Aurora Cannabis Inc. (ACB) Q2 2021 Earnings Report, Transcript and Summary

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. [Operator Instructions] As a remainder 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.

Thanks Maria and good afternoon everyone, and thank you for joining us for the Aurora Cannabis second quarter fiscal 2021 conference call for the three months ended December 31, 2020. This call is being recorded today, Thursday, February 11, 2021. With me are Aurora's 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 calls from our respective remote locations, there may be brief delays, crosstalk 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.

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'd 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 reorganize the business, reset strategy and mobilize our entire team, where they are now organized behind our strategic plan. We're squarely on offence. 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 intent on 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 Neilson ranked CBD brand and continues to be a platform provides us with significant optionality in the US. And four, our Canadian rack business where we've seen the market react positively to both our Generation 1 and Gen 2 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 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 costs 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 US CBD. Combining the margin in these businesses are generally 60% or higher on a run rate basis. SG&A was 42.3 million excluding a onetime 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 $58 million swing to 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 565 million. The reduced cash burn plus our newfound balance sheet strength and flexibility allows us to act quickly to an opportunity to grow and take market share rises. So 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.

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. I would 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. For appropriate, I will also note the sequential period comparisons. For second quarter fiscal 2021, the three month period ended December 31, 2020, we saw a strong performance in our medical business, especially international sales. And we continue to transform our consumer business with the 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. Yeah, these actions impacted recorded 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 $70.3 million, excluding product return provisions of $2.7 million. Our consumer cannabis business delivered $31.1 million in net revenue prior to these return provisions, and our medical cannabis segment continued to accelerate, generating $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 $2.7 million of product returned provisions, our overall Q2 adjusted gross margin is 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. So under utilization 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 of reduced cost at Sky. Now I'll provide some additional insights into recorded 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. So growth is 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 5.5% increase in revenue year-over-year. In our medical segment, adjusted gross margins were 56% relatively consistent with comparative quarters and our Q2 margins were impacted by the capacity under utilization 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 a little to no price compression. With revenues currently at $39 million dollars and growing and the 60% plus gross margins, it's clear that the 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 $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're very pleased that our consumer derivatives net revenue was $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 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. As the route forward for this facility is not yet clear, during the quarter we recorded a non-cash impairment of approximately $228 million for the shutdown. Looking now to SG&A which includes R&D, we are pleased with our $42 million run rate in Q2. This excludes approximately $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 on. So pulling all of this together, we regenerated an adjusted EBITDA loss in Q2 2021 of $12.1 million and that's excluding revenue provisions and restructuring costs. That's a dramatic improvement from $69.9 million dollars adjusted EBITDA loss in prior year comparative. There was a further $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 in biological assets increased $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 our 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 $20.6 million of cash to fund operations excluding working capital investments is the further $2.1 million in 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 $8.8 million for capital expenditures in Q2, down from 15 million in the prior quarter and down from $128 million in the prior year comparative. We continue to expect cash used for CapEx to be below $40 million for this fiscal year. Increased net working capital used $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 $10 million in cash during the quarter, a marked improvement from $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 $565 million in the bank, and about $97 million of outstanding term debt that is not due until the end of calendar 2022. We also expect to receive some additional non-diluted 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 Q3 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. 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. Now I like to turn the call back over to Miguel.

