Earnings Call Transcript - ACB Q4 2021

Operator, Operator

Greetings and welcome to the Aurora Cannabis, Inc. Fourth 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. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ananth Krishnan, Vice President, Corporate Development and Investor Relations. Please go ahead.

Ananth Krishnan, Vice President, Corporate Development and Investor Relations

Thank you, John, and thank you all for joining us for Aurora Cannabis fourth-quarter fiscal 2021 conference call. This is being recorded today, Monday, September 27th, 2021. With me today are Aurora CEO, Miguel Martin, and CFO, Glen Ibbott. After the close of markets today, Aurora issued a news release announcing our financial results for the fiscal fourth quarter and fiscal year 2021. The release and the accompanying financial statements and MD&A will be available on our website or on our SEDAR and EDGAR profiles. In addition, you can find a supplemental information deck on our IR website. Listeners are reminded that certain matters discussed in today's conference call could constitute forward-looking statements that are subject to the risks and uncertainties related 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 by the SEDAR and EDGAR databases. Since we're conducting today's call from respective remote locations, we may experience technical issues. We thank you in advance for your patience. Following the prepared remarks by Miguel and Glen, we will conduct a question-and-answer session. We ask that analysts limit themselves to one question. For retail and institutional investors, we will review the questions through the chat function of the webcast link. With that, I would like to turn the call over to Miguel. Please, go ahead.

Miguel Martin, CEO

Thank you, Ananth. We've made significant strategic and financial progress during the fiscal year 2021. In fact, as of fiscal Q4, I can safely say we are in the best shape the company has ever been in. While there's certainly more work to do, Aurora is on the right course to build shareholder value, particularly at these levels. Building value starts with profitability on an adjusted EBITDA basis. The entire team is focused on this effort; an additional facility closure we announced last week is another proof point to show that these actions are well underway. Building on that, let me speak to a few more data points that underscore our progress into 2021 and how that sets the table for value creation in 2022. First, Aurora is and remains the number 1 Canadian LP and global medical cannabis revenue, with margins over 60%. This is nearly double what we see in the adult recreational segment. For that reason, we will happily continue to allocate resources to the Canadian, European, or Israeli medical markets, where our regulatory expertise, science, testing, and compliance, combine to create a portable and profitable model. The second lever we're pulling is expense reduction. As you know, we are on track to deliver another 60 million to 80 million in incremental cost savings. And it's important to note that these savings won't affect any planned growth initiatives. These additional savings will also clear our path to being adjusted EBITDA positive by the first half of our next fiscal year, even if revenue were to remain constant with our fiscal 2021 fourth-quarter levels. That said, we do expect revenue growth in 2022. Another value creation data point that complements our P&L is the balance sheet. In a growing, dynamic, and fragmented market, our regulatory expertise and number 1 position in Canadian Medical are a further advantage with a strong balance sheet. I'm pleased to say that we have vastly improved ours with approximately 400 million of cash as of Friday, no secured term debt, and access to U.S. 1 billion of capital under a shelf prospectus. We've also gotten better at managing our operating cash flow, reducing the need for incremental capital. We also expect to leverage our significant investments in R&D and monetize a world-leading science and innovation program. The foundation of this is what we believe to be the world's largest dedicated cannabis breeding and genetics facility located in Comox, British Columbia. And lastly, we have strengthened our executive team by bringing in 2 highly skilled individuals in the areas of Operations and HR, Alex Miller and Lori Schick, respectively. With that as a backdrop, I want to remind our listeners that Aurora is comprised of 4 distinct, yet complementary components. First, a number 1 ranked Canadian Medical business by revenue in the largest federally regulated medical market in the world. Second is our international medical business, which ranks as the 2nd largest Canadian LP by revenue. Net revenue from these 2 businesses increased 18% during fiscal 2021. The third is our science and innovation business unit. We're monetizing our intellectual property in genetics and biosynthesis. And finally, 4th, our Canadian adult recreational business, where we've already made progress, although challenges remain. Let's take a deeper dive into medical cannabis as it really serves as a solid foundation for our future. Domestically, we represent about 1/5 of the Canadian medical market, but only about 1% of the population are currently medical cannabis patients. While our market share is roughly double that of our next closest peer, the top 5 LPs within the Canadian medical channel represent less than 40% of the market. This gap represents Aurora's opportunity to expand our presence, and we have done so through significant investment to help doctors and patients fully appreciate