Aurora Cannabis Inc Q2 FY2022 Earnings Call

Greetings, and welcome to the Aurora Cannabis Second Quarter 2022 Results Conference Call. At this time, all participants will be in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference is being recorded. I would now like to turn the conference over to your host, Ananth Krishnan, Vice President, Strategic Finance. Thank you. You may begin.

Thank you, Diego, and we appreciate you all for joining us this afternoon. With me today are CEO Miguel Martin; and CFO, Glen Ibbott. After the market closed today, Aurora issued a news release announcing our financial results for the second quarter of fiscal 2022. The release, accompanying financial statements, and MD&A are available on our IR website and via SEDAR and EDGAR. In addition, you can find a supplemental information deck on our IR website. Listeners are also reminded that certain matters discussed in today's conference call could constitute forward-looking statements that are subject to risks and uncertainties related to our future results or business performance. Actual results could differ materially from those anticipated in these forward-looking statements. The risk factors that may affect actual results are detailed in our Annual Information Form and other periodic filings and registration statements. These documents may be accessed via SEDAR and EDGAR. Following prepared remarks by Miguel and Glen, we will conduct a question-and-answer session. For retail investors, we have compiled questions submitted to us prior to the call. For industry analysts, we will ask that you limit yourselves to one question and then get back in the queue. With that, I would like to turn the call over to Miguel. Please go ahead, Miguel.

