Good morning, and welcome to Canopy Growth's Second Quarter Fiscal 2019 Financial Results Conference Call. Early today, Canopy Growth issued a news release announcing its financial results for the second quarter ended September 30, 2018. This news release will be available on Canopy Growth's website and filed on SEDAR. On the call this morning, we have Bruce Linton, Canopy Growth's Founder, Chairman and Co-Chief Executive Officer, and Tim Saunders, Canopy Growth's Chief Financial Officer. At this time, all participants are in a listen-only mode. And certain matters discussed in today's conference call or answers that may be given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect results are detailed in the company's annual information form and other public filings that are made available on SEDAR. During this conference call, Canopy Growth will refer to supplemental non-GAAP measurement, adjusted EBITDA. These measures do not have any standardized meaning prescribed by IFRS. Adjusted EBITDA is defined in the press release issued earlier today as well as in this period's Management's Discussion and Analysis document that will be filed on SEDAR after the close of financial markets today. Please note that all financial information is provided in Canadian dollars unless otherwise specified. Following the prepared remarks by Mr. Linton and Mr. Saunders, the company will conduct a question-and-answer session during which questions will be taken from analysts. [Operator Instructions] I would now like to turn the meeting over to Bruce Linton. Mr. Linton, please go ahead.

Great. Thank you and good morning, everyone. I know we're all going to want to talk a lot about what's going on in Canada in the first 30 days, but I want to frame what we're talking about I think in a bit bigger, more interesting way. We've run through as a company, the whole start-up phase in Canada and what you saw in this last quarter was really the ramp-up and I think what you’re going to see is there are sort of three 6-month segments of how this market's going to go. And the first 6-month segment is only 30 days old, but that it's going to be three sprints, which are get out of the gate and get the stores filled, the stores continue to be built out and the products roll in. The second part of it is going to be to keep up with the channel demand as we enter to the third phase, which is the more comprehensive products and I'll come back to that, but we don't generally give a comment on consensus or analyst numbers, because this is such a new sector and so all I would say is I don't think analysts were wrong on the target number, but I think they were early on the quarter and that I don't feel particularly concerned that you're way off on the year for our fiscal year. But you need to look at the things I’ll come back to later as the variables on that. So to kick off, really, what we've been focused on is the future in our opinion is intellectual property and converting cannabis flower into an ingredient and building it up to more value add products. And so we haven't historically talked a lot about the 15 clinical trials…

Yeah. Thank you, Bruce and good morning, everyone. Yeah, I think the key takeaways today are one, we had strong double digit medical cannabis sales in line with management expectations. Two, strategic acquisitions and investments have further strengthened our IP capabilities critical to our long term success. Three, we are well positioned for a strong start to the recreational cannabis market in Canada. And four, as Bruce outlined, we are building a strong presence in key international markets. So I’ll now proceed with a review of the second quarter. Revenue for the second quarter ended September 30 was $23.3 million, representing a 33% increase over the same quarter last year. Revenues in the second quarter were line with management’s expectations, leading into the opening of the recreational cannabis market. By intention, the company made limited test shipments amounting to $700,000 in order to test supply chain systems and logistics before the launch of recreational cannabis on October 17. Volume sales into the recreational channels did commence after the quarter end. In the three months ended September 30, 2018 and ’17, oils, including soft gel capsules, accounted for 34% and 18% of product revenue respectively. The total quantity of cannabis sold during the three months ended September 30 was 2197 kilograms and kilogram equivalents at an average price of $9.87 per gram, up from 2020 kilograms and kilogram equivalents last year, which were sold at an average price of $7.99 in the same period last year. The higher average price was due primarily to the change in the product mix, including the increased sales of oils and gel caps and higher priced strains as well as sales into Germany. The average price for a gram sold in Germany during the second quarter was $13.58 per gram. We have and continue to…

Thank you, Tim. I think I bet there are some questions that we might as well advance straight into those.

[Operator Instructions] Our first question comes from the line of Tamy Chen from BMO Capital Markets.

My first question is on the US market. It's looking like the Farm Bill for CBD may come first before the states act for federal decriminalization. And my question is, if so, could you talk a bit about what your initial strategy into the US may be under the Farm Bill.