the benefits of medical cannabis. That outreach includes education. Aurora's investments in sophisticated technology, coupled with unparalleled professional counseling and guidance in navigating medical cannabis alternative treatments, has enabled us to provide an end-to-end patient experience for our growing clientele of recurring Canadian patients. About 80% of our Canadian medical cannabis net revenue is constituted by cannabis insured and/or subsidized patient groups, which sets up the medical channels as a very solid core revenue growth. Also, our infrastructure to support a direct-to-patient distribution model, which begins with patient querying and then transitions to onboarding, a medical consultation, and finally, prescription fulfillment across a variety of price points, all being a key factor in our success. To improve our Canadian Medical business further, we are now leveraging technology in our patient intake and user experience to lower wait times, raise service levels, and increase product choices. This is a key driver of margin. In its totality, our market position in Canadian Medical, our innovation, and our tactical execution, have created a tangible barrier to entry which is good news for shareholders as we grow other parts of the business. In terms of international medical, we're leveraging core capabilities from Canada as new countries look at launching medical cannabis. This is a distinct advantage over our peers, creating a deep moat around our business. A data point here is our leading position in Germany in dried flower, with a growing share of the oil market there. In France, Aurora and Ethypharm were selected in October of 2020, by the National Agency for the Safety of Medicines and Health Products to supply the entire medical cannabis pilot program with dried flowers. We won 3 of the 9 tender lots, which included all available dried flower lots, and just delivered our first shipment in August. In Israel, we delivered an $8 million cannabis shipment in July as part of our supply agreement with Cantek. We believe this is the largest single shipment of cannabis that Israel has received. Speaking of Israel, we're excited to announce an extended supply agreement with Cantek, under which we just received a purchase order for a further $9 million shipment, which we expect to deliver in fiscal Q2. Our compliance expertise was responsible for the extension, all good news. Of course, our expertise in medical cannabis and ability to operate within a highly regulated framework gives us a great opportunity to expand in the global adult recreational market. History demonstrates that medical regimes eventually evolve to adult recreational, as companies like Aurora that have a proven ability to operate in federally regulated systems will have an advantage when new markets open up. Let's pivot to Canadian adult recreational. Those who follow the market are well aware of the industry-wide challenges, but I'll bring up 2 points. First, while fixing this segment will clearly take longer than expected, we did grow 8% sequentially compared to fiscal Q3 and are seeing early signs that our focus on higher-quality, higher-potency, higher-margin products is beginning to pay dividends. Specifically, our sales mix was positively impacted by a growth of about 400 basis points in San Rafael '71, offset by a modest decline in daily special. The growth in San Rafael represents an over 20% increase in dollar terms. We believe this momentum should continue with additional premium product introductions and a focus on innovation throughout all categories. Second, we believe the adult recreational segment is in the process of bottoming out and is now poised to rebound, given new store openings and rising consumer demand. The dried flower recreational category in Canada is a tale of 2 markets. First, the high-margin premium dried flower category, where margins are 50% or higher, and second, the discount flower category, where many SKUs are break-even or even negative margin. Our strategy centers on the premium category. We're not going to be chasing an unprofitable market share. We're going to be chasing profit pool dollars. Furthermore, our focus on product innovation and manufacturing excellence is squarely aligned with the expectation of our retail partners. The segment discussion is out of the way, let me pivot to our P&L and our primary goal of adjusted EBITDA profitability. Aurora has identified cash savings in the midpoint of our previous guidance, 60 million to 80 million. We plan to deliver 30 million to 40 million of those savings within the next 12 months and the remainder within 15 months. We expect approximately 60% of the savings will come from asset consolidation, operational, and supply chain efficiencies. For example, last week we announced internally a plan to centralize much of our Canadian production at our River facility in Bradford, Ontario, and the resulting closure of our Polaris facility. We expect the remaining 40% of savings to be sourced through SG&A. And keep in mind that these efficiencies are incremental to the approximately 300 million of total cost reductions achieved since February of 2020. Again, expense reductions, margin improvements, and sustainable cash flow generation won't inhibit our growth plans. To be clear, to reach adjusted EBITDA profitability by the first half of the next fiscal year, we do not expect any revenue growth in the Q4 of 2021 levels. But I hope you can tell we are positioned for top-line growth in 2022, and with that, adjusted EBITDA profitability should follow. With that, I will turn the call over to Glen.

