and accelerating cash flow in the coming quarters. In Q2 2021, our net revenue, all of it from cannabis businesses, was CAD 70.3 million, excluding product return provisions of CAD 2.7 million. Our consumer cannabis business delivered CAD 31.1 million in net revenue prior to these return provisions, and our medical cannabis segment continued to accelerate, generating CAD 39 million in sales. Adjusted gross margin before fair value adjustments on cannabis net revenue remained strong at 42%, compared to 48% in the comparative quarter.

Excluding the CAD 2.7 million in product return provisions, our overall Q2 adjusted gross margin was just 300 basis points lower than the prior period. Importantly, I should point out that our decision to reduce production at Sky to align it with demand and to reposition it to produce our premium flower brands did impact gross margins in Q2, though underutilization of capacity resulted in close to an 8% reduction in overall gross margins. Some of this is expected to reverse in the future as we have a full quarter reduced costs at Sky. Now I'll provide some additional insights into reported revenue and margins. Firstly, let's not lose sight of the importance of our medical business here in Canada and internationally. Our medical revenue was up 42.3% year-over-year and 16.4% sequentially.

This was primarily due to strong performance in the international medical business, which was up 562% year-over-year and 84% sequentially. Not only was revenue growth significant, but this segment also carries our highest margins. The growth was driven in part by continued progress in Europe, which is now five times the size that it was a year ago and up 36% sequentially. But this quarter also saw our first shipment of medical cannabis to Cantek Holdings in Israel. It's also important to note that we continue to have an ongoing advantage in the Canadian medical market share, and this is underscored by a 5.5% increase in revenue year-over-year. In our medical segment, adjusted gross margin for 56%, relatively consistent with comparative quarters.

However, Q2 margins were impacted by the capacity underutilization at Sky as production was smartly scaled back, and our overall medical gross margins would have been 66% at full capacity. I'd like to draw your attention to the fact that we've been selling in Canadian and European medical markets for over four years and have seen little to no price compression. So with revenues currently at CAD 39 million and growing and 60% plus gross margins, it's clear that our medical business is a key differentiator for Aurora and should be an important driver of future cash flow. Looking now at our consumer business, Aurora's Q2 revenue was CAD 31.1 million, down 7% from Q2 2020, not including return provisions. However, with provisions included, our reported revenue was up 24.7% over the comparative period. We are very pleased that our consumer derivatives net revenue was CAD 11.5 million, an increase of 18.4% sequentially.

This was driven by our focus on higher margin products such as vapes, edibles, and concentrates. Our consumer average selling price rose 6% in the quarter due to an increase in derivative sales and a continuing shift in flower mix towards our premium brands. Consumer margins were 27% compared to 38% in the prior quarter, and this is because of the underutilized overhead costs at Sky and an increase in product return provisions. Adjusting for just the return provisions, consumer gross margin would have been 34.2%. Also related to our production and demand alignment, we halted construction at our Sun facility in Alberta. The path forward for this facility is not yet clear. During the quarter, we recorded a non-cash impairment of approximately CAD 228 million for this shutdown. Now to SG&A, which includes R&D. We are pleased with our CAD 42 million run rate in Q2.

This excludes approximately CAD 2 million of termination costs related to our business transformation. So stepping back a bit, we've engineered significant change year-over-year, and that's highlighted by this past quarter's SG&A coming in at 63% of sales versus 143% of sales in the prior year comparative. We continue to believe this level of SG&A spend is quite sustainable and capable of supporting a much higher revenue line. So pulling all of this together, we generated an adjusted EBITDA loss in Q2 2021 of CAD 12.1 million, and that's excluding revenue provisions and restructuring costs. That's a dramatic improvement from the CAD 69.9 million adjusted EBITDA loss in the prior year comparative. And with a further CAD 7 million in our Q2 cost of sales that was related to facility and production rationalization, I'm pleased to see that our run rate EBITDA continues to improve.

Now, a few important points regarding our balance sheet cash flows and cash position. Inventory and biological assets increased CAD 16 million from the previous quarter, and that's a significant improvement as we made progress rationalizing production levels to current demand. As you know, with an agricultural product, alignment does take time, but our December decision to adjust Sky production was an incredibly important step towards our goal of shifting to a more variable and agile model. Another area of dramatic improvement this past quarter is cash and our use of cash. We used CAD 20.6 million of cash to fund operations, excluding working capital investments. We used a further CAD 2.1 million for contract and employee termination costs. Both are down materially from the prior quarter, and cash used in operations is down over 75% from the prior year.

We also paid a net CAD 8.8 million for capital expenditures in Q2, down from CAD 15 million in the prior quarter and down from CAD 128 million in the prior year comparative. We continue to expect cash used for CapEx to be below CAD 40 million for this fiscal year. Increased net working capital used CAD 30.4 million in the quarter. However, this was mainly due to shifts in the levels of accounts receivable and accounts payable, which we expect to settle out over time. Critically, the net change in inventory and biological assets used CAD 10 million in cash during the quarter, a marked improvement from the CAD 25.1 million in Q1, demonstrating our progress to more closely align production levels with demand.