Thank you, Ananth. We are pleased with our transformation plan and we're tracking with adjusted EBITDA profitability in the first half of fiscal 2023. That's less than a year away. Here's why. First, we remain the number one Canadian LP and global medical cannabis with strong sequential sales growth and margins exceeding 60%, roughly twice that of our competition. We continue to see growth in the number of countries including the UK, Israel, Australia, and Poland. And our experience and process-driven approach gives us a leg up to profit from the significant opportunity. Second, and this is great news, we continue to rationalize our expenses to the current environment and manage the Company with far greater efficiency. In Q2, we achieved the annualized run rate savings of $60 million. That is nearly double the $33 million we referenced back in November. And I'm pleased to report that we now believe that we will achieve the higher end of our targeted $60 million to $80 million savings annually by the first half of fiscal '23. Importantly, none of these cost savings will impact planned growth investments. Third, our balance sheet remains one of the strongest in the industry, and we continue to be smart in allocating capital. Moreover, our capital structure supports both organic growth and provides us with the resources to evaluate strategic M&A. Fourth, we recently launched our science and innovation business known as OCO, which we intend to use to deliver a continuous stream of innovation to the market. This business already has one of the largest catalogs of high-quality and high-potency genetics, IP and biosynthesis available for licensing. We've already commercialized several cultivars with other LPs, as well as our own San Rafael brand. We currently have more than 30 high-quality cultivars not available anywhere else in the market that are ready for media trial and exclusive licensing. Bottom-line, this is a capital-right long-term revenue growth opportunity we're really excited about. Let's now discuss our medical business, which is number one by revenue internationally and in Canada. I'm proud of the team for continuing to find ways to profitably grow the medical cannabis market globally. What sets us apart from the competition in international medical is our regulatory expertise supported by our compliance protocols, testing and science that are recognized and highly regarded worldwide. These attributes put us in the pole position for success when these markets open recreationally. During Q2, we demonstrated exceptional growth of 24% in international medical revenue compared to Q1, with success stories in the EU, Israel and Australia. In Poland, we delivered a total of 290 kilograms in the quarter, which included the largest shipments of any LP into the country. To date, according to the Chief Pharmaceutical Inspectorate, we expect this success to continue as we look to launch new cultivars there in Q3 accompanied by a marketing push. In Australia, our revenues have doubled year-over-year through our exclusive supply agreement with MedRelief Australia. We offer medical patients an EU GMP-certified range of products, including dry flower oils, soft gels, and plan to shortly expand our offerings to include vapes and gummies. 2021 was an excellent year for the Australian market, driven by more mainstream acceptance from patients and doctors and ongoing growth in authorized prescribers. We anticipate continued growth in 2022 as Australia strengthens its import requirements, which are already qualified for, and continues to ease patient access regulations. In the UK, we continue to surpass expectations with our revenues increasing more than fivefold compared to Q2 last year, with the growth driven by a rapid increase in patient numbers. We have already built a leading position in the flower segment and continue to see growth in patient numbers with no erosion in pricing. While the UK, Australia, and Poland are still in the earliest stages of development, we would expect all of these countries to be significant profit drivers for us in the future. In Germany, we have the number one and number two best-selling products in dry flower for all of the last calendar