Sure. So I had mentioned earlier in the call we have been hemp farmers for this past summer and busy on the processes related to drawing in the potential for extraction and scaling a bunch of IP and that results from an acquisition that we announced probably a year ago for some parties that had substantial hemp experience. We think a lot of that will carry over. What we want to do though is recognize that when hemp becomes convertible to CBD that I suspect will cause the effect of price of CBD to go to an extremely low point and so it's really going to be about the science of converting and its outcomes. And so things like the clinical trial we're running on, how do we make dogs less anxious, will have, I think, implications on how do we make geriatric adults less anxious in products that will be registrable with actual claims based on science. And so really what we're looking at is what do you turn CBD into versus how do you farm it, despite the fact that we think we’ll probably need to be in the farming and extraction business as well. And so I think we're well positioned with the resulting products you’d want to begin to launch that actually use the CBD in an effective fashion versus making claims that we see in the market in the US right now that aren’t validated.

And my follow-up is more on the EU side. So we're seeing growing momentum for further medical legalization in Europe. So could you talk a bit about Canopy’s strategies for the Europe medical opportunity and what advantages Canopy has relative to both other Canadian license producers and as well as other producers in Europe or Israel or LatAm with respect to getting into the Europe medical market over time?

So I think Europe is actually the most or almost the most exciting activity going on. So we've been busy in Germany. I think, we've been sending product there for, I guess, approaching two years. We have been educating physicians and pharmacists with our Spectrum educational package. I think we've had about 1000 pharmacies in Germany move our product and we're now in the process of seeking approval for upgraded formats of the product. We have plants in the ground in a couple of countries in Europe already in greenhouses. We have unannounced activities tied up in some of the emerging locations, because they're not material, we didn't announce them and we think that what we found over the years is everything we announce is a good idea and everybody tries to follow it. So our preference is now that we're executing before announcing and so it'll become evident what we're doing. But really most of the places want proven medical outcomes and they are not just looking for a medical ingredient, which is essentially what it’s classified in. And so I think a lot of the work we're doing is thoughtful and the trial design that that result and the methodologies would be, at least on an expedited basis, able to be introduced into the other geographies as evidenced. So, we're liking Europe a lot, we like the fact that the payee is often the government and the population seems to be somewhere in that sort of 400 million to 500 million, depends who you want to roll in, including the UK right now. We've been quite busy there.

Your next question comes from the line of Martin Landry from GMP Securities.

Bruce, you mentioned that your SKUs obtained I think 30% of listings in physical stores nationwide.

30% of the currently in stock inventory nationwide.

Sure. So meaning as of yesterday or?

Well, as we've been sort of running up, it sort of hovered 25% to 30%, but yeah, what our expectation was that, people might take things away from the medical world, push everything into the [rec] [ph] world, as it sells out, they don't have things for either market. That was not our strategy. We wanted to be like a sustaining winning race rather than a flash out of the gate.

Yeah. My question was more -- there was a limited number of stores operational, even today. So I find it would be probably a little bit more helpful if you can talk maybe about your market share in Ontario, the largest market in October, how you fared?

Yeah. So when we looked at it, we really had to be polite about the prior plan, which was to have almost no stores, call it 35 of them, population of 7 million people where there's over, I think, 800 liquor stores. So when you're in the sector, you say that's a good idea, because it's improper to say it's a bad idea to the government. It was a bad idea. When they then said we're flipping, we’re going to have the private sector create a lot of stores, that actually is a good idea. But in the interim, where it's a website where you can’t actually affect anything other than, you put it up and somebody buys and they saw was it the right stuff, did they make a good decision, is shipping going to be reasonable? We've been pretty up the curve on Ontario. I think the first place the OCS came to learn about cannabis was the Canopy Store in our business I should say at Smiths Falls. And it was our view that if they were successful in selling on the web, they would be unsuccessful in fulfilling, because it is a very different business, B2C than it is B2B. It took us four years to ship 1 million packages and they will have to ship a 1 million packages in 30 days probably. So we didn't push the OCS. We supported them, but it's -- where our push has been is where the physical stores are. So it's been a very intentional and will continue to add to what they have there, but it hasn't been our biggest priority to have the most product and push on Ontario. I think physical stores like Alberta, Quebec for sure, New Brunswick, Newfoundland, those jurisdictions have been where we pushed as hard as we could.