Glen Ibbott, CFO

Thanks Miguel, and good afternoon, everyone. I appreciate you joining us today and your patience with our slight delay in getting earnings out as we finished off the last bits of our audit. Before I get to our Q4 results, I'd like to take a moment to review the success of our business transformation program over the past year. As Miguel referenced, our financial fundamentals are in better shape now than they have been for several years. Our balance sheet, after having paid off the $90 million secured term debt in June and having invested approximately $30 million into our new insurance structure in September, still sits at around $400 million of cash as of Friday. That is excellent considering we started Q4 with 520 million and paid out $120 million in debt reduction and investment. The debt and insurance actions will save us almost $35 million in annual cash flow. Our core medical businesses continue to deliver overall growth in enviable margins that generally sit at 60% or better, with the results in gross profit dollars being an absolutely critical driver of our path to positive EBITDA. And of course, our SG&A and CapEx are a fraction of what they used to be, which is clearly good news for our investors. So now to Q4 results, which I believe demonstrated the importance of Aurora's diversified business in both consumer and medical markets across 12 countries. Overall, Q4 net cannabis revenue before provisions was $55.7 million. Our medical Canada segment continues to excel, generating $35 million in sales and gross margins of 68%. This represents about 63% of our Q4 revenue and almost 80% of our gross profit. Our consumer cannabis business delivered $20.2 million excluding provisions and a gross margin of 31%. Overall, Q4's gross margin was 54%, with just north of $30 million of gross profit. This makes Aurora one of the leading, if not the best gross profit generators in the Canadian cannabis industry. SG&A remained well-controlled, resulting in improvements in adjusted EBITDA, excluding restructuring. While still negative at 13.9 million, it is heading in the right direction. Now a bit more detail on each of our business segments. Our Canadian medical revenue was $26.4 million in Q4, essentially flat quarter-over-quarter, despite the impact of competition from continued store openings in the consumer market. Our Canadian medical patients can be segmented into 2 groups: those with cost reimbursement coverage, and those without a reimbursement program. Our success is really driven by our high-value insured patient groups, whose reimbursement makes them recurring buyers. And this is why we have made patient groups with reimbursement coverage a high focus priority in our medical business. That said, we may see some migration of price-sensitive, non-reimbursement patients from the medical channel to the adult recreational channel, as that market continues to develop over time. Our international medical revenue was $8.6 million, down slightly quarter-over-quarter, but up 88% versus a year ago. In Q4, this business delivered a 72% margin, beating our mid-60s expectations. This exceptional result was driven mainly by the country mix. Our Q4 international margin also benefited from the transfer of almost all of our European supply to our Nordic facility in Denmark. And while there were no sales to Israel in Q4, as Miguel noted, we did deliver approximately $8 million of medical cannabis to Israel in early July and have a further $9 million shipment planned for next month. BDS Analytics estimates the market size of about $3.2 billion by 2025, for just Germany, Poland, UK, France, and Israel. With that context, it is clear why international medical is worthy of our focus and investment, and why our leadership internationally is an important driver of long-term shareholder value. Our Q4 consumer revenue is about $20 million including provisions, which was an increase of 8% compared to Q3. We are seeing signs of Aurora's shift to the higher-margin core and premium segments that will underpin our future success in this market. Miguel noted, Q4 saw a step forward for our San Rafael '71 brand, and this contributed to an increase in our average net selling price per gram of dried cannabis. Now for SG&A, which includes R&D, it remains well-controlled, coming in at $44.8 million in Q4 excluding restructuring, a 30% decrease compared to last year. And while we have made a lot of progress in driving down SG&A over the past 12 months, as Miguel stated earlier, we are implementing further measures to take out costs that should get us well below a $40 million quarterly run rate at the time we exit the fiscal year. So pulling all of this together, we generated an adjusted EBITDA loss in Q4 2021 of $13.9 million excluding restructuring one-time costs. This represents about an $18 million improvement year-over-year, and a $2.6 million improvement from the prior quarter. To help investors think about our path to EBITDA profitability, I'll provide some thoughts on how the cost reduction plans that Miguel described will flow through to the P&L. Approximately 60% of cash savings are expected to be realized in cost of goods as inventory is drawn down. This should occur over several quarters as our lower production cost structure shows up in finished goods. We expect the remaining 40% of cash savings to show up in SG&A. These savings will be seen as they are executed, beginning with Q2 of this fiscal year. I noted earlier that we are financially stronger today than we have been for several years, particularly with respect to our materially improved balance sheet and financial firepower. We started Q4 with $520 million of cash. During the quarter we paid out our term debt facility using almost $90 million to do so. This frees us from restricted debt covenants and results in principal and interest savings of approximately $6 million per quarter, which moves us further towards positive free cash flow in the coming quarters. Despite paying off our term debt, we still ended the quarter at $440 million of cash. Additionally, we have the $1 billion U.S. shelf prospectus, including the full amount of the U.S. $300 million at-the-market facility still available. These are available as financial firepower as we prepare for strategic and accretive opportunities. So to wrap up, what I hope you take away from our Q4 financial results is the following. Aurora has a clear path forward to being adjusted EBITDA positive by the first half of our next fiscal year, through actions that we control. And we have significantly strengthened our balance sheet with more cash and working capital and having eliminated secured term debt. Now, I'll turn the call back to Miguel.

Miguel Martin, CEO

Thanks, Glen. Before we go to Q&A, I want to talk briefly about our science and innovation business group, which we feel is a real differentiator. We launched this group last May with the goal of commercializing patented and patent-pending technology, which we believe will be key to developing cannabinoid production in biosynthesis and the plant itself. Through licensing agreements, Aurora and 22nd Century Group share the global IP rights that are key in commercializing key aspects of cannabinoid production and biosynthesis in plants. We believe the long-term market for cannabinoid molecules produced through biosynthesis of the plant will be incredibly profitable. And we have seen global market size estimates of 10 billion by 2025. As I said, this is a long-term effort, but one that we believe will ultimately allow companies to bring a wide array of new-generation products to the market. When someone else is using the technologies and infringing our rights, we expect to be compensated, either willingly or through legal action. In addition to IP, our industry-leading genetics, and breeding program is positioning Aurora to win in the flower and concentrate consumer categories. This program is expected to not only drive more revenue by injecting rotation and variety into our product pipeline, but also greatly improve the efficiencies of cultivation through higher-yielding plants, higher cannabinoids, and better disease resistance. Our team has been able to screen over 7,000 unique cultivars in 2021 alone. In August and September of 2021, Aurora launched the first 3 new proprietary cannabis cultivars in our San Raf brand, all of which have distinct terpene profiles and high THC potency. We're already seeing the results through nearly 1 million in sales since their launch. The genetics and breeding program, which is an asset-light business model, is always expected to generate high-margin revenue through license agreements. So to wrap up our call today, I'd like you to take away the following. First, we are the number 1 Canadian LP in the global medical business by revenue, which has a huge and growing total addressable market. Second, the expertise here will transfer to adult recreational, as medical-only jurisdictions continue to open up, Aurora will be the partner of choice. Third, despite cost savings that would get us to profitability, we're still developing a proprietary and protected premium product that is being sold and licensed. Innovation will be the lifeblood of success in this industry and positive cash flow and a strong balance sheet will be required. Not all of our competitors have this, but Aurora does. Lastly, Canadian recreational will come back. But that timeline won't impede our strategic or financial progress. Aurora has shown incredible agility over the last 2 years. The final leg of our transformation is well underway and with the unique attributes that we bring to this dynamic opportunity, I've never been more confident in where the company is as we head into fiscal 2022. We look forward to sharing further progress on upcoming calls, and that concludes our prepared remarks. Before moving to analyst questions, I'll answer a few questions from our retail shareholders who were invited to submit questions ahead of today's call.