year and a growing share of its oil market, following the recent launch of our balanced extract. While we did experience some softness in Q2 due to some competitive pressures and smaller-than-expected market size growth, Germany remains the largest market in the EU with 83 million citizens, and we are extremely bullish on our future there given the new coalition's plans to legalize adult recreational cannabis and improved medical patient accessibility. While the timelines and regulatory framework are yet to be announced, our leadership position in medical puts us in a very strong position when that milestone occurs. In France, we are preparing our third shipment for the pilot program, where we are the exclusive supplier of dry flower, having secured all three of the available dry flower tenders in the French medical cannabis pilot program. In the Netherlands, we invest in Growery, one of 10 licensed holders involved in selling only legally produced cannabis, in approximately 80 out of 600 coffee shops in the country. We expect to recognize revenue beginning in calendar 2023. And over time, this is predicted to be a $2.8 billion market. We continued our success in Israel, by shipping over 10 million units of cannabis to our partners there in Q2. As of today, we do not expect to recognize revenue from Israel in Q3, but we remain committed to the Israeli market and our partners there, as they grow their business in the coming quarters. In these developing markets, predictability of revenue can be affected by regulatory complexities, such as the timing of government approvals and import permits. However, our reach in the multiple jurisdictions hedges us against this. I want to be clear here, we believe the growth story of the next several years in cannabis will be that of international medical and recreational, and we expect a domino-like effect as acceptance grows. Where there is money to be made in a federally regulated structure, Aurora will be there. And we will win because of our agility and unique set of capabilities, which I mentioned earlier. Some estimates put the cannabis market in the EU alone at $5 billion by 2025, and we expect to grab a sizable piece of this. This will ultimately help drive us to sustained profitability and generate shareholder value as markets develop. Turning now to the Canadian medical market, which we see as a competitive advantage for Aurora and is our most profitable business segment. Our overall revenue was flat in Q2 compared to Q1, although our market share expanded to 23.4%, up from 19.8% in the same period last year. Most importantly, our insured patients made up 72.7% of our domestic medical sales, up from 57.6% in Q1. We are excited to see opportunities for growth in attracting medium groups, employee insurance programs, as well as opportunities to pick up market share with our best-in-class patient experience. We have also launched a number of products and innovations that we believe will appeal to patients. Regarding the Canadian adult rec market, our Q2 revenue decline reflects ongoing macro challenges. There is a lot of excess inventory and increased pressure on older SKUs, which together has resulted in price compression. This irrational market is unsustainable in our view, and we are not going to chase unprofitable market share at any cost. Our focus is on maximizing profitability by leveraging our low-cost production facilities and selectively entering categories that have higher margins. We have the scale and resources to outlast the current environment. And once the market consolidates, we'll be in a strong position. In Q3, our innovation pipeline consists of 25 SKUs, which benefit both rec and medical channels. Highlights include three new cultivars from our breeding program, the launch of our refresh Drift brands, our first offering of infused pre-rolls in hash and a bevy of new vape, edible and concentrate flavors which we expect to hit the market in March. Our full year 2022 innovation calendar includes over 80 new and high-potency SKUs, which would be our most significant and successful innovation push since legalization. I would now like to turn the call over to Glen so he can provide his financial review.