Finally, as of today, we have a very strong cash position with CAD 565 million in the bank and about CAD 97 million of outstanding term debt that is not due until the end of calendar 2022. We also expect to receive some additional non-dilutive cash inflows from previously announced facility sales and COVID-related government grants over the next several months. So what I think people really need to take away from our Q2 results are the following. We continue to deliver excellent results in our high-margin medical business, both in Canada and internationally. We're seeing a positively changing product mix in our consumer business and have taken important steps in rationalizing and repositioning production. SG&A is well controlled, and cash flow items continue to improve, supported by a strong balance sheet.

So I'm very pleased with our recent performance, and I'm quite satisfied that we have the company well positioned today and on a firm financial trajectory. I'd now like to turn the call back over to Miguel.

Miguel Martin (CEO)

Thank you, Glen. As you know, calendar 2020 was a difficult year. We made some tough decisions and faced several challenges, not the least of which was right-sizing our cost structure, strengthening our balance sheet, and dealing with the pandemic. Yet by the fall, we formulated and introduced a new strategy, and I know I speak for our entire team when I say we're thrilled to be back on offense, pursuing profitable growth opportunities and creating an economic model that strikes the balance between where the industry is today and where it's going. The goal of the plan is simple: drive revenue from mostly premium products over more variable production costs and significantly lower fixed costs. The upshot will be higher margins, stronger cash flow, and long-term shareholder returns. And having our financial house in order, in my opinion, will attract new business and lead to untold opportunity.

Before we go to questions, let me take a deeper dive into our businesses and subsequent strategies, starting with medical. Our domestic and international medical businesses delivered a 42% revenue increase over last year's second quarter and generate consistently high margins in the 50% range. As I've mentioned, we are the number one medical cannabis company in Canada by revenue today, yet we still have lots of opportunity to grow in the years to come. Just one of the many initiatives we have is moving our patient intake and experience online, where we can now offer substantially more choices to our patients and veterans. Over time, the medical channel may see some migration to the consumer channel, but we see pockets of demand in the Canadian medical landscape that represent meaningful growth opportunities for Aurora.

Aurora is uniquely positioned with the infrastructure, regulatory experience, and compliance systems in place to continue to lead and take share in the medical market. These investments represent a significant barrier to entry, and key patient groups represent a very sticky patient group for our products. These attributes of our medical business support our expectation that the Canadian medical channel can continue to generate 60% gross margins for the foreseeable future. Our international medical segment has been a consistent performer and reported an 84% revenue increase quarter over quarter. We are already one of the leading providers of flower in Germany, and we continue to see opportunities in the oil market. In November, we entered into a strategic supplier agreement with Cantek in Israel, providing us with a great opportunity to expand our medical cannabis brand and industry-leading science.

In early January, Aurora and our partner, Ethypharm, were successfully awarded three of nine lots, which included all available flower lots, to the French medical cannabis tender program. Aurora has one of the largest global footprints, generating revenue in 13 countries today. We're excited about these opportunities and the global momentum they represent for medical cannabis regimes. Additionally, in January, we announced a long-term strategic agreement with MedReleaf Australia to exclusively distribute the Aurora, CanniMed, and MedReleaf brands in that country. MedReleaf is an asset-light, sustainable growth platform in Australia to help physicians, pharmacists, and patients access the high-quality range of Aurora cannabis medicines. We're also seeing other countries beginning to approach medical cannabis more favorably and compassionately, and we expect our experience in Germany, Israel, and Australia to position us to be a front-runner in new markets. That won't be by accident, however.

It will result from Aurora's commitment to science, compliance, testing, EU GMP-compliant cultivation, and our ability to operate in a highly regulated framework. This is unique to Aurora and provides us with transferable knowledge as we enter new medical markets globally. Now let's turn to our US CBD segment, which has been receiving a lot of attention due to the Democratic control of the presidency in the US, as well as both houses of Congress. Our Nielsen's top-ranked US CBD brand, Reliva, remains an enviable strategic platform, and we're excited to be announcing a new brand extension called KG7, an athletic-focused CBD brand in the coming weeks. Reliva provides us with critical distribution, regulatory experience, and relationships in the key high-growth US market.

Reliva focuses on brick-and-mortar stores and is the primary CBD supplier for some of the largest retailers and wholesalers nationally, and our products are in over 23,000 stores. Given its variable cost model, Reliva doesn't require any CapEx, but as I said, it's a foothold in the largest cannabinoid market in the world, which bodes well for Aurora's global positioning. We will continue to leverage our science and innovation, and it wouldn't surprise me if the non-THC parts of our portfolio are as big as the THC parts of our portfolio, particularly with positive FDA action in the U.S. Stepping back and specifically on the U.S. THC market, I would say the following. The U.S. is clearly one of the largest markets today. With legislative reform, that would allow companies like Aurora to operate THC businesses in the U.S. I would expect it could be much bigger.

