Earnings Call Transcript - ACB Q1 2020

Operator, Operator

Good afternoon, everyone. Welcome to the Aurora Cannabis First Quarter Fiscal 2020 Conference Call for the three months ending September 30, 2019. During today's call, Aurora will be referring to an earnings presentation, which listeners are encouraged to download from the financial reports section of the company's investor website, investor.aurora.com. Listeners are reminded that certain matters discussed in today's conference call or answers that may be given to questions asked could constitute forward-looking statements that are subject to the risks and uncertainties relating to Aurora's future financial or business performance. Actual results could differ materially from those anticipated in these forward-looking statements. The risk factors that may affect results are detailed in Aurora's annual information form and other periodic filings and registration statements. These documents may be accessed via SEDAR and EDGAR databases. I’d like to remind everyone that this call is being recorded today, Thursday, November 14, 2019. I would now like to introduce Mr. Cam Battley, Chief Corporate Officer of Aurora Cannabis. Please go ahead, Mr. Battley.

Cam Battley, Chief Corporate Officer

Thanks very much. Good evening everyone, and thank you for joining today's call. With me today are our Executive Chairman, Michael Singer; Terry Booth, our Chief Executive Officer; Glen Ibbott, our Chief Financial Officer. As we are doing today’s call a little later than usual, for today’s agenda, I’ll do a quick review of the quarter, including our operational highlights and discuss our upcoming next generation products and then Glen will discuss our financial results. We will then take your questions. I would like to point out what the operator referred to and that is our presentation that’s available in the financial reports section of our website investor.aurora.com. In particular, if you go to that site, you will see an innovation that we began using a couple of quarters ago and that is our dashboard with key performance indicators for the quarter. This quarter all the bad news is in the top left-hand corner, and that is that our Canadian consumer cannabis sales are down 33%, obviously not the number we were hoping for. However, if you take a look at the other eight key performance indicators that we’ve been tracking now for three quarters, they are all green. They are all positive. Our Canadian Medical revenue is up. Our international revenue is up. Our cash cost to produce is actually down 25%. We’ve moved under a dollar and we came in at $0.85 per gram for the cash cost to produce. Our average net selling price per gram is up 7%. Our gross margin, our industry-leading gross margin remains stable at 58%, which is head and shoulders above our peers. Our kilograms produced were up 43%, and even our SG&A, which we promised that we would control as part of our path to profitability, is actually down 3%, including the impact of a one-time out of period adjustment. And then finally, the number of active registered patients is up 8% to a record of 91,000. Now, I’d like to briefly address the current state of the market. The past few months have been challenging for the broader cannabis industry, due to governance issues, evolving consumer demand, and provincial retail bottlenecks. There's been no shortage of negative news. That said, I want to reiterate that our view of the opportunity in the Canadian and global cannabis industry is still extremely robust. It is important to remind ourselves that the Canadian consumer market is just over a year old. These issues will take a little time to resolve, but ultimately, we will be a stronger business because of it. At Aurora, our objective is to continue to define the future of cannabis worldwide and positively and significantly impact the lives of millions of people by cementing our leadership position in the medical, consumer, and hemp-derived cannabinoids markets. As we indicated on our Q4 call, we expected to see growth plateau in the market in Q1 2020. And in fact, as we reported today, our consumer market revenues declined as a result of changes in customer preferences and particularly challenges in retail and provincial distributors. I want to emphasize that we view these as short-term headwinds, and despite them, Aurora has continued to maintain our position as the leading producer and supplier of high-quality medical and consumer cannabis products. Our non-wholesale cannabis net revenue declined 19% this quarter totaling 60.5 million at the end of Q1. To that, we added a further 10.3 million for wholesale transactions. We believe that the wholesale market continues to represent an opportunity for Aurora, and we will be opportunistic. We are in a unique position to capture a greater share of that market in the coming quarters with potential white labelling strategies and other bulk sale opportunities. Our strong cultivation capability, highlighted by our record 41,436 kilograms of production in fiscal Q1, is part of what gives us the confidence in our ability to capitalize on this market. Our industry-leading Q1 2020 gross margins remain stable at 58%, providing 53.7 million in gross profit to fund our operations. I’m also proud to report that our high-tech cultivation facilities delivered on our promise to provide industry-leading indoor cash cost to produce below $1 a gram. In fact, this quarter we came in well ahead of our expectations at $0.85 a gram. While we continue to leverage our coast-to-coast supply agreement to offer a broad range of premium consumer products across Canada, Aurora also remains focused on supplying medical patients with consistent premium products. In Q1 2020, the total number of active registered patients increased by 8%, demonstrating the value of Aurora’s product and patient loyalty to the Aurora family of brands. Turning to the consumer side, the Ontario cannabis store, Ontario’s online retailer recently announced their top-selling dried flower products after the first year of consumer legalization. I’m very proud to report that our products performed exceptionally well, with San Rafael ’71 Pink Kush in the number one selling spot, followed by Aurora Blue Dream in second place and San Rafael ’71 Tangerine Dream taking third position. This is excellent confirmation that our premium cannabis products continue to resonate extremely well with Canadian consumers because we are adaptable to their demand for high-quality consistent products. We continue to be successful because Aurora has built up a product development strategy that focuses on strengthening our competitive advantage with innovative product forms, enhancing the experience of existing customers, and capitalizing on opportunities to attract new consumers and new patients. Great examples of this, or one great example of this is how we’ve continued to address the demand from medical patients for alternative delivery format and dosing options. A couple of unique products that we brought to market include the recent launch of Aurora oral dissolve strips, a sublingual strip that was created together with CTT Pharmaceuticals. Dissolve strips are a discrete, easy way to use the product that is ingested sublingually to provide more rapid bioavailability of the cannabinoids to the body. We’re also excited to have recently reintroduced Aurora Cloud for our medical patients. It’s the first and only legal concentrated CBD vape product in the Canadian market today. In addition, with the second wave of legalization coming into effect shortly, Aurora's insights and product innovation teams have done tremendous work to formulate new products in the right format that we think will exceed customer expectations and drive category growth. Aurora’s cannabis 2.0 strategy focuses on four key pillars: using quality extracts, leveraging proprietary extraction technologies to produce high-potency concentrates, providing a range of superior products to suit different consumer preferences, and using our expertise to produce consistent and reliable products at scale. The initial suite of new products that we will launch includes vapes, concentrates, gummies, chocolates, mints, and cookies. We've selectively partnered with a variety of organizations, prioritized our resources, and built the inventory to help ensure consumers across Canada will have access to our high-quality derivative products. We’re ready to ship products as soon as the regulations allow and are excited for consumers and patients to finally have access to a greater selection of product forms. Additionally, in advance of our new product forms being available to the market, we’ve launched a campaign called 'Ready for Edibles,' dedicated to educating new and experienced cannabis consumers on responsible consumption and safe storage of edibles products before they become available for sale in December. We want to ensure that Canadians have the information that they need to understand these new products, how to consume them responsibly, and most importantly, that they should be kept away from children and pets. Educational content will also focus on identifying signs of over-consumption, understanding the differences in onset times and effects, and cautions around mixing with alcohol and driving while intoxicated. This, we believe is the behavior of an industry leader. So, as you can see, we’re looking ahead, continuing our focus on strategy and execution, serving our medical patients and consumers with premium safe affordable products, and gaining consumer confidence and brand awareness. I’d now like to turn the call over to Glen to discuss the financial highlights of the first quarter and then we’ll open up the line to questions.