Ananth Krishnan, Vice President, Corporate Development and Investor Relations

Thanks, Miguel. Prior to analyst questions, we will be addressing 3 questions from our retail shareholders. So, Miguel, the first question is, 'When will you be EBITDA positive, and why should investors now believe that the time is right to be EBITDA positive? They've been waiting for profitability.'

Miguel Martin, CEO

Ananth, I completely understand the frustration regarding the unmet milestones in the past. However, there is a significant difference between the current situation and prior statements. Those previous forecasts were based on certain revenue growth assumptions, which we are not observing now. We have implemented strong cost-saving measures, and once fully executed, we anticipate achieving EBITDA profitability. Our core businesses do not require revenue growth or margin increases compared to Q4. It's crucial to note that we have a proven track record of successfully executing our transformation strategies. We have reduced SG&A expenses from over 100 million per quarter to the low 40s, aligned production with sales, simplified our network, and sold several facilities. We have made substantial cuts to Capital Expenditures and enhanced working capital. Additionally, we have assembled a completely new team, including Lori Schick and Alex Miller, along with outstanding talent throughout the company. As I mentioned, we are not depending on revenue growth to reach our goals, but we still expect to achieve it with confidence, unlike what has been communicated previously.

Ananth Krishnan, Vice President, Corporate Development and Investor Relations

Great. Thank you, Miguel. Our next question is, 'Should we expect to see any acquisitions anytime soon, given where the market is today and the recent consolidation seen in the cannabis sector?'

Miguel Martin, CEO

You know, Ananth, we're going to be really consistent on this point. Our primary objective is to be EBITDA positive, and nothing is going to take our attention away from this objective. So I know there are some people that want us to be bigger and to chase market share, but we're not going to do a deal that sacrifices profitability in order to be a bigger, less profitable cannabis company. So there's been criticism in the past about how the company has handled this space, and we're going to take a diligent and patient approach to M&A. I think if you look at what's happened in the environment recently, I think being patient and diligent is absolutely the right path. So we're going to continue to look, and if there's something that makes sense that has a strong strategic rationale and that can bolster our ability to make money, we have the balance sheet and we have the ability to do it. But we're not going to risk shareholder capital without a strong business case.

Ananth Krishnan, Vice President, Corporate Development and Investor Relations

Okay, great. And one last question from our retail shareholder base, Miguel, before we kick it over to the analysts. 'We've seen many of your Canadian LP competitors structure deals to enter the U.S. THC market when it becomes federally legal. Why has Aurora been slow in addressing this key growth market?'

Miguel Martin, CEO

Well, first and foremost, I would say we haven't been slow. We've been saying for a long time that the U.S. is going to take longer. Many of our peers thought it was going to happen faster and these investments would make more sense. I think investors don't want a company to make a structured deal that may or may not transition into a profitable situation; that doesn't mean we're not looking at the U.S., but a couple of things there. First is, and I'll keep saying it, our goal is to be EBITDA profitable; that is a unique position, the number 1 Canadian LP in terms of medical, and the number 1 global company in terms of all the things I've mentioned, and profitability, that's our goal. And so flushing that all down the drain to chase something in the U.S., I don't think is important. Secondly, we just had a big election in Germany and it's a big world out there, and I understand the interest in the U.S. and I've got a tremendous amount of respect for the MSOs and my Canadian LP peers. But if you look at Germany, if you look at Israel, if you look at France, you look at these markets, there is a lot of money to be made and we're doing that and we're doing, I think, an exceptional job of that. What the learnings are in those markets absolutely are applicable to the U.S. And we continue to believe that the path towards the U.S. will be through medical, through federal legalization and decriminalization, and clearly, if you look at the capabilities of Aurora, both in Canada and around the world, we will have a lot of options when the U.S. does open up.

Ananth Krishnan, Vice President, Corporate Development and Investor Relations

That's great. So at this time, John, I'd like to turn it back over to you to open up the queue for analyst questions.