We firmly believe that as a company with deep roots in science and experience and operating under federally legal frameworks, Aurora will have an opportunity to participate in that market in a meaningful way. I will not commit to how we will gain exposure to the current U.S. THC market, but I can say we won't simply wait for comprehensive legislation and that we are assessing ways to legally advance our shareholders today in addition to when comprehensive legislation is in place. One thing I am confident in is that the competitive landscape in the U.S. will look very different if THC is descheduled, and we believe social justice and economic reforms will ultimately drive it. For clarity, whatever we do in the U.S., whether that be in THC or in non-THC businesses, it will be carefully and thoughtfully done and make strategic sense for our shareholders.

Moving to the Canadian consumer market, we see it as having significant white space given the market, which is currently seeing a rollout of new stores. Currently, there are 1,450 stores across Canada, and we believe the store count could more than double in the near future. In an effort to capitalize on this opportunity, just last month, we entered into a strategic agreement with Great North Distributors, Canada's first and largest national sales broker for legalized adult-use cannabis. They are now the exclusive representative for our Canadian cannabis retail brands. Great North reaches across every province in Canada, including established relationships with provincially owned and operated retailers and private retailers in Canada's cannabis industry. Beyond this agreement, our strategic plan includes, first, focus on driving sales of premium brands and flower, particularly with our high-quality, high-premium brands such as Whistler, San Raf, and Aurora.

Secondly, win share in key margin-accretive growth formats: vapor, pre-rolls, edibles, and concentrates. Third, as we mentioned, we've already taken meaningful steps to align our production and manufacturing costs away from fixed and variable. Let's touch upon each of these topics individually. Core and premium categories are more important for Aurora long-term, even as we appreciate the importance of having a brand in the value segment. This is because the consumer is dynamic, trying different brands and, in doing so, shifting market share. We, therefore, have a great opening to market premium brands with vapes, pre-rolls, and premium flower offerings across multiple price tiers. This will attract premium consumers and, over time, build loyalty based on the quality of the product and the experience it provides. As seen in many states in the U.S., there are vibrant premium offerings in all key categories succeeding with consumers.

To that point, across every CPG category, there is always a consumer segment that will pay a premium price for premium products. We are blessed with a few of the best brands in the cannabis industry: Aurora, San Rafael, and Whistler. We are building brand ecosystems around each of them in various formats to foster greater visibility and provide greater choices to the consumers when they can work up the value chain. Achieving this goal will require alignment with production, focusing our resources on growing high-potency, high-terpene, premium cultivars on a consistent basis and reaching consumers who are willing to pay a premium for a premium product. We are well on our way to building these key pieces of infrastructure.

Recall that we generate significantly more gross profit dollars on our premium Aurora, San Rafael, and Whistler flower per gram than we do on Daily Special, and the difference between gross margin contribution per gram can be four or five times or greater. Therefore, we don't need to be cultivating the low-potency flower for Daily Special. As a first mover in these decisions, we're better off sourcing that product from the wholesale market more efficiently. Of course, premium segments must also be supported with classic CPG sales, marketing, trade marketing, and consumer engagement methodologies to build awareness, foster affinity, and generate outsized returns. Within vapes and pre-rolls, there is also a lot of opportunity to bring classic CPG elements in packaging, and alignment with traditional flower does not lend itself to.

We've already experienced a significant improvement in the vape category as the most prominent proof point in our innovation strategy, much like pre-rolls, concentrates, and edibles. Specifically, we've seen our market share in vape go from basically zero in September to approximately 8% at the OCS recently, which is great news. We've also launched a new product that we're really excited about, our OG Chemdawg concentrate, and the market reaction has been extremely strong. And we would expect to start seeing similar gains in other margin-accretive categories as other new products roll out. So I'm very pleased with our top-line strategy, and as I highlighted, we're making progress on costs. To give you a bit more detail, at the tail end of fiscal 2020, we announced the closure of four cultivation facilities across our network, and I can confirm that several of those facilities are now shuttered.

Most recently, we have terminated construction at our Aurora Sun facility and successfully reduced capacity utilization by 75% at our Aurora Sky facility. This will allow us to focus on premium-quality flower at this facility. We're already seeing data that a higher value, higher margin-driven product is a winning strategy. So in closing, I think the main takeaway today is that Aurora has never been better positioned strategically, operationally, and financially. We have over CAD 565 million in cash available, the number one medical business in Canada, industry-leading gross margins in our medical cannabis segment, and some of the strongest brands in the cannabis industry. And I say that at a time when the cannabis industry is presenting us with a generational opportunity. We intend on seizing the moment, and I look forward to keeping you all updated in the coming quarters.

I will now turn it over to the operator for questions. Operator.

Operator (participant)

At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press Star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press Star 2 if you would like to remove your question from the queue. Each analyst will be allowed the opportunity for one question. You may re-enter the queue by pressing Star 1. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the Star keys. One moment, please, while we pull for questions. Our first question is from Vivien Azer with Cowen. Please proceed with your question.