Glen Ibbott, Chief Financial Officer

Thanks, Cam, and good evening everyone. The figures I'll be going over today can be found in our financial statements and in our MD&A, and all are in Canadian dollars unless I note otherwise. For our first quarter of fiscal 2020, for the period July 1 to September 30, we reported net revenue of just over $75 million. Our total cannabis net revenue, including wholesale, came in at 71 million for the quarter. Non-wholesale cannabis net revenue was down 19% at 61 million, a decrease attributed primarily to a decline in consumer cannabis revenues. Of note, demonstrating our continued commitment to the medical market, our medical cannabis revenues grew 3% even in the face of challenges from the consumer system cannibalization. Finally, we did add a further 10 million in wholesale revenue at a very attractive 58% gross margin. I’ll now go into a bit further detail on each of these revenue streams. During Q1 2020, our medical cannabis net revenue increased 3% quarter-over-quarter to over 30 million, driven by our continued success in growing our patient base, which currently stands at just over 91,000 clients. Our revenue was affected by a slight decrease in the average net selling price of medical cannabis of 6%, but more than offset by patient growth. The decline in selling price was the result of temporary pricing incentives designed to support the move of valuable long-term medical patients to Aurora, and away from licensed producers that weren't servicing them well. As usual, our medical cannabis sales and gross margins were impacted by our decision to absorb the cost of excise taxes. We continue to lobby the government to remove these taxes from medical products. Our international medical cannabis sales during Q1 increased 11% to 5 million, comprising 7% of our total consolidated net revenue. We expect a higher rate of growth in our international markets, and over the last quarter, I have been adjusting strains under cultivation at our EU GMP facilities to better meet the needs of the European markets. We have also been growing our sales force in Germany and believe we continue to have the leading market share of natural medical cannabis. Consumer revenue was $30 million, a decrease of $15 million or 33% from the prior quarter. This decline, as you all know, was driven by constraints in distribution networks that have caused a temporary decline in ordering from the provincial distributors as they allow inventory levels to normalize. With adequate consumer choice now available, we’re also seeing consumers exercise that choice to select those products that they prefer. We monitor the sell-through rates from the provinces to the retailers very carefully, as we believe that to be a strong indicator that our products are meeting the needs of consumers for both quality and pricing. We are pleased that the Aurora family of brands continues to show strength across the major provinces for sell-through. We expect headwinds to persist through the next quarter before Canadian consumer infrastructure develops and matures throughout the back half of our fiscal 2020 with the license fee of new retail stores across Canada and the introduction of the new product formats. I do want to emphasize that our average net selling price of $5.60 per gram was a sequential improvement of 7%, further highlighting that demand for high-quality recreational cannabis is strong and that premium products can capture better pricing. During Q1, Aurora generated $10 million in wholesale revenues compared to 20 million in the prior quarter. Although the selling price per gram declined from the previous quarter, we consider that selling excess extraction grade product had a 58% margin with a very prudent decision. As we noted on our last conference call, we expect our wholesale revenues to continue to be uneven, and with our reliable production of quality cannabis with very low costs, Aurora is uniquely positioned to capitalize on this wholesale revenue opportunity. We do have line of sight to further wholesale revenues in Q2 2020 and are actively pursuing the development of a white label business as well. Aurora produced over 41,000 kilograms of cannabis in Q1, as compared to 29,000 kilograms in the prior quarter. This increase in output was primarily due to our production levels achieving a steady cadence at targeted capacities and our continued operational optimization at our Sky and Ridge facilities. In Q2, we expect production to have been closer to our targeted annual capacity of 150,000 kilograms as we undertake certain R&D initiatives designed to enhance the cultivation process and as we introduce certain higher potency but lower-yielding strains during high demand as consumer preferences evolve and become evident. Our cash cost to produce per gram of dry cannabis decreased to $0.85 per gram, down 25% from the previous quarter. As Cam mentioned, we delivered on a very important milestone that we have been talking about for several quarters: sub-$1 cost to produce. In an industry where reliable and quality supply is critical to building revenues and brands that will drive the company forward, we have a suite of production assets that deliver very high-quality cannabis on a consistent basis and with the lowest production cost among those of our peers that are operating at scale. It is hard to overstate how important this is for Aurora’s success over the next several years. This sets out an example; $100 of revenue at Aurora would deliver almost $60 to fund growth of the business without having to access external financing sources. It also allows us to move quickly to profitability as revenues recover. Let’s consider two comparable companies, each with $80 million of quarterly SG&A. Aurora would need to generate about $130 million of revenue to flip to profitability. A comparable company, let’s say a 30% gross margin, would need almost $270 million in revenue to breakeven. Our fundamental business leverage with these gross margins is incredibly important to building a long-term healthy business. It should be evident that Aurora can compete strongly in any market situation and would still deliver healthy returns at pricing that would not be sustainable for others. Now, I’d like to discuss our SG&A levels. So, I need to provide some context. You will recall that we were just over $10 million in audit adjustments in our last quarter. As we noted then, our true SG&A was about $83 million. For Q1 