Operator, Operator

Thank you. At this time, we will be conducting a question-and-answer session. One moment please, while we poll for questions. Our first question comes from the line of Vivien Azer with Cowen and Co. You may proceed with your question.

Vivien Azer, Analyst

Hi, thank you. Good afternoon. Miguel and Glen, I was hoping to dig in, please, on the consumer cannabis segment. I would like to hear how the quarter settled out, relative to your going in expectations, and if there are any key callouts in terms of form factor or price point drivers, as it relates to the 8% sequential revenue growth. Thank you.

Miguel Martin, CEO

Good afternoon, Viv. So let me kick it off and then I'll hand it over to Glen. I made the comment that it's a tale of 2 cities. If you look at the margins of discount flower, in many cases, if that's the break-even in some cases in certain big provinces are negative. And so that's just as this whole thing shakes out. Chasing that, and chasing overall market share at the cost of profitability really is not our strategy. That's not to say it may not benefit others. Where we're going is the higher-margin premium flower and the higher-margin concentrates. That's a place where consistently we're seeing almost 2X margins. And if you look at that coupled with the recreational business, because again if you can use the same products in both recreation and medical, their efficiencies, and we've seen a big uptick in patients looking for premium products. I think there's a lot of value there. So it's going to take a bit longer, Viv, I think in order for that discount flower business to shake out as people try to compete on price and it will, there's no way that's sustainable long-term. At that point, we've got some great brands and we've got some great capabilities, but at this juncture, we're going to focus on making money. Glen?

Glen Ibbott, CFO

Thanks. We are beginning to observe a shift, as I mentioned earlier and Miguel reiterated. For example, our San Rafael brand has been gaining traction, especially over the summer. In Quebec, we have gained at least 1% or more in market share. Although some data sources may not accurately reflect this shift, such as Headset data, our average selling price in Quebec is 80% higher than in Ontario due to the growth of San Rafael. We've historically performed well there. We expect this trend to continue, though we did not see a significant impact in Q4 in terms of revenue. However, there are many positive developments happening behind the scenes, with our core and premium brands gaining ground and the new innovations we launched during the summer showing promise. While we have high expectations, we are also witnessing some revenue decline as we move away from unprofitable segments, but I am confident regarding gross profit. We are seeing encouraging data and traction, and I believe it will be reflected in our financial results over the coming quarters.

Vivien Azer, Analyst

Okay. And I know no follow-ups, but just to clarify, relative to your expectations, maybe just on the premium side, was the premium side of your business on consumer cannabis in line with expectations?

Miguel Martin, CEO

Yes, I'll take that. I'm never satisfied. Innovation drives most of our products. If you examine the data, you’ll see that many of the products sold in the last 30 to 60 days did not exist more than a year ago. Our full-year 2022 innovation calendar includes 80 new SKUs, compared to the 85 we launched. I would like to see more progress in San Rafael, and I am confident that we have the right plans and infrastructure in place to achieve our goals. In summary, we are pleased with our current position, but we always strive to push for more progress.

Vivien Azer, Analyst

Of course. Thank you.

Operator, Operator

Our next question comes from the line of Pablo Zuanic with Cantor Fitzgerald. You may proceed with your question.

Matthew Baker, Analyst

Good afternoon. This is Matthew Baker on behalf of Pablo. We have 2 questions today, so firstly, can you discuss which of your cultivation facilities are currently operational? And in the case of Aurora Sky, how many rooms are currently operational?

Miguel Martin, CEO

Matthew, we've announced after our restructuring that we have several facilities including Sky, Whistler, River, Ridge, and our Nordic facility in Europe. This represents a very strong portfolio of manufacturing centers of excellence. Currently, Sky is operating at about 25%. There's significant progress, and it is one of the largest facilities in Canada with a CUMCS certification, which is quite challenging and necessary for shipments to Israel. We have ample capacity available if needed, and we also have the flexibility to adjust our facilities as required. Glen, do you have anything to add?

Glen Ibbott, CFO

Regarding your question about Sky, it's not about the number of rooms, as we are utilizing most of them. We have adjusted some of our cultivation practices to enhance the quality of our plants. Currently, we are operating at 25%, but we have significant flexibility to meet demands for Israel, other export markets, or any future growth opportunities, so we are quite optimistic. Additionally, we have our outdoor facility, known as Valley. We achieved commercial sales from Valley last year and recently completed a harvest, with another anticipated in the fall. We expect to produce commercial or consumer-grade cannabis from that facility as well, which is a substantial win for us.

Matthew Baker, Analyst

Thank you for that. For our second question, we wanted to know how you guys feel about the outlook for the year export business, and if it's reasonable to assume that this revenue flow could double in full-year 2022, compared to full-year 2021?

Miguel Martin, CEO

Let me talk a little bit about Israel now, kick into Glen you can talk about the aggregate. Israel is a very challenging marketplace. The IMCA, which is the regulatory authority in Israel, it's one of the strictest in the world. We have a wonderful relationship with the lead regulator there, Yuval Landschaft, and he is quite a leading regulatory figure around the world. They've really taken a hard stance in terms of what it takes. It's beyond CUMCS; it's a variety of different pesticides they look for. So we're not giving guidance on Israel because it continues to move around. We feel really confident that as long as the border is open for imports, we'll continue to be almost unique in our ability to navigate that with high-quality, highly regulated, and compliant cannabis products. And for a country of 9 million people with over almost 100,000 patients, I think we've done an excellent job, which really sets us up well for new markets coming on. I mentioned in my prepared remarks about Germany. We're thrilled with that election, and having the number 1 flower business with also a very challenging regulatory environment, sets us up well for that market. Glen?