Vivien Azer (Managing Director)

Hi. Good evening. Thanks. My question is on your medical segment.

Miguel, as you kind of think about the business over, call it, the next 12 or 18 months, clearly you're very satisfied with the medical cannabis business. And considering the substantially higher margin that you're getting on that, do you guys have any internal targets you can share in terms of revenue mix that you hope to see kind of by the end of fiscal 2022, for instance? Thanks.

Miguel Martin (CEO)

Yeah. Thank you, Vivien. I'm not going to get to the exact specifics of it. It's a little bit dynamic. Let me tell you sort of how I look at mix, and this is going to sound very familiar to you. First and foremost, when we think about premium-to-discount mix, discount to me is something you have to deal with, but you really want to look at price gaps and the interplay between the two.

I'd like to see, in a perfect world, from a revenue standpoint, about a 70/30 mix premium-to-discount. Now, some aspects, as you mentioned, of those Gen 2 products may carry a discount moniker such as Daily Special, but clearly a vapor product, a concentrate product, a pre-roll product carries a higher margin. So I guess the way I would sort of cut that up would be that 70/30 premium-to-discount or 70 to 30 of those Gen 2 products plus a premium flower product to discount price. I do think you're going to see a leveling out of the discount flower business in Canada. Clearly, the inventories will continue to be right-sized, and there clearly is a pathway forward.

We're also seeing from the provinces as they're starting to go through SKU rationalization and a focus on profitability per SKU that there'll be greater interest from them as well as the retailers on having a more premium focus and a more accretive sort of margin approach as it pertains to Gen 2 versus just low-cost flower. Operator?

Operator (participant)

Our next question is with Michael Lavery with Piper Sandler. Please proceed with your question.

Michael Lavery (Senior Research Analyst)

Thank you. Good evening. Just would love to get a little more thoughts on the U.S. You've touched on it some. You've made it clear that you've got an interest in maybe making a move ahead of significant reform. Maybe what would it take to what's a sufficient catalyst for that? And/or is something sort of like Canopy's, Acreage deal what you have in mind, or is there another pathway on your radar?

Miguel Martin (CEO)

Absolutely.

It's a great question. I mean, Michael, obviously, we're staying very close to the shifting legislation and policy landscape that's taking place in the U.S. I think to sort of reframe the question a bit, and then I'll talk about the triggers, I think it's important to understand what type of company we think is going to be successful in the U.S. We continue to believe that a company like Aurora or companies like us that have a history of operating in a compliant, highly regulated federal environment like Canada or Germany will be advantaged in a federal U.S. construct. I clearly believe the FDA is going to play a role in cannabis, and other federal agencies will play a role in cannabis in the U.S.

Those companies that have operated in that successfully, whether that's manufacturing, GMP, ISO, labeling, sales, and marketing practices, will all have significant legs up there. That's not to say the MSOs don't have their own advantages, but Canadian LPs that are science-based and compliance-based and have experience will benefit. It's, I think, a little bit short-sighted to say that those companies that have been successful around the world wouldn't also be successful in the U.S. Now, in terms of catalysts, the course of legislation is promising. We've heard comments, obviously, from Senator Schumer and others. We're seeing iterations of whether it's the SAFE Banking Act or MORE or STATES Act. I think, first and foremost, a version of the SAFE Banking Act that would allow a bit more clarity around financials, I think, has to make sense.

Interstate commerce, clearly, I think, is a benefit and is of interest to many key parties, including ourselves, and I think you're going to see something on that. And then from that, what type of investment makes sense? I think it's hard to say, but what I can say is we put the cash on the balance sheet to be opportunistic. And I think there's a lot of different ways that a company like Aurora can monetize its experience, its genetics, its IP, its brands, and whether that's through M&A or whether that's through partnership, we'd have to see. But clearly, there's going to be a significant advantage that companies like Aurora will have at a time in which the U.S. legalizes cannabis. And I think we're excited about that, and we'll take advantage of it when the time is right.

Operator (participant)

Our next question is from Pablo Zuanic with Cantor Fitzgerald. Please proceed with your question.

Pablo Zuanic (Research Analyst)

Good. Look, I mean, just a question for Glen. Obviously, this quarter, medical was 75% of your gross profit. So in terms of the domestic medical business market, that market is not growing, so it's probably going to get more competitive. You're saying you're maintaining your gross margins there. But talk about the stickiness in that business because, yes, you are the leader, but other companies are also talking about gaining share in medical, which is very attractive given the margins. And Glen, second question related to that, you doubled your exports, CAD 6 million-CAD 12 million. Is that new number sustainable? Do you stay there or were there some one-offs this quarter? Thank you.

Glen Ibbott (CFO)

Thanks, Pablo. Great questions. What we're seeing in Canada and medical is continued strength and actually growth in the quarter.