2020, SG&A actually decreased by 3% to $81 million. This decline was primarily driven by reduced fulfillment and shipping costs related to revenue levels and a decrease in sales and marketing expense as a result of smaller scale but targeted marketing campaigns during Q1. These cost reductions are partially offset by a controlled increase in corporate salaries due to annual salary increases and the addition of professional talent, both new hires and outsourced consulting to support strategic growth initiatives. As our company matures, we have made a number of changes to internal policies and oversight in order to closely manage the expansion of SG&A in our drive to profitability and prudent capital management. As of September 30, 2019, we had $153 million in cash and cash equivalents. In August, we announced the upsizing of our secured term credit facility of $360 million with an accordion feature for an additional $40 million of capacity, and in early September, we disposed of our remaining equity investment in The Green Organic Dutchman, generating approximately $86 million in gross proceeds. Our adjusted EBITDA loss for Q1 was 39.7 million, compared to a $26.6 million loss in the prior quarter, again when you take into account the impact of our year-end adjustments in Q4. The change in our adjusted EBITDA loss is primarily due to the quarter-over-quarter decrease in revenue. Developing a profitable and robust global cannabis company is extremely important to Aurora. We believe our industry-leading gross margins and high-quality cultivation philosophy will allow us to continue to thrive under any and all market conditions. We expect adjusted EBITDA to improve in the future as Canadian market constraints are relieved and as we increase revenue through the sale of higher margin derivative products and as we manage corporate development and SG&A growth prudently. As you may have seen in our press releases today, we have announced a decisive plan to immediately strengthen our balance sheet. This plan includes several steps that are designed to streamline our operations and provide financial flexibility and reduce financial leverage in response to changing market and regulatory conditions, all with a view towards long-term growth and sustainability. First, we continue to monitor and forecast supply and demand in the Canadian and international cannabis markets in order to time our scale-up for further Aurora production capacity as needed. As a result, we recently adjusted the construction timeline for both the Aurora Sun and Aurora Nordic 2 facilities to more closely align with our current expectations for the timing of increasing demand. These adjustments will result in significant decreases in our ongoing quarterly levels of capital investment and are expected to conserve approximately $190 million in cash over the next few quarters as compared to our previous buildup plan. With the work completed to date, the company will be well-positioned to advance these capital projects as global demand or as Aurora's market share grows. As we noted in our release, we still expect to complete approximately 238,000 square feet at Aurora Sun in January 2020, representing six grow rooms and a mother room. As I mentioned last quarter, Q4 2019 was the peak of our CapEx spend with over 20 capital projects on the go. Many of these projects continued through Q1 and have been substantially delivered in October and November. Our expectation for fiscal 2020 quarterly capital expenditures is that Q2 will be similar to the $108 million we reported this quarter, Q3 will be in the $70 million range, and Q4 will be in the $50 million range. Next, we announced that we have entered into conversion support agreements with investors representing approximately $155 million or 67% of the principal value of the March 2020 convertible debentures that are currently outstanding. Under this contemplated transaction, all holders of the March convertible debentures will be granted the special conversion option for a short period of time to convert their March convertible debentures at a price to be determined by our five-day trading formula. Any holders not exercising their conversion option will remain holders of their original debentures that will mature on March 9, 2020. Finally, we have been active on the overall $400 million at-the-market financing programs as it represents a strategically valuable source of equity capital. To be clear, cash raised under this program is transacted at the market price with no discounts, warrants, or other sweeteners offered. We consider the availability of the ATM for Aurora, given our normal trading volumes, could be a very important tool, especially given the current market conditions. Fiscal year to date, the company has raised gross proceeds of USD 124 million or approximately $165 million Canadian through the issuance of just over 29 million common shares. We believe that these measures to strengthen our balance sheet and financial position, in addition to solid operating performance we discussed earlier, strongly position Aurora to outperform the Canadian and international markets and begin to expand the size of the addressable market. I’ll now turn the call back to Cam.

Cam Battley, Chief Corporate Officer

Thanks, Glen. So, in conclusion, we continue to focus on what we can control in an evolving market. Consistent execution, operational excellence, and our focus on operating a sustainable long-term business. In addition to being agile and intelligent in responding to changing market and regulatory conditions. As our key performance indicators show, Aurora delivered solid operating results this quarter. This is exemplified by our industry-leading indoor cash cost to produce, which declined 25%, and our continued strong and industry-leading gross margins in market share. Our announcements of a formal plan to settle the March convertible debentures, a reduction in our capital investments over the next several quarters, and raising over USD 124 million in gross equity proceeds since the start of fiscal 2020 through our ATM are designed to put Aurora on a solid path to being a long-term winner in the global cannabis business. I’d now like to ask the operator to open the call for questions.

Operator, Operator

Certainly. [Operator Instructions] Your first question comes from the line of Vivien with Cowen and Company. Please go ahead. Your line is open.

Cam Battley, Chief Corporate Officer

Hi, Vivien.