Thank you, Glen. As you know, calendar 2020 was a difficult year. We made some tough decisions and faced several challenges, 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 offence, 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, 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 generated consistently high margins in the 60% 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 migrate 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 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 n 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 lives 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 has an asset light, sustainable growth platform in Australia and help physicians, pharmacists and patients access to high quality range of Aurora cannabis medicines. We're also seeing other countries began 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 in 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 KG-7 [ph] 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 they said it's a foothold in the largest cannabinoid market in the world, which bodes well for Aurora's global positioning. We'll 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 US. Stepping back and specifically on the US THC market, I would say the following. The US is clearly one of the largest markets today. With legislative reform that would allow companies like Aurora to operate THC businesses in the US. 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 we'll gain exposure to the current US THC market, but I can say we won't simply wait for comprehensive legislation. Although, we are assessing ways to legally address 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 US will look very different if THC is de-scheduled. And we believe social justice and economic reforms will ultimately drive it. For clarity whatever we do in the US, whether that be in THC or 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 whitespace given the market which is currently seeing a rollout of new stores. Currently there are 1,450 stores across Canada. We believe the store count can 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 to legalize adult use of 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 in flower, particularly with our high quality, high premium brands such as Whistler, , 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 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 US, there are vibrant premium offerings in all key categories exceeding our consumers. To that point across every CBG category, there's always a consumer segment that will pay a premium price for premium products. We're blessed with a few of the best brand in the cannabis industry, Aurora, San Rafael and Whistler. We're building brand ecosystems around each of them in various formats to foster greater visibility and provide greater choices to the consumers when they could work out the value chain. Achieving this goal acquire 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're 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 program that we do on Daily Special and the difference between gross margin contribution per gram can be four, five times or greater. Therefore we don't need to be cultivating a low potency flower for Daily Special. As a first mover in these decisions, we're better off sourcing that product in the wholesale market more efficiently. Of course premium segments will also be supportive of classic CPG sales, marketing, trade marketing, and consumer engagement methodologies to build awareness, foster affinity and generate outsized returns, and within vapes and pre-rolls there's 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 up from basically zero in September to approximately 8% at the OCS recently, which is great news. We've also launched a new product that really excited about our OG Chem [ph] concentrate, and the market reaction has been extremely strong and we would expect to start seeing similar gains in other marginal created 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 cause. 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 Aurora Sun facility and successfully reduced capacity utilization by 75% at Aurora Sky facility. This will allow us to focus on premium quality flower at this facility. We're already seeing data that the higher value higher margin derivative products 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 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 presented 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'll now turn it over to the operator for questions. Operator?

At this time, we will be conducting a question-and-answer session. Our first question is from Vivien Azer with Cowen. Please proceed with your question.

Hi, good evening thanks. My question is on your mix by 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 than 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 '22 for instance? Thanks.

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

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

Thank you. Good evening. I just would love to get a little more thoughts on the US. 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 for – 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?

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 US. I think, to sort of reframe the question a bit and then I'll talk about the triggers. I think, it's important understand what type of company we think is going to be successful in the US. 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 US 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 US. And so 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 US. 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 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 it's 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 have to see, but clearly there is going to be a significant advantage that companies like Aurora will have at the time in which the US legalizes cannabis, and I think we're excited about that. And we'll take advantage of when the time's right.

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

Good, look, I mean, just a question for Glenn. 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 maintain 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, 6 million to 12 million. Is that new number sustainable? Do you stay there? Or were there some one off's this quarter? Thank you.

Thanks Pablo, great questions. What we're seeing in Canada in medical is continued strength and actually growth in the last quarter [Technical Difficulty] 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 we're working very, very hard on making the patient experience as easy as possible. You think Amazon, right, they just make this a beautiful experience. And in a focus on our high value patients, we actually see a tremendous opportunity there, Pablo and we're not signing up to the presumption that a market just to be milked to 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 $3 million. We had significant growth across the rest of the countries that we sell in. Germany itself is up 21%, quarter-over-quarter. Poland, UK, a number of countries in Europe are showing good strong growth. And so that might sound 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's going to be an important market for us. Thank you.

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

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.

David thanks for the great question. I think it is validation. If you look at what they paid for, 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 talked 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 US is going to be how genetics and IP and that type of – those types of assets work in the US. There's obviously litigation right now against GW that I think will really set the stage for where that fits, but there's no reason to believe that this category won't operate some of the other categories and there will be companies like Monsanto, there will be a farmer 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 for when the day in the US, 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 there was 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 US, because we have that experience. But you're right, the science piece outside of the brands and the rack and the Consumer Action is really an untold part of the story and I think a really exciting piece of it.

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

Andrew we're not hearing you.

I apologize. Can you hear me now?

We can go ahead.

Absolutely. Sorry about that. Wanted to ask about the kind of the – what's 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 adjustment, kind of – give us kind of a thinking of how the Canadian kind of consumer business is trending next quarter.

You got it. Well, 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 skew rationalization, and a variety of other aspects to it. Third is there are a lot of sort of LPs that are sitting on low cost flower. 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 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.

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

Thanks. Good evening. I wanted to follow up on the earlier question on the International Medical business over the next couple 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.

Yeah, John, thank you. I think if you think about international sales, we see growth opportunities, even in existing markets. And then as the products become more accustomed to the patience, 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 US. 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 rack 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 or the prepared remarks about getting three of the nine tenders in France. Between what's happening in France and the UK 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 and as 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.

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

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 margin, Glen, I apologize, I may have missed this. But I just wanted to better understand when you talk about the under utilization 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. And if you could just kind of clarify again, what you meant by that this headwind might reverse course? Thank you.