Glen Ibbott, CFO

Now I'll add Europe, which is important for our operations in 12 countries. We are experiencing strong sales growth in key markets such as the UK, Poland, and Germany. While we're not providing specific guidance for the next year, we see significant growth opportunities, particularly in Germany and other markets. I referenced some projections from BDS regarding certain European markets expected to expand by 2025; these are substantial markets that justify our investment. I'm pleased that we hold a leading position in Europe. The projected $3.5 billion market in the countries I've mentioned by 2025 presents ample growth potential. Our team in Europe has consistently delivered impressive results quarter after quarter for several years, which gives me strong confidence in our international medical business.

Matthew Baker, Analyst

Thank you, guys.

Operator, Operator

As a reminder, we would like to remind you that we request only one question, please, for the following questioner. Our next question comes from Michael Lavery with Piper Sandler. You may proceed with your question.

Michael Lavery, Analyst

Thank you. Good afternoon. You previously mentioned the IP and some potential royalty opportunities before the Q&A. Can you provide us with an idea of the timing or what to expect regarding how that might develop?

Miguel Martin, CEO

It's a great question. The company has previously invested significantly in these assets, which originated from the Anandia acquisition. As we've mentioned, we are partnering with 22nd Century, a well-known company. Currently, we are in the early stages of this partnership, but all signs indicate that the biosynthesis and intellectual property related to those pathways are quite critical for cannabinoid molecules. We've observed that some of our competitors are making progress in this area, and we've also found that in various categories, this represents a substantial business opportunity, particularly for companies that prefer not to pursue vertical integration. Michael, we will likely begin to defend our intellectual property, and you can expect more detailed discussions on this topic. We are eager to share on Analyst Day some of the new talent we have brought into this field, both in scientific and business development roles. With this, you'll gain a clearer understanding of the timing and scope of our efforts. If you examine virtually any evolving category, you'll find a considerable amount of intellectual property involved. Moreover, the legal framework for protecting this is robust. Companies will indeed be capable of defending this type of intellectual property. While the U.S. offers stronger protections than some other markets, there is a reliable and well-established process for companies globally to safeguard their biosynthesis pathways and other related matters. We are excited about the potential in this area.

Michael Lavery, Analyst

Okay. Great. Thanks so much.

Operator, Operator

Our next question comes from Andrew Carter with Stifel. You may proceed with your question.

Andrew Carter, Analyst

Good evening. I know you've mentioned the stores opening, but I guess what we're seeing right now from stores is Canada's beyond saturation. and stores aren't getting into some areas where it needs to. The other thing we're seeing in the retail inventory levels is pretty high relative to where they started the year. So could you just kind of help us understand how your portfolio is positioned to grow with the market I mean, we're at the end of this quarter, so should we see another sequential increase, taking a lot of heavy lifting, cleaning up the portfolio, just help us with that. Thanks.

Miguel Martin, CEO

Absolutely, that's a great question. The retail environment is quite distinct, with out-of-stocks, marketing challenges, and restrictions on merchandising programs due to inducement provisions. There's a notable variation from province to province, and while there are excellent retailers, overall store counts are limited, and we're seeing saturation in some areas. We are still in the early stages of optimizing the retail landscape, and provincial buyers are beginning to adapt as we move past COVID. The high out-of-stock rates for major brands and the fact that the top SKU in Canada is only available in about two-thirds of stores present significant opportunities for us. Regarding our portfolio, we are optimistic because we are launching high-potency products for both ourselves and some partners. North 40 has done impressive work utilizing our genetics in their product, Farm Gas, which boasts almost 30 potencies. Additionally, we have partnered with GND, a division of Southern Glazer, giving us the ability to make three times more calls than before, thus enhancing our network's efficiency. We are encouraged by the primary category; however, we won't pursue market share aggressively. Any company seeking to rank among the top five would need a considerable amount of discount flower, which isn't our goal. Our retail partners are also prioritizing margins and products that sell well. We are committed to maintaining our approach, ensuring profitability, and believe the market will stabilize as competitors shift away from aggressive discounting and begin focusing on margin enhancement.

Andrew Carter, Analyst

Thanks. I'll pass it on.

Miguel Martin, CEO

You're very welcome. Appreciate it.

Operator, Operator

Our next question comes from Heather Balsky with Bank of America. You may proceed with your question.

Heather Balsky, Analyst

Thanks, Heather Belsky. So I'm just curious, I'm putting some of the comments together that you've made with regard to consumers' demand for value versus premium. And I think you mentioned that it's taking a bit longer than you originally expected. I am just curious what you're seeing in terms of now that markets are trying to open up, people are going into the stores more. Are you seeing changing trends? Any interest from the consumer? We've heard that there has been a fair amount of turnover in the budtender, I guess in budtenders in general, just how that's impacting demand for value versus premium. And just anything you're seeing as markets are opening up.