Vivien Azer, Analyst

Hi, good evening. Thank you for the questions. So, I'd like to unpack your revenue priorities, please. I appreciate your commentary around the margin benefits around white label products. That's certainly evident in your near 60% gross margin which is CPG-like and very impressive, broadly in staples, but at the same time ACB has been uniquely delivering higher quality cannabis and impressively low cost. So, after this week, where we have seen so many of your peer’s report earnings, we know it's been increasingly challenging for your peers to achieve, but I want a couple of things. Number one, how do you get comfort on demand planning around wholesale, and number two, do you think that your high-quality production is replicable and scalable? Thank you.

Michael Singer, Executive Chairman

Glen if you could take the financial side of that then I can speak to the production.

Glen Ibbott, Chief Financial Officer

Hi, Vivien. You are asking how we get a view on wholesale as a long-term business. What we are seeing is that the extractors – and as you know, there are a number that have scaled up over the last year and are playing an important role in the industry right now – are actually being selective about the quality, the inputs that they are getting. And so, we in this quarter of the 10 million, there is at least three, it kind of spread evenly amongst three extraction companies and a small bit through a licensed producer, and we continue to get the interest as long as we can supply the quality of cannabis that they are looking for, for continued buying. We’re just trying to be cautious, because remember the last quarter because we still think it will be a little bit lumpy and there will be sort of an opportunistic element to this, but we do have a view for continued revenues; I’m not going to go as far as saying as much as this quarter, but certainly have to pay attention to. The white label piece of this I think is really interesting to us. We are seeing a number of licensed producers that are either late to the game and are more interested in building a brand or simply just starting to realize that they may be timed to exit the cultivation side. The manufacturing scale-up is incredibly difficult, and we have the capacity across the chain from seed to sale built within our business now to be able to execute a white label business. So, we do have a team working actively on that. I think that's a real interest in terms of the additional capacity that we can produce to go that route because I believe long-term that will be where the better margins are. I believe on the wholesale bulk opportunities that companies will see pricing pressure develop over time. We haven't seen it yet, but we will see it, so much more interested in white labeling side. Cam?

Cam Battley, Chief Corporate Officer

Yes, so Vivien, to get to the other part you asked, whether we think that our high-quality cannabis production is replicable and scalable, the answer is yes, that's exactly how we designed our production technologies and innovations from the very beginning, including our large Sky class facilities, and we keep getting better and better at this. So, we already had the highest production efficiency per square foot in the world, and we think that we can continue to enhance that. So, yes, our production with that high quality at low cost is designed specifically to be both replicable and scalable.

Vivien Azer, Analyst

And just a follow-up…

Terry Booth, Chief Executive Officer

Just to add to that, Cam – Terry Booth here – Vivien, how are you doing?

Vivien Azer, Analyst

Hi Terry. Very well.

Terry Booth, Chief Executive Officer

Good stuff. I just want to add to Cam's and Glen's comments with respect to these wholesale deals that we're doing. They mainly consist of trim and shake, and it's the lower quality product that comes off of our product, which we would normally extract for ourselves. In fact, some of the supply agreements in that bulk sale include us extracting for other licensed producers, so it's another line of business; it's a profitable one with products that we would not normally consider high importance to us.

Vivien Azer, Analyst

That's super helpful. Thank you. A very quick follow-up. I want to be mindful of everyone else in the queue. But, like, is there a framework – can we define what quality means? Because I was chastised several times over the last two-and-a-half days at our conference in Boston around pegging potency to quality, and that could very well be right. I don't know that the Canadian marketplace is so sophisticated and I don't know that your buyers are so sophisticated either, but you guys are clearly delivering a better product that has wholesale demand, and I want to understand what the demand drivers are for that wholesale business that carries such a nice margin, please? And thank you.

Terry Booth, Chief Executive Officer

Can I speak to that, Cam?

Cam Battley, Chief Corporate Officer

Yes. Please go ahead, Terry.

Terry Booth, Chief Executive Officer

Sure, so quality – the quality of cannabis, it’s something that has to be grown in a pristine environment, it has to be grown in an environmentally controlled environment with the appropriate levels of CO2, micromoles, temperature, and humidity, and at the end of the day, we know we can grow great cannabis, and that's attested to by the awards that we receive from consumers, who are largely very educated with respect to cannabis. It’s really the profile of the cannabis, including the THC levels, CBD levels, and terpenoid profiles that are very important. Those three need to come together to create a pleasing effect, if you will, and that is what charts upgrade products like our Tangerine and our San Rafael and our Blue Dream. It is what educated and longtime users of the products look for. Now, those licensed producers that can't grow properly get non-competitive products which can burn your throat and those products aren't doing very well, are they? That is because they are growing in environments that are not suited for high-quality production.

Cam Battley, Chief Corporate Officer

That's a good summary, Terry. Okay. Next?

Operator, Operator

Your next question comes from the line of Tamy with BMO Capital Markets. Please go ahead, your line is open.

Cam Battley, Chief Corporate Officer

Hi, Tamy.

Tamy Chen, Analyst

Hi, thanks. First question is, could you clarify what you mean by the lock of support in the press release on the debentures? So, are the committed CAD 155 million shareholders subject to a share lockup, and if so, for how long?

Cam Battley, Chief Corporate Officer

Yes, can I ask Glen and Michael to weigh in on that.

Michael Singer, Executive Chairman

Sure, it's Michael. So, we indicated that we had secured a commitment of up to 155 million. The majority of that is irrevocable commitments, and they will be free-trading stock at the time at which we grant those to the holders. So we're very confident that obviously that represents a significant portion of that convertible debenture, and we feel good that we're making a huge step forward in strengthening our balance sheet by virtue of this decision.

Tamy Chen, Analyst

Okay. So, they will be free trading at the moment of grant. There is no lock-up period.

Michael Singer, Executive Chairman

There is no lock-up period. Correct.

Tamy Chen, Analyst

Okay, thanks. My follow-up question is, I'm just trying to reconcile between your commentary about the number of your strains or products, I should say, are top-rated in a number of these provinces versus the sell-in that we've seen this quarter. Recognizing that there is limited distribution and number of stores, but we've seen some of your peers increase their share of sell-in sequentially. So, could you help me reconcile these two aspects? Thank you.