Let me start with the gross margin, Tamy and Miguel, you can kind of chime in on Daily Special or is expecting that to go. What I was 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 are very – vary with production level. So 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. So we expect to put 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 in a 25% capacity. Obviously, those fixed costs make each in a per unit measure a little bit more expensive. So we should see improvement in Q3. I have to tell you, Tamy, like when we think about margins and EBITDA and just the business, so we're really taking purposeful long-term decisions to create value. So I'm a little – I'm going to say this, not so fast about what this will look like in Q3, but over time, we know it's the right thing, because we're 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. And you can think of the difference in the economics, as Miguel alluded to, when we're selling products from our facility that generates three, four or more times the gross profit dollars. So that's a big part of it. So 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, you touch on the Daily Special and where we are at and where we wanted to?

Yeah, I mean, Daily Special at 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 turret levels of that product. I think we'll have to see where that falls, I'm much more interested in San Rafael and to be honest, Aurora and Whistler and still 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 is lower days on hand than some of the other provinces and we've been pretty pleased with that. We'll start to see it and the other quarters, you'll pick up on it on high fire and headset data and buddy data that I know you'll 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 and Gen 2 and 30% from the discount area, particularly low cost flower. 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.

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

Thank you. Good evening everyone. Just wanted to dig a little deeper on the adult use penetration here when we look at maybe consumer mindshare, took a step back here in sequential declines in your – 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 in here, it's 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.

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. So 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 hasn't impacted 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, 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're a bit – we get some from some of the key accounts that we partner with a Tume [ph] or a High Tide or Meta or Nova or others in what I would say is what you would expect. The newer higher quality, higher potency product, we see that much better take rates. I mentioned, the 8% quick move that we saw on 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 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 skew rationalization, how they're handling, the cadence of new products, is definitely a change. And I think as they adjust to, and I give them a lot of respect for how they're going about it as the rest of us trying 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. 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 your other core metrics that you're used to hearing from.

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

Thank you. You noted that you expect to see continued improvement in the rate of free cash flow burned. 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 substantially larger inflection in revenue or cross structure. So the question is like how much offence 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?

Listen, we continue to expect to make progress on, 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 EU GMP. And we do expect the rack business to turn around. The other three parts of our business are doing really well. So we're comfortable with it. In terms of know, 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. We've had the – this is the best cash position we've ever had. This is the best state the balance sheets 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 and I'm not concerned that we don't have what we need in order to make a move if we needed to.

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

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.

Vivien I'm sure you didn't say it wrong. I'm sure I misunderstood it. I expect medical to be steady and potentially slightly off 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 rack business and then 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, but gain share. You've seen some pretty significant union announcements around medical cannabis benefits that give that opportunity. I also think that there's opportunities in moving some folks from the legacy market into it. Internationally, the medical business now 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 rack business. How that all plays out with COVID and store accounts in Canada? It's hard for me to say that, but that's how I would sort of describe it. So I apologize if that doesn't give you the precision that you may want.

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

Good evening, thanks for taking my question. Now just wanted to touch on the really, really the business if possible. Now it looks like it contributed roughly 1 million to the top line in the quarter and 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?

Great, I was pointing out when I talked about Reliva. The catalyst is very simple. It's FDA regulation. We've seen some very positive news, as of late around the Shea and the potential placement of CBD within a dietary supplement framework, we'll have to see what that looks like. It was always my belief that the additive nature believe it 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 being advanced for the FDA as they connected up with large tobacco companies, so there's that. I mean Reliva right now is wonderful optionality and reason I think you've seen a bit of a deceleration is COVID has pretty dramatically affect grocery stores, supermarkets, convenience stores, and pharmacies around foot traffic. And so it just is 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 US give 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 KG-7 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. And I think that's going to be a time in which it definitely will be material to it. And the other part is Reliva is a brick and mortar brand. And I know in an age of e-com and Amazon and everything else, but the reality is that 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, so that 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. And you may even see that throughout the Aurora system in a variety of different ways that compliment the infrastructure we have in those countries. So I think that's another piece of it, more to follow on that and future quarters.

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

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 flick from some of the texts 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.

Yeah, I'd 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 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 product with high temp levels and high quality. So there's a long history of being successful with Whistler, with San Rafael and Aurora products. And as it pertains to Sky, we are making progress. It is a pivot, 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 what 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.

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.

Well, thank you everyone. We really appreciate it. We're also 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.

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