Miguel Martin, CEO

Sure, I'd be happy to, Heather. I think it's a couple of things. One is everybody is trying to figure out what the new normal looks like, and the reality is particularly on a 28 gram discount flower. It's a challenge to make money on that format. We also see similar to what you see in Colorado and California that over time, there is absolutely a strong group of consumers that will pay more for premium. This is now going to be the one regulated category where all that is sold as a discount and to steal a line from one of my peers, this isn't going to be like everyone just goes and buys moonshine in the alcohol business. Johnnie Walker, Tito's, they're valuable brands. Is it taking a bit longer? Yes. Now, you bring up a really interesting point about the budtender. And I think to be fair about the environment when you have an environment where there are massive out-of-stocks, when you have an environment where you can't have formalized merchandising programs, and you have a market where each of the manufacturers is trying to figure out exactly what is their specific approach. And with half the sales, 60% of sales being something that didn't exist a year ago, the budtenders hold an incredibly powerful hold over the consumers and what they are. Many companies like us are starting to develop educational tools from a category standpoint, not just in a self-serving way. And I know the chains are also trying to bring category management principles to it. So I think you're going to see an evolution of it, particularly as we get into concentrates in Gen 2 and Gen 3 products that take a little more explanation. And clearly, like I keep saying, this is not going to be the one geography in the world and the one category where there are no premium products sold for our premium margin.

Heather Balsky, Analyst

All right. Thank you.

Miguel Martin, CEO

You're very welcome, Heather.

Operator, Operator

Our next question comes from John Zamparo with CIBC. You may proceed with your question.

John Zamparo, Analyst

Thanks. Good afternoon. I wanted to follow up on a comment you made, Glen, really just trying to reconcile what we're seeing from data providers at the retail level with the commentary about San Raf improving and just a modest decline in daily special. And what have you seen in FY Q1 to date that gives you the confidence that you are turning around in terms of the consumer markets?

Glen Ibbott, CFO

Let me begin and then Miguel will likely add to this. I want to emphasize that much of the available data is limited because Quebec controls retail distribution, which means we don’t get direct data from them. Instead, data sources often rely on extrapolated information from the rest of Canada or France. Quebec has always been a strong market for us, especially for San Raf. In fact, in most quarters, we sell more flowers in Quebec than in Ontario. I've pointed out that we're selling higher-margin products like the San Raf flower, which has an average selling price that is over 80% higher in Quebec than in Ontario. I just want to reiterate that while we've asked you to examine the data, it is still evolving and relatively new, which presents challenges in interpretation. I’m not trying to exaggerate, but this is indeed one of our key markets, even if it’s not fully reflected in the data. Miguel mentioned the importance of innovation, and we’ve finally streamlined our pipeline effectively. The introduction of three new cultivars under San Raf launched in Quebec in August, followed by launches in Ontario and a few other provinces in September, has received a great response. These products have unique terpene profiles, with several in the mid-20s for trimmed THC potency, and through our Farm Gas partnership, some batches are achieving nearly 30% THC with an impressive terpene profile. We have solid science and genetics to support our innovation efforts and a robust launch plan for the coming quarters. This is where we see a continuing shift towards the premium segment of the market. Miguel?

Miguel Martin, CEO

Yes. I guess the only data point I mentioned is when you look at competitors, when you put out a high-quality product, whether it's new or whether it's an extension. And what do I mean by that? North of 22 potencies in a format that's interesting, potential high turf levels. It almost uniquely does well. And so it's not a secret recipe in terms of what is required here in order to meet the consumer needs. Clearly, I have played a lot with market shares in the premium category; it's not where I wanted to be, but I think to Glen's point if you look at what we were able to do and get over $1 million in revenue out of 3 brand-new SKUs in a couple of core provinces. I think we're on the right track, and we'll keep pushing on that.

Operator, Operator

Thank you. Our next question comes from Frederico Gomes with ATB Capital Markets. You may proceed with your question.

Frederico Gomes, Analyst

Hi, good afternoon, guys. Thanks for taking my question. I just wanted to touch on your CBD segments. I know you guys said an impairment there. But can you provide an update on Relive and the strategy for that segment? Do you guys plan to grow that business or invest any money or is this not a priority right now? Thanks.

Miguel Martin, CEO

Well, this is a great question. Today we launched a secondary line called KG7, that's got more of a sports orientation to it, and actually has a better price point on gummies, which is the largest segment. We continue to have, if not the largest, one of the largest amounts of store distribution in the U.S. And while we are a bit frustrated with the progress that we see at the federal level, we did see what may be the most important state that has lapped California pass an important piece of legislation that will allow CBD to be sold there. I continue to think that our positioning of the brands of choice for mass retail throughout the country in a responsible and compliant way will pay dividends for us. I would also mention it's such a highly variable model that you're just not seeing losses as you see from some of our competitors in that space. So it's one real piece of optionality. We're also starting to see some international markets be interested in what continues to be the number 1 Nielsen ranked brand in CBD, and that would be additive to the overall financials.