Sorry? Operator? Okay. What we're seeing is growth in Canada, and as I mentioned, year over year, we've seen that growth. With a renewed focus on that segment, we've actually put new leadership in there and working very, very hard on making the patient experience as easy as possible. Think Amazon, right? Just make this a beautiful experience and a focus on our high-value patients. We actually see tremendous opportunity there, Pablo, and we're not signing up to the presumption that that's a market just to be milked and see it through to the end. So no, we expect growth out of that, and we certainly have some internal targets that would be part of that plan over the next couple of years. Internationally, yes, we benefited this quarter from a sale into Israel. That was about a little over CAD 3 million.

We had significant growth across the rest of the country that we sell in. Germany itself was up 21% quarter over quarter. Poland, U.K., a number of countries in Europe are showing good, strong growth. And so that might run a little counter to what you're hearing from others, but even in the face of COVID headwinds, our international medical business continues to accelerate, and that's been growing quarter over quarter. Now we're adding new countries. So the Israel supply agreement may be a little bit lumpy quarter over quarter, but just modeling it in long-term, it is going to be an important market for us.

Pablo Zuanic (Research Analyst)

Thank you.

Operator (participant)

Our next question is with David Kideckel with ATB Capital Markets. Please proceed with your question.

David Kideckel (Managing Director)

Hi. Good evening. Congrats on the quarter all.

I wanted to take this pretty high-level here, Miguel, with the recent acquisition of GW Pharmaceuticals and other company that I cover. I'm wondering what you think the ramifications are for the industry as a whole, but also Aurora specifically, just given your strong base within deep science and plant genetics. Thanks.

Miguel Martin (CEO)

David, thanks for the great question. I think it's validation. If you look at what they paid for it, if you look at what they were getting, if you look at how they plugged into it, clearly the economics of a strong scientific base, genetics, IP, biosynthesis, all the things that you talk about a lot, was recognized as a significant value in that situation. So I think it is validation.

One of the most important aspects of the U.S. is going to be how genetics and IP and that type of those type of assets work in the U.S. There's obviously litigation right now against GW that I think will really set the stage for where that sits, but there's no reason to believe that this category won't operate similar to other categories, and there will be companies like Monsanto. There will be a pharma approach to cannabinoids, and it's a deep bench of opportunities there, so I thought it was very bullish sort of representation of the value that we have there. Clearly, experience and compliance and science will win the day in the U.S. We've seen that in Germany. You see that in France with the recent tenders. You see it in these other markets.

And clearly, the same companies appear to be winning time after time after time, and Aurora is one of them. And so that's one of the reasons why we're really bullish on the category, particularly as it pertains to the U.S., because we have that experience. But you're right. The science piece outside of the brands and the rec and the consumer action is really an untold part of the story, and I think a really exciting piece of it.

Operator (participant)

Our next question is with Andrew Carter from Stifel. Please proceed with your question.

Glen Ibbott (CFO)

Andrew, we're not hearing you.

Miguel Martin (CEO)

Andrew, we couldn't hear you.

Andrew Carter (VP)

I apologize. Can you hear me now?

Miguel Martin (CEO)

We can. Go ahead.

Andrew Carter (VP)

Absolutely. Sorry about that. Good afternoon. I wanted to ask about kind of what your expectations are from the consumer business because we have the COVID lockdowns in place right now.

I assume that's hitting the shipments for the provinces. Obviously, a seasonally lower quarter. Should that be flat? You've taken obviously a lot of adjustments. Kind of give us kind of a thinking of how the Canadian kind of consumer business is trending next quarter.

Miguel Martin (CEO)

You got it. Well, Andrew, listen, it's a bit of a convoluted answer. So if you think about what's happening in Canada right now, there's a couple of things that make it difficult to sort of predict exactly what's happening. First and foremost, you mentioned COVID. That's having an impact, particularly in Ontario, in the ability of stores to be open and consumers to access their products. Secondly, you're having the provinces in a very sort of aggressive way start to bring in things like SKU rationalization and a variety of other aspects to it.

Third, there are a lot of sort of LPs that are sitting on low-cost flowers. So I think that's a long-winded way to say we're going to be in this environment, I think, for a bit longer until we see COVID and the stores open up. I don't think you're going to see back to that normal growth, but I do expect we'll get back to last quarter's growth, and we're optimistic about that. Right now, there's roughly 1,450-1,470 stores. I think every expectation that's going to double in the next six months, and there's a lot of incentive for it to double. We also continue to see volume move from the illicit market or the legacy market into this type of market.

And so I think it's hard to predict, Andrew, but I think this disruption that you're seeing right now probably gets you to the, I don't know, beginning of the summer, and then I think things will take off pretty aggressively. The flip side of that is we haven't really seen an impact in the medical business, which is obviously really strong for us. And so I think for those that participate in the medical business, you're not going to see the same type of disruption, which benefits folks like Aurora.

Operator (participant)

Our next question is with John Zamparo with CIBC. Please proceed with your question.

John Zamparo (Equity Research Analyst)

Thanks. Good evening. I wanted to follow up on the earlier question on the international medical business over the next couple of years.