Cam Battley, Chief Corporate Officer

Yes, this is Cam. What we're tracking is that our brands remain either number one or number two in all the major markets across the country. What we're seeing is that we obviously moved an awful lot of product in the previous quarter, so it takes time for them to work through the inventories. That's essentially what we anticipate. We're getting nothing but positive feedback on our brands, and we believe that we continue to have leading brands in the marketplace, if not number one, then number two.

Terry Booth, Chief Executive Officer

Cam, I would like to add to that. What happened with the provinces last October was there was an undersupply, and the licensed producers took heat; the provinces took heat. We allocated the best we could; I don't think many of our contracts were undersupplied. Then we all started growing cannabis, and some started growing cannabis a little bit later and were not able to provide stuff to the shelves at all. During the summer, the provinces feasted on the supply that was available and stocked their shelves to the limits. While that may have been a good idea in their minds, they are not going to have supply issues for the retailers anymore, but it also affected the next quarter in which they didn't buy as much. The other thing that's occurred is, some licensed producers, including ourselves, have put some product aside for Cannabis 2.0 and getting ready for this derivative market, which is the higher-value market. Some of our higher top strains weren't as available to these provinces because we were saving it and we were extracting it and we were creating pens and gummies and cookies and things like that that are going to be available for 2.0. So, I think that if any licensed producer has increased its sale, this is because they came to the party later or they finally had the ability to provide the contractual amount that they were committed to.

Operator, Operator

Your next question comes from the line of Chris with Bank of America. Please go ahead, your line is open.

Cam Battley, Chief Corporate Officer

Hi, Chris.

Chris Carey, Analyst

Hi, good evening. So, maybe I just want to ask a higher-level kind of philosophical question. It's the second time today that I've used that word, and so I guess maybe just trying to understand your decision process, right, and maybe how that's evolved and what you've learned over the past six months. We've known for a bit now that things were slowing and that CapEx has stayed high. Obviously, it's coming down going forward, which is good to see, but you have to use this ATM and kind of dilute your shareholders more just to kind of buffer your balance sheet, and I get that sort of what's required right now. But, there is another aspect of it that discretionary spending has been pretty high, and here we are, really having to buffer the balance sheet where things are not so ideal. So, maybe just kind of how your decision-making process has evolved over time and how we should think about things over the next six to twelve months?

Cam Battley, Chief Corporate Officer

You've asked, what we've learned? The answer is a lot. You noticed that we started to change our behavior, including our spending habits right at the beginning of 2019, and that's when we started to get very serious about the path to profitability. Since then, we've been putting an awful lot of effort into controlling our cost management, right? You see that our SG&A has been well managed and until this quarter, it has been growing less fast than our revenues. So, we have learned a lot. I think you should also take a really close look at the margins, our commitment to high margins and higher margins than our peers while continually bringing those costs down, while increasing scale – that speaks to a sustainable business. Now, you say that there have been indications that the retail infrastructure would not be there. Well, yes, but that's true, and we'll take our lumps on that as long as everybody else does too. I don't just mean other producers, analysts, and observers across the board; I think everybody anticipated that there would be more retail infrastructure available by now than there is. Now, if the question then becomes, what do you do about it? We think that we are doing the intelligent rational things. We're scaling our production to make sure that it's there to meet the demand; we're going to try and enhance that demand and stimulate that demand certainly, but we're also making very careful steps to ensure that we maintain that high margin and keep delivering those high margins over time. To us, that speaks to the companies that will come out the other side after a win-win because we all know that not all existing cannabis companies, including publicly listed ones, are going to make it. To us, that business strategy speaks to a company that's going to be a long-term leader.

Chris Carey, Analyst

Okay, thanks, Cam. And then as a follow-up, and Glen, I suppose I asked you something similar last quarter, and the pieces have just changed a little bit here, but if you kind of take that, what's remaining on the credit facility and the fact that you don't probably have to pay as much on the convertible obligation in your calendar Q1, but even if you kind of assume cash burn at the improved CapEx and maybe even operating cash flow better, is it kind of your base case now that you need to exercise all of the ATM to kind of get you to your fiscal 2021 cash flow when maybe you get cash flow positive? Or maybe said another way, if that's not the right way to think about it – what's the appropriate way to think about just cash burn relative to funding needs and how you're going to get there? Thanks so much.

Glen Ibbott, Chief Financial Officer

Yes, Chris, and yes, that's an excellent and an obvious discussion we've had before. What really, I think, about this is there are a lot of things yet to come, and I know some of our peers have strong revenue guidance because we need to see how a few things play out. We had excellent feedback from a number of sources on our initial product offering for the 2.0 products. The provinces won't issue purchase orders until December when they're legally allowed to purchase. But we're starting to get a view that we’ve got the right lineup of quality products at the right price, and we think we'll be off to a good start there. A big part of this is showing up with good product portfolios, and it will also depend on how our peers show up as well. As we talked about earlier in my example of leveraging the margin, the profitability or EBITDA line is going to be highly dependent on how the consumer market with the new products and with the retail footprint if we take Ontario at their worth and speed things up; that's going to impact our revenues a lot and finally impact how much cash and when we get to profitability, about how much cash we'll need. But we are also trying to balance our need or desire to continue to build a global business. So, part of this I think will inflect as we look at certain strategic transactions we’re looking at would certainly be accretive, but we will see how it plays out. Right now, my anticipation isn't that we would need to use the ATM to the extent that we currently have approved, but I'm going to have to wait to see how 2.0 and retail rollout and certain strategic transactions play out over the next several quarters before I can – before we can land definitively on that. I'm certainly happy to continue to talk to this because I think we are learning every step of the way as to how things are going to look over the next couple of quarters.