And if you’d have to pick a market share that you think you've achieved so far in direct market, can you give us some sort of order of magnitude for us to work with?

Well, we're not -- so we've gone 30 days of launch where there were almost no stores as we've discussed. There were only websites in some places. What we're looking at is how do we sustain our delivery, how do we differentiate our products and how do we migrate people from buying Bud to buying format so that actually make us all more margin. And I think when you look at that over the 90 day period of Q3 for us and over the fiscal balance of the year to the end of March, we know we’ve stated our goal is that we'd be disappointed if we had a 30 share, but we're working for that as the minimum and I don't think we're in a spot where we have the limited resources of cannabis or the limited formats. So I think we're going to be durable and get there and so that's the revenue opportunity.

And just finally, is there any – do you have any bottlenecks internally that could prevent you to attain these numbers at this point?

Sure. Every day, there is a different bottleneck, but I would suggest that they're more less of an issue, so things like applying those damn excise stickers was a bottleneck because they didn't want to apply to certain things and we were running short runs which meant we couldn't put as many packages through, but I would say with our engineering and operations team, we feel like we're actually getting, moving and maybe the mental image is watching, we talk internally about watching the races, where are you saying bull would always win, but he didn't start off leading because he had to get the momentum going. We feel we're in a bit more like that mode, but moving around bottlenecks, that’s where we have internal resources to run all of these things and not outsource. And so it feels like we're in very good shape to deliver the product, fill all the orders, have all the formats. It's feeling like a very solid position.

Your next question comes from the line of Vivien Azer from Cowen.

From a high level perspective, I'm going through my model and I'm hard-pressed to find a quarter over the last four years where your revenues declined sequentially. Yet, the first quarter where you're ramping into, adult use which I appreciate having waves and whatever lots of – had hits and starts as the market transitions, like I'm hard pressed to understand like how you guys posted a 10% sequential decline in revenue. So help us understand that please.

Sure. So really there was no product shipped. Functionally what we're doing was stress testing the system at our request with all the provinces so they can actually make sure their bar codes match with our -- their scanners matches ours, but really there was, call it, no revenue shipped to the provinces. But with all the hubbub around it, what we saw was a bit of a distraction we think in our medical customers and a couple of hiccups in terms of getting the normal run rate to Germany in terms of permitted exports and the product approvals and things getting across. So I’d attribute half of the decline to just not a normal course Germany and a little bit of a pause with the medical people. Now that said, once rec happens, I think we're going to see an uptick in truthful conversations at doctors' offices because before rec was available, if you said to your doc, don't really like the side effects of my RA medication, they might look over their glasses at you and wonder if you just wanted to party. Now, you have that choice and we have a doctor discussion. I think, people are going to be more transparent. So we'll see over the next couple of quarters, but I think you’re going to see a strengthening of the medical business and Germany, I think, we're now back on normal track. So yeah, it is the first time in our history that I'm aware of where we actually had a slowdown, but I think it was more of a distraction than a pattern.

Okay. And then the follow up with that please, given your commentary on consensus and despite the fact that we are materially below consensus you came in, below both our estimates and the streets, so I think it would be prudent for you guys to comment on the cadence of the revenues for the back half of the year please?

Yeah. I think most, we’re expecting that the provinces will be taking product in a material way and as we look across the entire sector, the provinces were not ready to take product and then it became urgent and it remains urgent on the product shipping. So when we look at it, I think the other way to open it, as I said, you are early on the anticipated volume, but I don't think you're materially wrong on and I can't comment on every individual, but as we look across the general group on what the year could look like for our fiscal. And so, we really, I think, we're starting to slide into the model as you're thinking about it. We tried to signal on September 27 that we were not shipping to provinces other than stress testing I think was the exact phrase we used. So, now, it's prank time and it's feeling like the provinces are starting to get their momentum as well.

Your next question comes from the line of Oliver Rowe from Scotiabank.

So you touched on it previously, but with the Constellation deal closed now, could you just elaborate on your capital allocation plans, how you plan on putting that 5 billion to work and how you measure return on the capital?