Thanks Miguel. Good afternoon, everyone. I'll now review our fiscal Q2 2022 financials. These results clearly demonstrate the inherent strengths of our business model and how well we are executing our transformation program, which is ahead of schedule. So let's begin with a few key highlights. We have one of the strongest balance sheets among Canadian LPs, including approximately $445 million in cash as of yesterday, no term debt, and access to a $1 billion shelf perspective. This perspective includes a $300 million ATM, from which we have recently drawn down nearly $90 million, meant to position us to take advantage of strategic M&A opportunities in the future. Our cash flow continues to improve with $20.3 million used in operating and working capital in Q2 compared to $67.3 million in the same period of last year. And we continue to progress towards our EBITDA positive milestone, reducing our loss this quarter by over 20% from last quarter to $9 million, as we begin to see the cost savings from our business transformation plan flowing through the P&L. In short, we have more than sufficient cash on hand to fund operations and we are moving closer to profitability. Q2 net cannabis revenue was $60.6 million, a slight increase from last quarter. Net revenue would have been 4% higher but was reduced by a $2.4 million provision reflecting past and current international shipments that had batches outside the targeted potency range. This provision is not expected to recur. Our leadership in medical cannabis continued to deliver a robust overall growth along with consistently strong margins of about 60%. This enviable margin profile has held steady over the past few quarters and is the key gross profit driver for our business, distinguishing us from our competitors and is critical for us in reaching positive EBITDA in the first half of fiscal 2023. SG&A and R&D also remain well controlled, down 10% quarter-over-quarter as we continue right-sizing costs. These expenditures are already a fraction of what they were in years past and will be reduced further as we proceed through the implementation of our business transformation plan. Clearly, our overall Q2 results benefited from a large broad diversification across the international medical, Canadian medical and adult rec segments. So now let me address each of our core businesses in a bit more detail. Our leading medical businesses in Canada and Europe continued to perform exceptionally well, generating $45.7 million in sales and a gross margin of 62%. Medical represents about 75% of our Q2 revenue and about 89% of our gross profit. Canadian medical revenue was $26 million in Q2, up slightly, but really reflecting the consistent performance compared to Q1, even as the consumer retail market continues to roll this out. As we have said previously, our Canadian medical patients can be segmented into two groups: those with cost reimbursement coverage and those without a reimbursement program. Our success in Canadian medical cannabis is really driven by our insured patient groups because reimbursement makes them consistent and high-volume buyers. While we have seen some migration of price-sensitive non-reimbursement patients from the medical channel to our direct channel, we have been able to attract more insured patients, resulting in steady sequential revenue and an overall market share increase. Our international medical revenue is $19.8 million, reflecting 67% growth versus the prior year and 24% sequentially. Q2 revenue included slightly over $10 million in sales to Israel, which we believed to be the largest export of medical cannabis to the Israeli market. Excluding the one-time $2.4 million provision, international medical revenue was up 87% year-over-year. Sales to Israel do not recur every quarter, so to give you a sense of the underlying international business, excluding the impact of Israel sales in Q1 and Q2, international revenue was up 41% sequentially. Recall that BDS Analytics estimated a market size of about $3.2 billion by 2025 for just the medical markets in Germany, Poland, the UK, France, and Israel. So clearly, Aurora's leadership internationally is an important driver of long-term shareholder value creation. Our Q2 consumer revenue was $14.8 million, which reflected a 22% decline compared to last quarter. Consumer cannabis represented about 24% of our Q2 revenue and about 11% of our gross profit. The revenue decline is primarily attributed to price adjustments in our core and premium products, intended to improve sales velocity by reflecting the continuing price compression in the market. The average selling price decrease was partially offset by a 5% positive shift in the company's brand mix from daily special to San Rafael '71, as Aurora continues to pivot towards premium offerings. In fact, San Rafael pre-roll and flower revenue is up 18% over the last two quarters, driven mainly by the new cultivars launched in our Q1. While we saw an increase in sales towards our premium brands, our consumer gross margins declined to 24% in Q2 from 32% last quarter. This was driven by downward pricing pressure partially offset by an improvement from the shift to premium. Also negatively impacting margins this quarter were opportunistic bulk sales, which depressed margins in the quarter. Turning now to SG&A, which includes R&D, it remains well controlled coming in at $44.6 million in Q2, which included approximately $3.7 million in restructuring and other one-time costs. So SG&A is $40.9 million, excluding those costs. We have already made progress in driving down SG&A, but we are certainly not done. In fact, we expect our quarterly run rate will be well below $40 million by the time we exit this fiscal year. In Q2, we also recorded a $31.6 million inventory provision as a result of facility consolidation and the clearing out of obsolete inventory balances. This provision included a non-cash net realizable value adjustment of $11.5 million, driven by price compression in the market. So pulling all of this together, we generated an adjusted EBITDA loss in Q2 2022 of $9 million. The $2.5 million improvement in adjusted EBITDA loss, as compared to last quarter was primarily driven by the $3.1 million decrease in SG&A, while revenue and adjusted gross margins remained relatively steady on a consolidated basis. Let's review our path to adjusted EBITDA profitability. Approximately 60% of cash savings under the business transformation program, now estimated to be close to $80 million, will be reflected within our cost of goods as inventory is drawn down, following the implementation of our lower production cost structure. We would expect to see those savings in our gross margins and logistics costs beginning late fiscal '22 and into next year. The remaining 40% of cash savings will show up in SG&A as they're executed, and we see that now beginning in Q2. Overall, we exited Q2 having executed plans that result in annualized run-rate cash cost savings of $60 million. So, we're well on our way. This concludes my remarks, there are three key takeaways from this financial review. First, our balance sheet remains strong, supported by a healthy cash balance and improved working capital and cash flow. Second, our medical businesses in Canada and international, so clearly differentiating us from our competitors, are critical parts of Aurora's target of sustainable profitability, having delivered 89% of gross profit this quarter. And finally, we are ahead of schedule with a transformation plan and now expect to be at the high end of our $60 million to $80 million total annual cost savings range. This reinforces our already clear path to adjusted positive EBITDA in the first half of fiscal 2023 through actions that are within our control. Now, I'll turn the call back to Miguel.