Terry Booth, Chief Executive Officer

Hi Chris, it's Terry here. Just to add to Glen's commentary there with respect to Cannabis 2.0, there's a few things here with 2.0. I also include the Ontario retail government processes being fixed. Alberta met Ontario sales; we've got one-third of the population in Ontario. So, that tells me there's a significant amount of cannabis users because we have the same cannabis users per capita in the provinces of Ontario and Alberta. There’s a massive amount of people who have not been brought into the web of legalized cannabis because it hasn't been as available. If you think about it, all that we’ve really been selling to these poor retailers was only joints, capsules, tinctures, and bud. We’re going to be adding numerous different product lines to truly meet the mandate of the federal government and the UN Convention when you legalize adult cannabis; you have to show that you're going to be competing with and reducing the gray market. This 2.0 is going to do that, and it's going to allow the retailers to do better off; it’s going to increase sales on the high-value products and bring in more users that are already in the system but still choosing to go to the gray market. I'm excited to tell you about 2.0; I don’t want to be told to be conservative, but I really am pumped about how Aurora has done its job in getting ready for 2.0, and all indicators from our retailers, provinces, Health Canada and all the little hints we've seen indicate that Aurora is at the top of that pack as well. So, we're pretty pumped.

Operator, Operator

Your next question comes from the line of Doug with RBC Capital Markets. Please go ahead, your line is open.

Cam Battley, Chief Corporate Officer

Hi Doug.

Doug Miehm, Analyst

Thank you. Hi, how are you doing? Got a couple of questions that maybe have been obvious, but I'm just curious about how things are going with the US CBD deal in terms of timing, and first to on time, or if there is anything new you want to add to that discussion?

Cam Battley, Chief Corporate Officer

Yes, I'm going to hand it to Michael and then maybe come back at the end because we've learned a great deal about the U.S. market because remember, it's not just the Canadian cannabis sector that's been struggling; it's the U.S. sector as well. So, there's a lot to learn about that. Michael, do you want to speak to this?

Michael Singer, Executive Chairman

Sure. So, no surprise, we remain very active in looking at opportunities in the U.S., and they have to fit a number of certain criteria. I think what we're looking to do is to try to piece together a number of different strategic initiatives that I'll put our way out. We are obviously going to have to operate under the current regulatory framework. That's a key criterion for us. We see the U.S. market as a platform for us to be able to capitalize on not just the U.S. market but use that as a springboard for international CPG expansion, and that links very nicely to our relationship with Nelson and the Congress and the connections that Nelson has provided us in terms of strategic partnering discussions. We're actively involved in negotiating a long-term relationship with these CPG companies with Nelson's help in terms of how we're going to structure this so that we could link together, like I said, not just a U.S. strategy but one that integrates into many different industry verticals that we see as a huge global opportunity. We’re not at a point at which we can announce that today, of course, but we continue to make tremendous progress, and we're excited about the development of those discussions or the continued dialog that we have with numerous parties. I think when we do eventually announce a U.S. entry and strategy, it’s going to be very clear as to how this ties together; it’s not just those strategic partners we've announced but we're looking at other strategic partners as well, like the UFC, and so all of this is going to be all encompassing and a very clear path forward for how we feel we're going to operate in many different developing industry opportunities.

Doug Miehm, Analyst

Okay, great.

Terry Booth, Chief Executive Officer

If I could add, Michael, on the regulations, it's been pretty slow at this, but it's important that we know what the regulatory framework will look like. The USDA just recently, like two weeks ago, maybe less, finally put out their requirements around the production of hemp and the testing of hemp and CBD, and that drives a lot of our decisions on which partners we choose to enter into the United States. So, we're happy that that's finally out, and that will expedite the decision on the entry point.

Doug Miehm, Analyst

Okay, perfect. My follow-up question just has to do with product velocity. We have seen good product velocity with your various products, but maybe what you could do is just compare what you're producing in Sky versus MedReleaf/Whistler and then maybe dovetail that into, we've seen a lot of issues, and maybe this was touched on earlier around product returns and those sorts of things. Do you believe that there is any evidence that you could face potential pricing decreases or product returns in the future? And with that, I'll leave it there. Thanks very much.

Cam Battley, Chief Corporate Officer

Yes, it is Cam; I'll take the first crack at that. We have not – to date, we have not seen significant issues with product returns. I know why you're asking because that's really kind of plagued some of our peers. We're not having the same issues. I want to touch wood because you never know what will happen in the future, but we do not anticipate that we will have those issues either. Just remind me what the first part of your question was, Doug, if the microphone is still open.

Operator, Operator

Doug is no longer connected.

Cam Battley, Chief Corporate Officer

Okay. I'm sorry, Doug; we'll have to do that in a follow-up call. It's been a long day, and having that microphone is still connected.

Operator, Operator

Your next question comes from the line of John with CIBC. Please go ahead; your line is open.

Cam Battley, Chief Corporate Officer

Hi, John.

John Zamparo, Analyst

Good afternoon. Hi. Cam, you referenced changes in the – or in customer preferences impacting your revenue in the quarter. I'm just hoping you can elaborate on what that is. And just to clarify your commentary from earlier, do you expect to grow revenues in Q2?

Cam Battley, Chief Corporate Officer

We're not projecting that. We're not giving guidance on that. As Glen indicated earlier, we'll have better visibility once we see exactly what the rollout of new retail infrastructure is going to look like and also what happens with the uptake on the Cannabis 2.0 products.

John Zamparo, Analyst

And impact during the quarter, like the change in customer preferences?

Cam Battley, Chief Corporate Officer

Yes, look, we are constantly evolving our product mix. One of the things, if you were on an earlier call today, is one of the other companies, perhaps had difficulties with the volume of certain derivative products that they were trying to move in the consumer market. In terms of flower too, we're always adjusting based on what sells well. So, we have already started to change the mix of cultivars that we're growing, and we will continue to do that. I think actually we're very, very agile. We've got very good market surveillance, and I would suspect better than most of our peers, and that's essentially what we're talking about there.