Frederico Gomes, Analyst

Thank you. I appreciate that.

Operator, Operator

Our next question comes from Tamy Chen with BMO Capital Markets. You may proceed with your question.

Tamy Chen, Analyst

Good evening. Thanks for the question. I just wanted to ask. What's the plan for Sky? And you mentioned it's still operating at 25% capacity. I would assume that's not the level of capacity you have liked it to be running at, for the status quo and going forward. So what's the plan with that facility? And can you just confirm with respect to your San Raf sell-in, is that all coming from internal sourcing, or do you procure from third parties for some of that? Thank you.

Miguel Martin, CEO

Sure. So, as I mentioned, we currently have about 25% of the capacity operational at Sky. However, the margins in our international business, especially in Israel, can become very appealing quite quickly. As more of these businesses come online and we navigate the challenges of obtaining CUMCS certifications, Sky's role becomes increasingly significant. We're also observing positive developments with the new cultivar being grown at Sky, which is demonstrating improved potency. This is encouraging, and if we can align that with Sky's cost structure, it will significantly enhance our operations. We are pleased with our progress there, which gives us a strong advantage at that facility, and we are eager to see how it evolves. Glen, would you like to address the second part?

Glen Ibbott, CFO

I mean, Sky operating at current levels with the type of business we're driving out of there is actually quite a nice cash flow generator, so don't get thrown off at the 25% because that's not a low-margin facility anymore. It's delivering stuff that brings higher margins with us, which was really an important part of the repositioning and the improvement in the quality potency coming out of that facility. Sorry, the second piece of your question?

Tamy Chen, Analyst

I just wanted to ask if for your San Raf supply, if that's all coming from the internally produced product, or do you wholesale some of it?

Glen Ibbott, CFO

They are acquired. We've acquired a couple of small batches from some craft growers that are launched into our Growers Stash brand. But San Raf itself with the 3 cultivars that's all being driven out of our new genetics, out of our coast facility with genetics coming into the coast.

Operator, Operator

Our next question comes from Doug Miehm with RBC Capital Markets. You may proceed with your question.

Doug Miehm, Analyst

Yes. Good afternoon. The question just has to do with the craft growers and what we see in the Canadian marketplace. We know that earlier in the year they did quite well. They were taking market share from the larger LPs. And I'm just wondering if you're seeing that as being sustained, or do you see yourselves and maybe some of the other larger competitors taking that share back from the craft growers?

Miguel Martin, CEO

It's a great question. There's always going to be a place in the super-premium segment, even if the volume is limited for a very craft regional grower, similar to what we see in micro beer or the spirits business. The large licensed producers, with Aurora leading the way, have improved their offerings to meet consumer demands. As we've observed with San Raf, the strengths of large licensed producers—such as access to listings, retail execution, innovation, and scientific advancements—will become evident. It's not just that the largest producers will only account for 35-40% of the market; it might take longer than we all would like for things to shift. However, there are inherent advantages that we all have, particularly Aurora, that will enable us to increase profitable market share. If someone wants to focus on discount products and chase lower margins while losing money, they are welcome to do so. But in the core and premium segments, companies like Aurora are poised to perform very well, especially as consumers begin to expect more from the larger licensed producers.

Doug Miehm, Analyst

Thank you.

Miguel Martin, CEO

You're very welcome.

Operator, Operator

Our next question comes from Adam Beaucam with Scotiabank. You may proceed with your question.

Adam Beaucam, Analyst

Hey, guys, thanks for taking my question. So I wanted to touch back on Israel. I guess I have 2 parts. The first one is thinking about the 2 large sales that you've made. First in July and then I guess the upcoming one. Can you maybe talk to how much of this is there really being up the bottleneck that's occurred there? And then secondly, are you able to comment on how many Canadian LPs are supplying Israel currently?

Miguel Martin, CEO

I don’t think it’s a bottleneck. I visited in July and found that local Israeli companies are high-quality and growing cannabis. The IMCA, which I respect a lot and had the opportunity to learn from, anticipates that Israel will have some of the strictest regulatory requirements globally and will lead in regulatory compliance. That’s quite challenging. Many would like to enter the Israeli market and benefit from its margins, but first, you need to excel in regulatory compliance. You also need a strong partner that can operate on the ground, and we are very happy with our partnership with Cantek. Additionally, a long-term commitment as a company is crucial, and we couldn’t be more satisfied with how everything is aligning. I don’t know all the different licensed producers trying to enter Israel, but with the attractive margin structure, it’s likely that many want in. However, navigating the CUMCS and pesticide testing isn’t easy. Only a few companies have managed to do so. I would argue we have done it better than most, and we are excited about our progress.

Adam Beaucam, Analyst

Great. Thanks.

Operator, Operator

At this time, we have reached the end of the question-and-answer session, and I will now turn the call over to Ananth for any closing comments.

Ananth Krishnan, Vice President, Corporate Development and Investor Relations

Thanks very much, John, and thanks very much for everyone for joining the call. We look forward to coming back in November, reporting our Q1 Fiscal 2022 financial results. Everyone else, please stay safe, and hope to speak to you soon. Thanks so much.

Operator, Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.