Thanks Glen. Before Q&A, let me share some final takeaways. Aurora is laser-focused on EBITDA profitability and long-term growth, and we're making significant progress on both. First, we are getting to the high end of our cost reductions, which is great news and our medical cannabis revenue growth globally shows tremendous promise given our regulatory expertise and the trend of medical converting to recreational. In Canada, the recreational market will eventually correct, likely with fewer players, which will provide us added opportunity. And our science and innovation program adds another capital-light opportunity to our portfolio. Lastly, our balance sheet is in the best place it has ever been, which positions us for continued organic growth and strategic M&A, and the transformation plan is firmly on track. We appreciate your interest and time today, before we take questions from analysts that cover our stock, I'll turn the call over to Ananth so he can ask a few questions from our retail shareholders. We're invited to submit questions. Ananth, please go ahead.

Thanks, Miguel. Our first question is regarding the stock price. What are your plans to improve the stock price and perhaps reassure shareholders?

Well, I mean, obviously it’s a question we get a lot. I think first and foremost, you have to go back a little bit in time and understand that there was incredible exuberance about the growth of the global cannabis business that starts with the U.S. We have been saying for a year that the U.S. is a ways off. We also believe strongly, and I spent my entire career working in the U.S. with regulated agencies, that it's going to be a medical focus, with the FDA regulating the product with decriminalization, and then we'll see a pathway towards recreational. That's what we are seeing in other markets, and we'll see it there. Canada and the challenges in Canada around the recreational business – I know many people are incredibly focused on the recreational business as opposed to the medical business, which I'll talk about in a second. But the recreational business in Canada is only three years old. You've got roughly half of that business still in the legacy market and you have irrational marketplaces. We've spoken about it. There are 250 LPs today. That's twice as many as there were a year ago. You've got excess inventories and people having negative gross margins on key products. That's not sustainable and now it's going to turn around. We recognized quicker than almost anybody else that we've had to right size that recreational business so that we can be in a situation to not have that overextended incredible success that we've had in medical. So I think first and foremost for investors, is really focusing on the long-term versus the short-term. And the long-term for cannabis is incredibly bright. If you look at key markets, such as Germany and France, and the UK and Israel and on and on and on. Those are big markets where you're seeing medical cannabis grow in significant places. Also, you're seeing the same companies win time after time after time. Secondly, we've done the things we said we were going to do. We are focused on shareholder value. We're focused on being profitable. And this was another good quarter, making progress. The EBITDA progress was a 22% improvement over last quarter. And we are reaffirming the guidance to be EBITDA positive by the second half of our fiscal 2023. Things that we've done are setting up for shareholder value in the future. We've talked about the balance sheet. We've talked about the cash position. We are properly allocating the capital to high-growth, high-margin opportunities. And lastly, when you think about long-term benefits, Aurora has significant assets that haven't been monetized yet. IP, biosynthetics, and genetics will always play a significant role in agricultural products all around the world. So, I understand the question and I understand the history, but I think if you look forward and take a longer view, you see that there are a lot of traditional elements that you would look at most companies, that Aurora has.

Our next and last question pertains to our path to profitability, Miguel. What gives you confidence that we're on track to meet our stated EBITDA timelines?

Well, I think anytime you're looking at a company and seeing if you believe what they're saying, you should look at what they've done. And if you look at our history of announcing an additional $60 million to $80 million in cost efficiencies, we're already at $60 million, and we're really commenting today that we're going to be at the high side of that. Secondly, progress has been made so far; positive EBITDA doesn't happen overnight, and we've made progress once again this quarter. When you look at aspects of what would be a drag on that projection, we quickly moved out of those less profitable areas, such as key components of the adult recreational business in Canada, and markets that we may have participated in that didn't have upside, and yet still found the cash and investment to do innovative deals, such as the Growery in the Netherlands, where even now legally, we can have a majority position. We can consolidate and recognize revenue as early as 2023. So we're on track; we demonstrate that what we say we're going to do, we do, and I think we're always keeping the shareholder in mind as we make key decisions.

Thank you. We will now open our question-and-answer session on the phone. Our first question comes from Vivien Azer with Cowen. Please state your question.

So I wanted to focus on medical and the supply appears very strong results, but in particular, your Canadian medical business, Miguel, the call outs during the prepared remarks around the benefits of insurance coverage were really interesting to me. And I would love for you and Glen to expand on that. So one question in two parts. First, can you just level set on the scope of insurance reimbursement as it stands today? And then part two: What are the opportunities to expand patient coverage or from a reimbursement standpoint?

First, I'm going to talk more at a macro level, and I'll address your point on opportunity. I'll let Glen walk you through the reimbursement numbers, the percentages, and the key stats, and we can obviously follow up for details of the key components in that. In the medical business in Canada, it is a really good business. And again, with my people, I know it's a bit older than the recreational business. But it really is starting to develop sophistication. It really is a direct-to-consumer business. We've done a lot of things that I think most people would expect out of a customary DTC business, but it's harder to do in medical cannabis. And all of these things have really been focused on not only increasing the basket size, but acquiring new patients. While all of our overall revenue is flat, as we mentioned, we grew market share. We have almost a 23.5% market share today of the medical business, up to 19%; the closest competitor is half of that. Firstly, we've added significantly to the portfolio of products and premium products. We have found that our patients are particularly interested in premium cannabis products. I think most people would understand that with medication, but it's coming a little bit later to the overall cannabis business. Secondly, the service for not only the patients, but for clinicians and physicians has consistently improved. And looking at that, there are several reasons to think that we will continue to grow share in that critical category. The other two points I'll make are that the infrastructure to service the medical patient both to acquire, retain, and move through that process is incredibly expensive and requires an incredible amount of effort, which is why you see so few competitors doing well. The other part is, it is completely portable, and a lot about that same infrastructure and knowledge and experience with patients in the Canadian market is directly applicable, which is why we are dominating in other key markets such as the UK, Germany, and France. The regulators have a common set of understandings. So Health Canada has an outsized impact on the regulations in Western Europe, as well as Israel and other markets. So again, muscle memory, expertise, portability all factor into growing the overall medical business not only in Canada but internationally.