Sure. So, we've been going through with our new board and with Constellation. We have a roster of elements we might wish to acquire, none of which are producers in Canada, but there are a number of technologies that we think make sense that are out there on a global basis. So that [indiscernible] mix of cash and shares would probably nibble up close to $1 billion of things that we look at and I’m not saying we're pulling the trigger on all of them. We're also building out a capacity to have a bottling line, which is now finalized and designed and site preparations have commenced. So we think beverages will be a formatted product that makes sense of the regulations of Canada. There is no certainty but we think that could be a be ready for Q4 calendar 2019. So that adds up a little chunk and then what we're trying to do is be ready as one of the callers talked about the crank in Europe is significant, but hemp in the US could be sooner than you think. And so we're going to have some dry powder ready to go rather than reacting and looking for capital and structuring that we will be instantly in. And so that build out, we’ll use it all, but the first building, we certainly have a plan on. And I don't know if Tim wants to comment more. We certainly looked at our models and we've become a lot more disciplined in NPV in the way we structure our acquisitions. And from a money management perspective, it's been quite remarkable to cast that wish to. Being a money manager, and I don't know if you want to speak to that Tim or further comment.

It's certainly the kind of the transactions we’re looking at the future. These are cash generating businesses or fifth strategic niches or needs that we have in the company so that they have earned themselves to more traditional ways of value these things as opposed to some of the M&A activity in the first couple of years of this industry where there was an unknown future, unpredictable cash flows. So there's a lot more rigor around the ability to valuate these investments and they’re actually traditional valuation models to make sure that we're covering the cost of capital and generating good returns, but most importantly, adding to the strategic needs that they need to build at this business.

So we've started to see companies locking in retail leases in Ontario, despite ongoing policy uncertainty. Have you made any headway on figuring out your strategy that could get you into the Ontario retail market? How do you sort of see that playing out?

Yeah. So the rules haven't been printed yet. Really, it's going to come down to certain definitions. We would be quite fine with the locations, which we have under, I'll call it, control that they became franchises that maybe they're operated by others, but the carrier brand, because really for us, retail does give you a little bit of torque, but you have to sell into the warehouse for the province and then out to retail. But data is critical, what's moving, what's not moving, what are the points of education that are causing an upsell. So we do want -- we want to be able to have access to data as our primary driver and we think we have a lot to trade in that process. We do expect to have somewhere between 1 and 4 licenses granted to us if it's based on license projection sites we have for in the province.

Next question comes from the line of Mike Hickey from Benchmark Company.

I guess it sounds like you're prepared to sort of map some pretty big resources to the US. You're probably one of them most people expect, but hopefully, the passing the Farm Bill. I guess just how big do you see the CBD market increase, because it seems to be exploding here, mostly anecdotal, but I’m just sort of curious the map behind your intent to probably take a big move to the US. And I'm also wondering as you think about building brands and products around CBD in the US that there’s a natural extension to recreational cannabis or medical cannabis down the road once we have the appropriate federal guidelines in the US.

Yes. So it's a bit of a touchy one to answer because we're still with our weekly updates on what's going on with GR, it's hot, it's cold, it's hot, it's cold, but right now, the indications are Farm Bill is hot. CBD I think, as an ingredient, can be very disruptive across everything from anti-inflammatory scenario, so whether it's sports drinks to other scenarios of that nature to, I will call it, anxiety modification or management. And it's going to come down to who gets the data to get the branded product that actually works and I think we're doing a very good job on that and I believe we have a leadership position on that. How big is the market? Is it going to be fragmented? Will they allow interstate commerce with CBD? What's going to happen with all the adjacent THC rights? So the definition I have as it has 0.3% or less THC, well, do you think about how many hundreds of thousands of kilograms of CBD are going to be extracted from hemp, multiply that by 0.3 and you end up with a lot of THC. Well, we have the right to use, THC and scientific endeavors. So there's a whole bunch of adjacent elements to that whole hemp discussion and we haven't actually factored in any of the utilization related to disrupting and things like that to offset somebody else's business, maybe, it's a saleable product, but the segment can be huge. The form factor, what you feed into an extractor as hemp is just really not a whole lot different than marijuana for THC. So I think you'll see a value of moving early and getting really good extraction as preparatory step. So you may see overspend to be extremely well positioned, but I don't think that'll be unrewarded.