I mean, presuming no legalization of any major countries, do you think the primary driver of this growth is going to be taking share or just addressable market growth? And then secondly, are there arrangements similar to Cantek that you're working on right now that we could potentially see over the coming quarters? Thanks.

Miguel Martin (CEO)

Yeah, John, thank you. I think if you think about international sales, we see growth opportunities even in existing markets. I think as the products become more accustomed to the patients, if the systems become more developed, the economics become more developed, I think you're going to see a growth like you've seen in medical markets in the U.S. And so we're very bullish on existing markets. What you also see in some of these markets is a movement, obviously, from medical to rec, and that's a potential in Israel.

I think Israel is early days, but very exciting in terms of what we're seeing there with Cantek. We mentioned in the written remarks, sort of prepared remarks, about getting three of the nine tenders in France. Between what's happening in France and the U.K., those are really significant markets, and there is an evolution there. So we have no reason to believe that international can't continue to grow. And while we'll always be looking to take market share from our competitors, one of the things we do see in those international markets is there's a pretty high barrier to entry. It's expensive, requires a certain skill set, requires a significant amount of experience, requires EU GMP manufacturing in many cases, which is why we're so thrilled about our facility in the Netherlands that we describe as Nordic.

And so I'm very optimistic and bullish on the international markets, whether we get a massive movement in terms of countries opening up or not.

Operator (participant)

Our next question is with Tamy Chen with BMO Capital Markets. Please proceed with your question.

Tamy Chen (Director)

Hi. Thanks for the question. I was wondering if you're able to help us understand or possibly even quantify of your consumer revenue mix this quarter, how much was in that Daily Special category and how much was the Aurora, San Rafael, Whistler? And then on the gross margins, Glen, I apologize, I may have missed this, but I just wanted to better understand when you talk about the underutilization or the less absorption of fixed costs, as we think to the fiscal Q3 quarter, I apologize if I missed this. I mean, do you expect that that headwind is larger because it's a full quarter impact?

If you could just kind of clarify again what you meant by that this headwind might reverse course? Thank you.

Glen Ibbott (CFO)

Let me start with the gross margin plan and then Miguel can kind of chime in on Daily Special where he's expecting that to go. What he's referring to with Sky is we actually took the costs out right at the end of the quarter, and I think you saw that we announced publicly mid-December reduction in headcount and some of the costs that vary with production levels. We didn't actually get much of a cost reduction in the quarter, although we took production down. What we'll see in Q3 is that those costs will be gone for the full quarter. We expect on a per-unit basis to recover a little bit in terms of our efficiency there. Not wholly.

There is some fixed costs, and when we're operating at a 25% capacity, obviously those fixed costs make each kind of per-unit measure a little bit more expensive. So we should see improvement in Q3. I have to tell you, Tamy, when we think about margins and EBITDA and just the business, we're really taking purposeful long-term decisions to create value. So I'm a little, I'm going to say this, not so fussed about what this will look like in Q3, but over time, we know it's the right thing because a big part of what we're doing at Sky, yes, aligning our production with our demand, but almost as importantly is repositioning Sky to be able to produce our premium products.

You can think of the difference in the economics, as Miguel alluded to, when we're selling products from that facility that generate three, four, or more times the gross profit dollars. That's a big part of it. We expect margins to improve through two things, just the full quarter of the cost recovery, but more importantly, shifting to a higher average selling price coming out of that facility. Miguel, your thoughts on Daily Special and where we're at and what?

Miguel Martin (CEO)

Yeah. I mean, Daily Special had a high watermark, 13%-14% share back in March and April. It really had that sort of price point to itself, and now it's roughly half of that. We've made significant changes in Daily Special. That's not to say we're focused on discount, but as I mentioned, pretty significant changes to the potency and THC levels of that product.

I think we'll have to see where that falls. I'm much more interested in San Raf and, to be honest, Aurora and Whistler. It's early days on that turnaround plan. It's got really sort of three parts to it. The first will be the higher quality product. We've seen it in already getting through Quebec, which has lower days on hand than some of the other provinces, and we've been pretty pleased with that. We'll start to see it in the other quarters. You'll pick up on it in Hifyre and Headset data and Buddi data that I know you look at. And then start to see some further work on Aurora and Whistler.

So hard to say where that's going to land, not knowing the competitive thing, but as I mentioned earlier with Vivien's comment, long term, we'd like to see 70% of our revenue come from premium products in Gen 2 and 30% from the discount area, particularly low-cost flowers. So I think the best answer, Tamy, I can tell you, is our first launch with that vapor product. We were pleased with that. The next was concentrates, and it takes a little bit longer on the flower, but this quarter and next quarter, I think you'll start to see that, and I'll be able to give you a better answer in terms of mix and blend.

Operator (participant)

Our next question is with Matt Bottomley with Canaccord Genuity. Please proceed with your question.

Thank you. Good evening, everyone.