Thanks, Miguel. Yes, it's a great question. A minority of our patients do the majority of the ordering and delivering the majority of the gross profits and there are the reimbursed patients. Now, there is a significant portion of our patients who have the highest number of veterans and first responders in the country, and they are a critical group. Obviously, this is a really important medical treatment for them, if you're dealing with PTSD or if you've been in a war zone, you've been in the front lines of healthcare or policing. This is a really important treatment for you. Through some of the coverage programs that some of these folks qualify for, they are reimbursed for up to high single-digits per gram on cannabis. So they become a little less price sensitive and much more focused on getting the right medicine, which is a really critical component of this. So, I think they are a great group. It's an important treatment for them, but strictly financially, they really drive repeat orders at high average dollars per gram. For the growth that Miguel was alluding to, we have told you in the past that we've invested in technology to support our medical business. This is a key part of it, as employee or employer benefit programs, and some of the insurance providers that run those programs, offer us medical cannabis as an option. They do under health spending accounts. We have got the infrastructure now to connect directly into their system, so that a patient can order medical cannabis without having to go out of pocket for it and be directly covered through the insurance program, through their work. So, that's an opportunity for us to continue to work on the reimbursed or insured patient group, which we think probably provides the best, stickiest, highest value patients. This is also quite frankly near and dear to our hearts, as we actually are making a difference in their lives. Thanks for the question.

Thank you. Our next question comes from Michael Lavery with Piper Sandler. Please state your question.

Thank you. Good evening. You've touched before on how medical and international medical is attractive in part because of the high margins and price points. Can you help me reconcile, you talked about international sales being up 24% sequentially in the quarter, but then your company-wide average selling price was down 10% sequentially. Was there any of that pressure from international or what are some of the pricing dynamics there? How should we understand what that looks like?

Yes, Michael, the pressure was not international; it was domestic. I'll let Glen walk you through the numbers, but we had pressure from some opportunistic wholesale selling which, as opposed to destroying product, we sold it at a very low point. We also had some pressure in the recreational business. Some of that was offset by mix. But the international margins really haven't moved at all, and they're incredibly strong. The reason why, and I'm always surprised, there is not more interest in it—medical cannabis is the fastest growing segment of cannabis internationally. You're seeing huge markets really being put on the path of thoughtful, legislative process to bring cannabis forward. You don’t need a list of all the countries where we’re in 12 countries, and some big ones. The margin setup because it’s really medications run through a federal contract does not have the same market pressures and is a much more challenging end of the business. I mentioned that a year ago there were 125 LPs; today there are 250. There’s only a handful of cannabis companies that can meet the incredibly strict requirements internationally. In Germany, for example, you have to be within a 10% range of specs both potency and top levels. People will say that’s pretty broad, but it’s not when you have a balanced product that only has a 10% THC number or a 1% variance on an agricultural product. It is really hard. So international is where the growth is; international is really hard to do well. The same companies are winning time after time. The margins are great, they’re not moving, and you’re seeing steady progression and consistency in how the countries look at it. Glen, anything I missed on the margin?