Second question is sort of how you think about sort of second half calendar year ’19 and the legalization of edibles and content that you expect sort of the smoother launch or share expectations, et cetera. And then on to that, just sort of any updates I guess on your work with cannabis infused beverages in terms of onset duration, you’ve had some success there and I guess how you think about the market opportunity for induced beverages beyond the dispensary because at least a mistake, you have brand products, but it remains a rather niche market and you wonder if it's just sort of trapped in the dispensary was really hard to justify I think for a lot of retailers to keep shut, but your thoughts I guess on the small basket of questions will be appreciated?

So, I think the two parts were what about injectables, because I don't think it's going to be just edibles in the second half 2019. I believe no matter which government is in power, their objective will be to remain consistent which is they're not going to hold back this program, because it's going to be about diminishing criminal returns and the returns on [indiscernible] are very good. So I'm reasonably confident they will for sure stay due course on that launch and then it will be questions as to what evidence do you have of efficacy, safety, et cetera. Our governors in every province or state are the liquor authorities and I think if you come to Canada, you'll find that they principally sell beverages which are shelf stable and nothing else, so their comfort with that form factor is going to be very high. The second part though is, yes, we have been working on bioavailability flavorings and we have worked with Constellation on branding, analytics of who wants what when, there's been a lot of work on beverages and the fact that they have any share in most of the US markets surprises me because mostly what we focused on was what's wrong with the products that exist, which is takes too long to onset, has too much in it for duration and generally isn't a particularly appealing beverage in terms of coloration or flavor because a lot of masking agents. And I think our researchers have done a good job and I think Green Star, which was a Constellation division spent money well to look at where we need to hit. And when I left our facility on Monday, we were clearing and preparing the site where the bottom line will be and it has a scheduled construction that. I hope will let stay on and see the sort of complete sometime in May as far as the actual structural building. So I think we're lining up the governance model, the product and the production. Stuff could go wrong, but I don't think anyone else is in the same space, thought process or position at all as we are.

[Operator Instructions] Your next question comes from the line of Graeme Kreindler from Eight Capital.

I was just wondering, can you please elaborate on the strategy in terms of meeting and keeping up with growing demand in medical markets domestically and internationally on top of how you characterize it as sprint in the recreational market, how the company looks to stay ahead of the curve on all three of those.

So we're running, Tim, correct me if I'm wrong, I think we're at about 4.3 million square feet of approved production assets, which do include the capacity to extract and things of that nature. And we have about another 1.7 million-ish square feet that we think is ready for and generally should be approved almost, some of the buildings are still small portions and say New Brunswick or Newfoundland are at that stage, what we're talking 100,000 or 200,000, 300,000 square feet of that. And so we have, in our ops curve, our commitment to medical patients was that if you're a patient on July 1, when it was announced, we’ll always have the product for you. So what we map out is what does the market look like for medical, what's the form factor for medical which is shifting as you can see in our price point to increasingly gels and then our production up in Denmark and some of the products that we have been harvested down in Spain, we're focusing on how do they meet GMP or GAP practices so that they could actually begin supplementing our domestic production in Canada for product markets in Europe. And so that combination sort of looks like it works quite well to get through the target revenues that we have. So it does need to work, but it's not all new to us and the practices that we put in in places like Spain and Denmark bore quite a lot from what we've learned over 4, 5 years running greenhouses as the first operator in Canada. So it feels like it's going to work, it's going to come down form factor, but the shift to oil seems to be quite steady.

Your next question comes from the line of Vivien Azer from Cowen.

So first, I appreciate your strategy on focusing on brick and mortar stores versus e-commerce, but I'm having a hard time reconciling that commentary with the continued inventory build when a province like Quebec is so tight on supply that they're closing their doors 3 days a week. So help me square that.

So I think if you look at Quebec and who's showing up with the product, we're increasing our position and what we're fulfilling. So I wouldn't necessarily attribute their absence of product to us and increasingly not. So the first province in which we put our job caps was Quebec. We think that if they open and they keep scarcely happening in our products there, it's going to do quite well. It's not a perfect great word, everything's not balanced yet. It's a 6 month window, but that's the sort of shift, we're doing it and I think they'll have a time where they start opening their doors more and that the products they have represent more and more of us and Quebec is Exhibit A why we actually chose to put our jobs there first.