Matt Bottomley (Managing Director and Equity Research)

Just wanted to dig a little deeper on the adult use penetration here when we look at maybe consumer mind share. Took a step back here in sequential declines in the consumer side, but can you give any color as to how you think your sales to end users out of these dispensaries? Because I think the inventory balances and the lower days of sales on hand here is affecting all the players across the board here in Canada. So just any color on how you think your branded products are actually selling in these dispensaries, particularly relative to last quarter. And then lastly, any commentary on your Adjusted EBITDA for next quarter? I know you said last earnings season that potentially you'd get close to break even this quarter. So is that possible as we look to fiscal Q3? Thank you.

Michael Lavery (Senior Research Analyst)

You got it.

So on the Adjusted EBITDA, part of the change in the financing allowed us to not have to hardwire EBITDA targets by quarter. I understand people are interested in it, but there are things that you want to be able to do to naturally run your business. As an example, the significant investment we made to put higher quality product into the system, take back lower quality product, accelerate it through the provinces, has an impact on EBITDA. If we were just singularly focused on that, we wouldn't do it, which is not the right thing for the business, nor is it the right thing for the consumer. So what I can tell you, Matt, is it's our intent to make progress. We've done that here pretty significantly, and we intend to keep doing that.

It is my stated goal to run a profitable business, but I think hardwiring or giving guidance to a particular date when you have a category that's this dynamic and moving this quickly, I think you do yourself a disservice. In terms of takeaway data, we get some from some of the key accounts that we partner with, a Choom or a High Tide or a Meta or other Nova or others. What I would say is what you would expect. The newer higher quality, higher potency product, we see much better take rates. I mentioned the 8% quick move that we saw in our vapor launch. Concentrates are doing really well. I think it's a bit early days on some other sides of the flower. What I will tell you, though, is you're right. There definitely is an impact across all LPs, what's happening.

It's not just COVID, though. It's also, I think, the evolution of how the provinces are handling days on hand, how they're handling SKU rationalization, how they're handling the cadence of new products. It's definitely a change, and I think as they adjust to it, and I give them a lot of respect for how they're going about it, as the rest of us try to navigate that as well, it will be a bit bumpy, but in the long run, I think it's the right thing for the category, particularly as you're adding so many stores. So I think we're in a bit of a weird time here. There are impacts across the system as we get on the other side of COVID and the more stores open, and the data gets better, which is something we're really pleased with. The data is getting better, the syndicated data.

I'll be able to give you a much better answer in terms of retail takeaway and some of the other core metrics that you're used to hearing from.

Operator (participant)

Our next question is with Matt McGinley from Needham. Please proceed with your question.

Matt McGinley (Managing Director)

Thank you. So you noted that you expect to see continued improvement in the rate of free cash flow burn, but the top line at present doesn't look like it'll be strong enough to revert the cash flow back to a positive state without a substantially larger inflection in revenue or cost structure. So the question is, how much offense can you play with strategic M&A if you're still burning cash at such a high rate? Unless the M&A is cash generative, which it seldom is, do you feel the visibility into improved operating fundamentals is there where you could do that without putting the company at risk?

Miguel Martin (CEO)

Listen, we continue to expect to make progress on it. I think we're getting close to a point where things look a lot different than they have historically. If you look at what we need to be able to execute our plan, we don't need cash to do it. Our last big significant investment we needed to make was the finishing of the Netherlands facility to be EU GMP, and we do expect the rec business to turn around. The other three parts of our business are doing really well, so we're comfortable with it. In terms of being able to make a play, I don't think it's out of the woods that there would be something that would have upside to it that would allow it to be more obvious, but we're not concerned about it. This is the best cash position we've ever had.

This is the best state the balance sheet's been in for a long period of time, and we're going to continue to find efficiencies and work our way forward. So I'm not concerned at all that we have what we need to execute our plan. I'm not concerned that we don't have what we need in order to make a move if we needed to.

Operator (participant)

Our next question is with Vivien Azer with Cowen. Please proceed with your question.

Vivien Azer (Managing Director)

Thanks for taking the follow-up. I just wanted to clarify, Miguel, I apologize if you misunderstood my question or I didn't deliver it well. My question was around targeted mix shift between medical and consumer given the very high margins on your medical cannabis business.

Miguel Martin (CEO)

You got it. I'm sure you didn't say it wrong. I'm sure I misunderstood it.

I expect medical to be steady and potentially slightly up, as Glen was quite articulate. We have not seen margin compression in that business. In terms of from a mix difference, we do expect to see growth in the rec business and there potentially is upside internationally medically. I don't know how to put that all together other than saying we don't believe that the Canadian medical business is going to decline, and we do think we can not only grow it but gain share. You've seen some pretty significant union announcements around medical cannabis benefits that give that an opportunity. I also think that there's opportunities in moving some folks from the legacy market into it. Internationally, medically, the medical business has the potential to be stronger. We're seeing early days in Israel.