No, great talking about the margins or insights into the margins. Michael, specifically about average selling price—yes, there’s a little bit of pressure in the consumer market. Our average price in our Canadian medical market came down as we proactively adjusted a couple of key products down to the reimbursement level I talked about just to make sure that there’s no impediment to these first responders and veterans ordering. So it actually picked up the velocity, even though the ASP was down slightly overall. Internationally, listen, we had some very high ASP markets come on this quarter. But the Israeli sales are bulk sales. And so, the way they show up in our average selling prices may actually look like they’re decreasing ASP, but the margins are extremely high because they’re just shipping a big bale of cannabis. There is no post-harvest handling; there’s no bottling again in that stuff. So margins are great even though the average selling price per gram may go down. It’s a great question because I think in the future we’ll have to fill out a little bit for you to give you the transparency on the impact of large international bulk sales in our ASP, because quite frankly, if we pull that out, you’ll see our ASP going up.

Just along the same lines on international markets. Can you talk more about the stickiness that you’re talking about? Because when I hear about shipments to Israel, I wonder that buyer could switch to another supplier next quarter. I'm sure they're going to buy from Colombia yet to regulatory issues. So, I want to understand the control that you have over the supply chain there. Are they selling your brand? Do you have your own salespeople on the ground? Or are you shipping from Canada and they take control of the value chain, which means it won’t be so sticky? Then the second point when you talk about this unique ability to navigate complex regulatory environments, that sounds great, but in Germany, when only 0.1% of the population is patients, I wonder how unique that really is? I mean, I suppose other companies, as domestic patients grow in Germany, will also have that skill set. Could you expand on those two points?

Sure, we are happy to. Israel is unique, and that I've spent a lot of time with that situation. What you have today in Israel is you've got roughly 100 local growers, including growers that are on the combusted side, and they hold really an outsized political influence. The situation in Israel right now—a country of 9 million people—is that locally they've not been able to grow the quality of cannabis that they need in that market. It’s a very high margin market. A 10-gram increment is going for about 360 shekels. What you’re referencing is the least sticky of all the markets. Why is that? Because right now, Canadian LPs and others that can meet the spec. Now the spec is incredibly hard to meet. CUM CS, the IMCA, which is the regulatory agency in Israel, has created what may be one of the strictest, if not the strictest barriers to get into pesticide testing that no one else sees. But if you can meet that standard, you can get your product in, and import permits go through hot and cold. Because cannabis is so hot right now, there's not a lot of brands—what I would call equity—with the possible exception of a local grower such as maybe InterCure. There's not that much stickiness for Canadian LPs because the brands haven't developed themselves. If you can meet the standard, you can get your product in, and because there’s such demand, you can get there. I think over time Israel will get stickier. I also think over time the local growers who are getting better each and every quarter will have a larger percentage if not the majority of sales in Israel, which is why we talk a lot about successfully diversifying your business in the early days. You’re going to see quarters like we had this quarter, where we shipped the largest shipment ever in Israel. We held the record previously as well. We are saying that in the quarter we are currently in, we're not going to have a shipment. So it's going to go hot and cold. Now, stickiness outside of Israel is absolutely strong. Getting into Germany, for example, is a year-plus challenge and requires significant investments in filings, packaging, product production, naming conventions, and those clinicians are pretty steady with what they pick. Australia is another one. If you have a new SKU in Australia, it takes 6 to 8 months just to get it registered. That's not the case in Israel. The other markets are absolutely sticky. If you look at the concentration of those companies that are successful, it’s the same companies in France, the UK, Germany, and so on. They all share the same common elements: history in medical; strong product portfolio; exceptional regulatory excellence; and a commitment to significant investment that takes a couple of years to return. That’s not unlike other regulated markets in other categories. Israel is a bit of a one-off, but all the other markets are there. You also don't see the margin degradation we talked about in these medical markets because there’s really no incentive to do it.

I wanted to ask, so you said—so I guess, instead, I want to ask about the Canadian consumer business. You've reiterated the positive EBITDA. What does that consumer business have to do? Does it have to stabilize, or conversely, could you just go with a 100% medical focus? Would you be able to—with some incremental savings—be profitable?