John Zamparo, Analyst

Okay, thanks. And then my follow-up is on profitability. So, the various puts and takes in the market and we all know there are not enough stores. You'd previously expected profitability a couple of quarters ago. So, I'm trying to get a sense of when do you expect this now, and what ability do you have to flex SG&A down in case the retail rollout delay continues?

Cam Battley, Chief Corporate Officer

Glen, can you speak to that?

Glen Ibbott, Chief Financial Officer

Sure. Listen, I think it’s important – we do have a long-term view on this industry. Cam outlined that a little bit earlier. We're very excited, and I haven't seen anybody pull back on the accessible market projections in Canada, in the U.S., and globally. So, we're balancing – you're asking specifically about tackling SG&A. We think we have it at a pretty good state right now; the focus in spending, of course, is containing and controlling; we are really watching it closely, but I'm also recognizing we're trying to build a global leader here and sometimes you have to be careful not to pull that too far short-term at the cost of the long-term value creation. SG&A is at a good level; we'll manage it prudently. In terms of profitability and EBITDA, as Cam mentioned earlier, I don't think there is any of us on this call expecting Ontario, a year after legalization, to expand 24 stores. They made the right noises slightly, or are certainly a little more optimistic that they are not going to get out of the way and start licensing that province properly, and it’s we harp on Ontario simply because it is the biggest province, and it is far behind the leaders like Alberta, which has almost 300 stores as compared to Ontario's 24. When we were looking at EBITDA positive, we were expecting an Alberta retail footprint; we've seen retail stores go in, and spending is very encouraging at those stores. So, we expect that to be a big driver. But we're just being very cautious right now. We're controlling, and I think controlling effectively all the levers that will take us to profitability. Certainly, amongst our large-scale peers, we think we'll get there much earlier than others, but we've gone on about the margins. We think that's incredibly important again; using my example, the difference in revenues you need to generate whether you're operating 60% margins or 30% margins to get to profitability are astounding. With controlled SG&A, we deliver the product mix that the market wants; all those pieces are in place; we just need the retail infrastructure, the provincial distribution, and the new products, and then we’ll see how this plays out. We’re staying away from projecting when that will happen, but we know what we're monitoring to see what that ramp looks like.

Operator, Operator

Your next question comes from the line of Michael with Piper Jaffray. Please go ahead, your line is open.

Cam Battley, Chief Corporate Officer

Hi Michael.

Michael Lavery, Analyst

Thank you. Good evening. I have kind of a strategic question and a quick follow-up after. But strategically, I guess if you look at your business, you've got the highest growth gross margins in the industry; you've got the lowest cost – at least by far almost anybody; and yet your EBITDA margin is negative; it got worse. It's obviously behind the targets for profitability you've had for 4Q, and if I'm hearing you right, there's not really necessarily a light at the end of the tunnel. As you look at your wholesale sales and the attractive margins there even slightly better than total company gross margins, and also the outlook you gave with very positive remarks around white label sales, I guess I just want to understand how you think about where your right to win is and where you're best positioned. Would you ever rethink how you approach your position in the market and maybe pivot a little bit more to take advantage of where you've got these advantages and rethink a little bit of who you want to be when you grow up?

Cam Battley, Chief Corporate Officer

Let’s look to unpack that. Let’s start with wholesale. Let’s remember that virtually all the wholesale product that we're selling is trim and shake and maybe some popcorn buds, the smaller, less attractive flowers. So, there is a limited amount of that. We also have – Aurora arguably has the most attractive medical brand, certainly in the world, and we've got the most attractive consumer brands in Canada. I would not say that our chief strength is just cultivation; it is cultivation, and that's great. We've emphasized now for what three quarters that we see the critical success factor in the short term here in this industry being able to consistently produce without crop loss; high-quality, low-cost cannabis and to move it through multiple distribution channels. But that's not the only thing we are good at. Our technology is amazing, and one of the reasons we are so confident about Cannabis 2.0 is because our product development team, led by Dr. Shane Morris, is just amazing. We have a tremendous product development team, and we're very excited about our products. We think that in general, Cannabis 2.0 advantages will tend to benefit the larger companies more than the smaller companies, and we think that we have particular advantages there. So, we're not prepared to concede any aspect of this business right now.

Michael Lavery, Analyst

Okay. That's really helpful color, and just to follow up, I’d love a quick sense if you look at it this way or have some way to quantify it. When you look at your portfolio and your yield – your crop, clearly we've seen stronger demand on the higher potency side. I don't know if 20% is the magic cutoff; I'm not sure how you may classify it. But when you look at your portfolio and what you sell, do you have a sense of how it breaks down by potency?

Cam Battley, Chief Corporate Officer

Terry, do you want to take that?

Terry Booth, Chief Executive Officer

Sure. You're bang on; potency is the driver at this point of the popularity of cannabis flower. If you think about it, potency and the next products as whatever we want it to be, right, we can take it right up to the max or it’s going to be derivative products like shatter, hashish, and oils in the future and near-term future that will have extreme potency. We’ll be able to shake out exactly where that demand is, as people really want to take it to a 95%; well, we’ll see. I think that the cultured community people that are chronic users of this excellent product will be looking toward that. But we don't have all the stats. The West Coast of the USA can provide some insight into that. They are certainly higher value products; and you're right, the demand for the high potency is there, and that's why we’ve pivoted over the last six months to start focusing on the higher potency. You don't think that what I would use this, but because it does take you through a different state of mind, and I think that people are still looking for it. The millennials are looking for – they think that they are getting more product when they get more kick. Until they get fully educated about the different combinations of terpenes, CBD, and THC, and the other 114 cannabinoids that may have – they'll find their way and they’ll find their brand. We're still in year one here; this is probably inning two in Canadian adult usage, and Aurora has nailed it. You will have to remember these other companies had a six-month head start on Aurora, and I'd hate to belabor that point, but we've caught and passed them, and we've done it two quarters in a row, and we're doing it in a great way. The Aurora story is a great one because we went with a method of grow that was not risky; we de-risked the method to grow by having these purpose-built facilities. I can't say enough how proud we are of the teams that have assembled these; we are becoming the employer of choice. We’re becoming a partner of choice globally. These health departments across the world are calling us first. The team that works outside of Canada is excelling across the board. I'm excited to tell you, yes, we had a drop in cannabis sales, but it was anticipated, and we let you know that the provinces were oversupplied and some of us producers – not us – foresaw an oversupply of those provinces and hence the return issue. We had our allocation plan, we didn’t take the bait, we maintained our allocation percentage as per our contracts, and that’s why we have very few returns, if any, of a very notable nature; we get the odd broken box. But there’s a significant difference between us and the rest with respect to quality, and I don’t want to suggest that we’re just great producers; that's crazy. We are great at every vertical that we've entered and will continue to execute in every vertical that we enter by hiring people who want to come over and work for us.