We're seeing growth in other key markets such as Germany and Poland, and we do expect to grow the rec business. How that all plays out with COVID and store counts in Canada is hard for me to say, Viv, but that's how I would sort of describe it. So I apologize if it doesn't give you the precision that you may want.

Operator (participant)

Our next question is from Adam Buckman with Scotiabank. Please proceed with your question.

Adam Buckham (Analyst)

Good evening. Thanks for taking my question. Now, I just wanted to touch on the Reliva business if possible. Now, it looks like it contributed roughly CAD 1 million to the top line in the quarter and CAD 2.7 million on a six-month basis, which I believe is a little bit of a deceleration versus historicals.

Can you maybe walk us through what the bottleneck is on the CBD side and then what catalysts we should be looking for in terms of acceleration in this line?

Miguel Martin (CEO)

Great. I'm more than happy to talk about Reliva. The catalyst is very simple. It's FDA regulation. We've seen some very positive news as of late around DSHEA and the potential placement of CBD within a dietary supplement framework. We'd have to see what that looks like. It was always my belief that the additive nature of Reliva to Aurora, a company that has science and deep genetics and a variety of other things, puts it in a place where Reliva would be advantaged with the FDA in the same way that you saw vapor companies be advantaged with the FDA as they connected up with large tobacco companies. So there's that.

I mean, Reliva right now is wonderful optionality, and the reason I think you've seen a bit of a deceleration is COVID has pretty dramatically affected grocery stores, supermarkets, convenience stores, and pharmacies around foot traffic, and so it's just not as viable. Now, that being said, we continue to garner significant regulatory learnings and experiences. The fact that those products are in stores, in 23,000 stores, and are in the top three wholesalers in the U.S. gives it a pretty significant leg up at a time in which I believe we will have comprehensive FDA regulation, particularly around ingestibles. So we're excited about Reliva.

We'll be launching a new brand called KG7 that I mentioned in our prepared remarks, and I clearly expect whether you want to say that the US CBD business is $2 billion or $5 billion or $10 billion, that under an FDA protocol that allows for the sale of it by compliant companies, Reliva is going to be advantaged. I think that's going to be a time in which it definitely will be material to it. The other part is Reliva is a brick-and-mortar brand. I know in an age of e-comm and Amazon and everything else, but the reality is it requires a lot of regulatory expertise to operate in brick-and-mortar stores, and we think that's a big advantage for us at a time in which the FDA, I believe, will pass comprehensive science-based legislation. That's how I would describe the Reliva situation today.

The only other point I would make is we are seeing international markets open up for CBD, and that's exciting, I think, for a brand like Reliva. You may even see that throughout the Aurora system in a variety of different ways that complement the infrastructure we have in those countries. So I think that's another piece of it, more to follow on that in future quarters.

Operator (participant)

Our next question is with John Chu with Desjardins Capital Markets. Please proceed with your question.

John Chu (Analyst)

Hi, good evening. I guess my main question here is with the pivot to a premium focus, the key question for me is whether or not Sky is capable of producing premium flower. So I'll just stick with some of the text I've read in the MD&A.

You're still conducting tests on Sky's abilities, but can you give us a bit of an insight as to how these tests are progressing? Because obviously, being able to produce that premium flower Sky is core to this premium strategy. Thanks.

Miguel Martin (CEO)

Yeah. I'll be happy, John. I mean, first, though, let me remind everybody we have other significant facilities beyond Sky. Obviously, Sky is one of the largest and is an important piece in producing high-quality flower at a low price. So we have tremendous experience, whether that's at facilities like Whistler or River or Ridge or whether it's at our Nordic facility. So it's not like we're new to producing 20-plus potency products with high terp levels and high quality. So there's a long history of Aurora being successful with Whistler, with San Raf, and Aurora products. As it pertains to Sky, we are making progress.

It is a pivot, and there's no question about that. We made the tough decision of taking it down to 25% production that allows us the ability to test a variety of different mechanisms and systems and cultivars and genetics at the Sky facility. I would argue, though, that we have some of the deepest experience and some of the best scientists, and so we're well on our way to see that. We also are complementing that process through external buy, which allows us additional flexibility. But I think the best thing I can describe is we're early on to that process. We just made the decision in December to take it down. I think we'll be able to talk more specifically about it in the coming quarters, but this isn't reinventing the wheel. This isn't establishing new protocols or developing new skills for us.

It's taking what we've been able to do for years in other facilities and applying it to the Sky facility. So that's how I would describe it.

Operator (participant)

Ladies and gentlemen, we have reached the end of the question and answer session, and I would like to turn the call back over to Miguel Martin, Chief Executive Officer.

Miguel Martin (CEO)

Well, thank you, everyone. We really appreciate it. We're awfully excited about where the company is. We're even more excited about where the company is going. We appreciate your questions. We appreciate your interest. And while it's early days for me as the new CEO, I can tell you the team, the infrastructure, and the entire strategic plan is well on track, and we look forward to bringing you even better results in the quarters to come. Thank you. I hope all your families are safe and well. All the best. Bye.

Operator (participant)

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.