Great question. So right now, as we mentioned, the Canadian recreational business is completely irrational. You're seeing core SKUs that are selling at a significant negative gross margin. You're seeing an exceptional amount of over inventory, and you're seeing a situation like with Quebec where you’re seeing a 16% to 20% drop in sales because of the vaccine mandate required to enter either an alcohol store or cannabis store. The current market continues to be impacted by COVID. Obviously, the LPs also have impacts because of labor. Short term is defined by the next three to six months. You're seeing an acceleration of downward pricing in discount flower and other categories. We recognized we had to exit certain categories that don't make sense and lose money. We won't chase. If you look at the average selling price and you can see that, you'll see the dramatic decline across core product categories, particularly in the value segment. Overall market share is not as much of a focus for us. We'll spend time looking at categories that are profitable. If it means market share going away, fine, but gross profit is what’s going to drive us to overall profitability. I think we’re trying to get away from what’s the market share and what’s happening on the revenue side and really focus on driving in the areas that allow us to be profitable in the Canadian consumer market and add that to the already strong position we have in the medical market to create a strong company.

I'll just add—just to second that. As I said in prepared remarks at San Rafael, I mean in using it as an example of investing in the right places. San Rafael is quite profitable for us. We saw an 18% increase in pre-rolls and flower over the last two quarters because we launched some nice new cultivars into that. As Miguel mentioned in his remarks, we’ve got a lot of innovation coming, a number of new cultivars under different brands in profitable categories. So we’re focused there where the profit pools are. If that means losing market share, then that’s fine—gross profit is our focus. We're trying to get away from what’s the market share and what’s happening on the revenue side and really focus on driving profitability.

Thanks for taking the question. Building on some of that stuff on consumers—so you talked about why you want to be involved for a variety of reasons. But can you give us some sense of how you see that market shaping up over the medium term? I know it’s irrational now, but you lay out the idea for profitability in fiscal '23, first half, in your forecast. Where do you think that segment is headed?

Sure. First and foremost, let me highlight a critical province for Canadians is Quebec. They have a vaccine mandate in place to enter either an alcohol store or cannabis store. Sales in Quebec are down 16% to 20%. The province has indicated that by the end of the month, some of that will be lifted. The current market is going to be impacted in the next 6 to 9 months. Until pricing gets normalized, you are seeing big brands that have 100 basis points or 200 basis points of sales being sold at a negative margin. I think you’ll see that continue; it’s not dissimilar to what you saw in California and Colorado in the early days. By all indicators, they are about 18 months ahead of us. You see brands articulate and brand equity scores going up in those markets. You see premium market shares becoming much more relevant. You see manufacturers making money, and I know the economics are different in the U.S. But I think the Canadian recreational business is going to get there. It’s just too big a business, it’s growing too much not to. Timing is the issue. Chasing right now doesn’t make any sense. You’re seeing market shares move 100 and 200 basis points in a week. I am used to seeing that move in a quarter. So, in that market, you don’t need to be first; you can wait a little bit. We’re right-sizing our efforts. We’re focusing on those areas that we can bring to both the patient and recreational consumer, as well as internationally, and we’re going to have our spots. When we come out of it, there will be a much smaller subset of LPs who are much better operators, and there will be a large market where people can make money. It’s just going to take a bit longer than I think some would hope.

Thank you. And that's all the time we have for questions today. I'll turn the floor back to Miguel Martin for closing remarks.

Well, first and foremost, let me thank everybody for taking the time and the coverage that you provide to our stock. We really appreciate it. We're really pleased with the quarter. Once again, we've put a plan out; our transformation plan has three key components, which is growth in the markets where we can make money, particularly in medical. We've done that, focused our cost structure on the opportunities as they present themselves, and we've done that. We’re raising our guidance on $60 million to $80 million in cost savings, and third—everything we're doing is focused on being sustainably EBITDA positive. You've seen that progress with the 22% improvement from last quarter to this quarter. We really appreciate it. I hope everyone is safe and well, and I look forward to seeing people in person in the near future. All the best.

Thank you. This concludes today's conference. All parties may disconnect. Have a good evening.