Operator, Operator

Your final question comes from the line of Matt with Canaccord Genuity. Please go ahead, your line is open.

Cam Battley, Chief Corporate Officer

Hi, Matt.

Matt Bottomley, Analyst

Hi, how are you guys doing? Thanks for taking the question. I know it's getting late. I'll just keep it to one. It relates to – you mentioned the importance of your gross margin as a key metric; and it's something, as you sort of look at all the different capacity expansion plans throughout the industry that are starting to reach inflection points here. You've noted a couple of facilities where you're going to be taking your foot off the accelerator as a means of reallocating capital. But what's your view on the risk of facilities that are currently already up and running, where that money has already been invested and capital has already been invested, becoming underutilized as more and more capacity comes online, and how that might impact your gross margins in the near term given that I think it's generally understood that there’s a huge oversupply trend of overall capacity, let alone the inventory that's sitting at the retailers right now? I'll leave it there. Thanks again.

Cam Battley, Chief Corporate Officer

Okay. I'm going to take the first crack at this and then hand it to Glen and if he wants to take it home. Overcapacity is really an interesting question, because there is really no such thing in economics over the long term, right? It's going to find its appropriate level, and we always felt from the very beginning that we had to be able to produce a very large amount of cannabis, but particularly economically; something that a number of our peers have not demonstrated the ability to do. Now, you're right, a lot of capacity has come into the system. I don't know how much of it's going to stay, and there are producers out there who are not economic right now and they'll never be economic because they simply don't have the capability to produce cannabis at low cost. From an Aurora perspective, on the contrary, we are quite prepared to generate very, very healthy margins even if there is price compression over time, and that stands us in very good stead, as Glen has emphasized, to be able to continue to succeed under any market conditions. Glen, do you want to add to that and take us home?

Glen Ibbott, Chief Financial Officer

Yes, I think it's important to make the point that we hear about oversupply as we've seen there is oversupply of some poor-quality product resulting in not moving through. As I mentioned in my prepared comments, we monitor sell-through from the provinces to the retailers closely. I think that's a good indicator of the viability of the business, or if we're producing products that the consumer wants. When we're number one or number two in the major provinces in sell-through rates, it's important because it says that we're producing so is everybody else. We’re producing products that people want. So, when we talk about oversupply, you need to peel it apart a little bit and just say oversupply of what? If it's oversupply of poor-quality cannabis and we are seeing a few new companies in the industry launching what they've said are value brands, but that in some cases means that they're dumping inventory brands. Yes, they’re going to have to get rid of that inventory at whatever price the public is willing to pay for it, and that's a whole different ball wax than us producing a quality product. Even if we want to compete in the value category, a quality product with healthy margins that consumers want. So, I think as Cam said, there will be some capacity that exits the market if you can see price compression on the poor-quality cannabis and you can produce for that under CAD 1, but even if you can produce for less than CAD 3, then you are going to have a real problem remaining variable on the cultivation side. We’ll see; it's a very interesting time. I think over the next year, a number of quarters are going to play the game out here and we’ll see who is left that can compete with healthier companies like us.

Terry Booth, Chief Executive Officer

Glen, if I can add to this quality question, you know when we negotiated with these provinces a year ago, they didn't want to differentiate between the quality of cannabis because they didn't know. In fact, we knew that we had better cannabis than most, and we were trying our very best, but they ground us hard. They didn't want to price us differently until we see where the demand is. Now that the demand is up, they are starting to see their favorite products. More and more people in the industry are seeing that people want Aurora cannabis on shelves. There are some strains that we can't grow enough of, and we're on that; we're trying to grow as much as we can of the brands that are in high demand and that’s just catching up now. And I didn’t realize this – we didn’t realize it, and it took a year to sort of figure that out. Now we're going back to these provinces and saying to them, here are the criteria, here's the demand, here's how much the retailers are ordering, this is what they're selling, this is what the consumers want, and we're able to put that price up even more. They think about it, we have the ability to command a price premium because of high-quality cannabis, and we're the lowest-cost producer. That's a recipe for success. That’s what makes me excited in a big way, and I think you're all going to be happy campers if you're investing in Aurora come the closure of 2.0 and can really look at the success of 2.0 then. That might not be the last calendar quarter; it might be the first calendar quarter, which that better be if we're driving a bus. This is a rosy picture for Aurora; I wouldn't want to be in some of the other shoes out there in this industry. We know that access to capital is difficult. That's why we set up great instruments at the market, not discounted, not warrant, just good solid financing plans. We are making sound decisions in reducing CapEx based on global demand, and we're able to turn that back on in a heartbeat. I do feel that we're going to see a lot happen within a short time frame, but let's see how it all pans out. Aurora has once again taken another step to meeting its world goals to be the greatest cannabis company in the world, and we're very proud of that.

Operator, Operator

This concludes the question-and-answer session. I will now turn the call back over to Mr. Battley.

Cam Battley, Chief Corporate Officer

Yes, and I'll just wrap it up. I want to thank everybody for your questions. Thank you very much, and we look forward to speaking to you next quarter. Have a great evening.

Operator, Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.