Okay. That seems reasonable. And then just as a follow up, pivoting to Ontario, you've got an e-commerce model only for the next like 5 or 6 months. So help me think through why that province in particular, given how large it is doesn't deserve a different strategy?

Well, I think as you get to that -- as you get further out, you will see more and more of our product there, because I think you're going to find that there's less and less of others and that we support them more and more, but we're going to have more and more stores open, right. I don't think the objective of Alberta’s 17 stores is a lot more. So it's going to be constantly a bottleneck balancing act. The initial order from Ontario was quite small and our subsequent order was quite large and there were bottlenecks for them in that a truck can arrive, but maybe it doesn't get up to the store for 7 or 8 or 10 days. So those things are all being worked through. You will see more of our product there, but we're talking about the first 30 days out of the gate. And our view is that people will buy what's ever there, there will be no limit – there will be no opportunity to inform them. It's going to sell out from most others and then we sustain ourselves is going to actually reward us with the top line growth that we want over the 3 months and 6 months, not the first 30 days. So just keep an eye on that site, it is as hard as it is to search stuff, like if you've been on that website as much as we have there are probably 100 things you'd like to fix on that website, but I bet they fix them and I bet we shop more.

Your next question comes from the line of Martin Landry from GMP Securities.

Two follow ups for me. Your gross margin, I think, came in around 28% and it was much lower than what we were looking for. I was wondering when can we expect things to improve on the production cost side. You're getting bigger scale, you're growing greenhouse which should be lower costs, at some point, at what point do you -- does your gross margin move up towards the 60%, 70% percent where it was at some point?

I think what you're seeing that during the quarter, we went from a 2.3 million to 4.3 million square feet of license space and during that time, there was still a lot of under-utilized capacity. So once -- we guess we’re now up to 4.3 million square feet after the most recent license upgrade in October. So you’re going to see more utilization. We’ve got approximately 4.4 million square feet of greenhouse space between [indiscernible]. Once those are fully producing, you’re going to see higher utilization at that space and cost of production. So what we're seeing is a period of transition, getting these facilities ready to produce and so those costs are pushing through right now in the P&L, but those will be behind us.

And I can’t remember, when you think about all the additional licenses granted, that was exciting and good news. What it meant though is much of it had to be turned into a clone factory. Now the clones are everywhere, they’re propagating out at those locations and we convert back into the primary purpose for the Smiths Falls facility, but you also get the yield of the other one. And so in this past quarter, you saw quite a lot of that going on.

So if I hear you well, Q3 should -- we should see a nice improvement on your gross margin line.

Yeah. It starts improving and then you start having -- at the initial point of racking Canada, provinces are screaming, get me product, which means that you don't necessarily optimize cost, you try to make sure you get them products or sometimes you might have to put on a plane, sometimes you're running a lot of overtime but we’re finding that craziness for the first 30 days is now starting to become a predictable, more reasonable model and we can actually start and really look at how we run the business versus how we satisfy the end of prohibition and I think you'll find that as we go through the quarter even. We really sort of walking down on that.

And my last question is, you had a marketing campaign, a national campaign with your high logo, wondering, do you have any data point you could share in terms of brand awareness or clicks that would help us understand a little bit how much traction your brand is getting.

Yeah. I don't have that right at my fingertips, but we're talking about it because in major markets, up until the night of the 16, we ran really effective pop-ups, meaning, engagement and community, billboards and systems that put Tweed front of mind further. And then we had to take them down and we did not receive a letter from House candidates to say that we were not in compliance because we actually took things down around them properly. Now if you go to a social event where it's perhaps in a bar which is 19 and over, you will see a stage back of my Tweed and you'll see bathroom posters where it's in those little steel frames and so we're staying in compliance and we're actually seeing quite good traffic and engagement, particularly on social media where people are posting up, but I don't have the exact click through data. I'll make sure for the next call I do.

And that concludes the Q&A portion of today's call. I’d like to turn the call back over to Mr. Bruce Linton for some closing remarks.

I think we've covered everything off and I will get now to explaining it to on CNBC and CNN and other locations in New York. So thank you for your time everybody.

This concludes Canopy Growth first quarter fiscal 2019 financial results conference call. A replay of this conference call will be available until February 12, 2019 and can be accessed following the instructions provided in the company's press release issued earlier today. Thank you for attending today's call and enjoy the rest of your day. Goodbye.