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Canopy Growth Corp
Canopy Growth Corp
TSX:WEED
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Good morning, and welcome to Canopy Growth Fourth Quarter and Fiscal Year 2019 Financial Results Conference Call. On June 20, 2019, after the close of the financial markets, Canopy Growth issued a news release announcing its financial results for the fourth quarter and fiscal year ended March 31, 2019. This news release is available on Canopy Growth's website and on SEDAR. On this call this morning, we have Bruce Linton, Canopy Growth's Founder, Chairman and co-Chief Executive Officer; and Mike Lee, Canopy Growth's Executive Vice President and Chief Financial Officer. [Operator Instructions] Certain matters discussed in today's conference call or answers that may be given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect results are detailed in the company's annual information form and other public filings that are made available on SEDAR. During this conference call, Canopy Growth will refer to supplemental non-GAAP measure, adjusted EBITDA. This measure does not have any standardized meaning prescribed by IFRS. Adjusted EBITDA is defined in the press release issued yesterday as well as in this period's management's discussion and analysis document that will be filed on SEDAR. Please note that all financial information is provided in Canadian dollars unless otherwise specified. Following prepared remarks by Mr. Linton and Mr. Lee, the company will conduct a question-and-answer session, during which questions will be taken from analysts. [Operator Instructions] I would now like to turn our meeting over to Bruce Linton. Mr. Linton, please go ahead.
Great. Thank you, and welcome, Mike, to your first call. So the platform was busy last year. We were expanding globally, delivering multiple market platforms from rec to medical, investing quite a lot of capital. And the net effect is revenues on a 12-month basis were $226 million, a 190% year-over-year growth. We saw gross revenue in Canada with the rec market $140 million. About 24,000 kilograms in the fiscal year compared to 8,700 kilograms of prior fiscal year, and we shipped over 5 million units in the fiscal year compared to about 1 million in the prior year. So we have a very active business on that level, but really what was it about? Well, today, we sit with IP of 90 patents that were either acquired or issued and it's our view that intellectual property, the containment of novel outcomes, creating unique brands based on science is going to be the future and we're heavily invested. So there is a portfolio growing day-on-day. We announced approximately 2 weeks ago, 60 trials that are either ongoing or near term ready to get going. And what you're going to see is a shift globally from a discussion of medical marijuana to cannabinoid therapies. Our positioning of Spectrum is about that, our acquisition of C3 expands that. It's a major theme. And so we expect that while year-on-year, if you look at the total number of patients we had in the medical sales, it's taken a bit of a step back, which was anticipated. We've gone to book 70,000 patients, but that's in part when you migrate products such as LBS, could also be known as Leafs By Snoop, and DNA products from the medical platform to the recreational platform. We've just readjusted our portfolio, and we expect to see growth year-on-year in medical. This is not something that we didn't expect and we are well prepared to ramp it up. U.S. hemp, we announced our plan, and we're in full ramp-up mode. Contracts for farmers, announced sites, RFPs out for construction works that we could begin refitting buildings, working on multiple states so that they take a pattern and follow a process that's very similar to New York state, developing brands, creating and testing products and getting into production ramp that well there is no absolute certainty. We certainly are aiming to have a Q4 in channel product set. Acreage. Yesterday -- day before yesterday, we had our mutual votes with great shareholder support. Yesterday, you saw some activity in the U.S. system of making decisions on what is going to be permissible, where it certainly looks like the host representative supports cross-party basis with the notion that the DOJ should not be using funds to go and pursue states that have made a decision to act in certain ways, whether it's recreational or medical. And so we continue to believe that the 20 states that Acreage has and our soon ability to license our IP, our brands and our products into them should accelerate their ability to be very dominant in those states. And we believe that the alignment between Canopy and Acreage is excellent now and we'll continue to benefit from what we've learned on scale. So what do we learn on scale? If you look at Q3 fiscal '18, Canopy had about 600,000 square feet of license facility. And we understood and delivered a margin, a gross margin greater than 50%. And we could have stayed there, and we would have been a nice tidy little company, probably quite profitable. But what we thought was important is when you acquire a bigger supporting partner and they bring CAD 5 billion and there is a global opportunity, which we are, in our opinion, the best position for, what you need to do is use that capital to build scale and we did. And so you've seen, I think, the bottom of our margin trough, which is about 16% this quarter. And it's because as you build out from 600,000 square feet license in Canada to 4.8 million square feet over about a 5-quarter period, you end up with a lot of assets that are coming on stream but are not on stream and they carry burden that doesn't show up and benefit. But the point is the exercise does not benefit in a quarter or in a day or a week, it's by the time we exit this year, we're moving up the margin model back to where we were and we'd like to do that well or better. And how you get there is events that will happen in December of this year and carry on into the future, which is the platform that will regulate the sale of higher-margin products because they move up the finished good value chain, things like chocolates or vapes. Our facilities for producing chocolates and producing vapes are licensed platform right now where we could be producing cannabis products. We can't yet produce chocolates or vapes, but the actual platform as far as the medical marijuana and recreational marijuana licensing schemes in Canada has been approved in those areas. So we're not chasing approvals. We're waiting for regulations to say that we're permissible to produce. We've had a lot of talk about beverages. Our beverage platform, the photos necessary to submit to Health Canada are scheduled to be prepared and could be submitted on or about June 28. That would follow where we will start to see tanks arriving early July; processing skids mid and late July; things like piping equipment and consumables early August; qualification of the equipment August to September, so that we're looking at a mid-September finish construction. And I will give you that detail on that. There is a bit more spend to go, but the finish line will be products measured in 2 to 10 milligrams in a beverage that will be unique, differentiable, we believe, highly brandable. We think we're in the leading position globally to create these products that are differentiated and that the margins that will yield off of them are going to be rewarded to you as an investor and to us as a company because we've really put our focus on how do we get to the front, how do we get to scale. And this has sort of been the line where we got you. Finally, we don't want you to just focus on Canada, but we expect by the time we get to the end of year, this is going to be a country in which we can show you a product set, a margin set and a breakout of R&D and core spend. So you will understand this is a business that could go global. Global is now starting to be a very significant part of our spend. We acquired C3 in Europe, which is Europe's largest cannabinoid-based pharmaceutical manufacturer, 5 approved cannabinoid therapies and they had sales of $40-plus million in 2018. That is a key piece acquired and this works, it's a global leader in natural skin care and sleep solutions. It's going to strengthen our ability to enter markets and bring CBD-based offerings that align with a well-established 34-plus country channel. So these are the sorts of actions that we've taken. I'm going to hand it over to Mike because I would like him to take the time to walk through the model, and we can move to questions. But this is a framework we're operating in. Mike?
Thank you, Bruce. Good morning, everybody. First allow me to introduce myself. I joined Canopy Growth Corporation in February of this year as Executive Vice President Finance, working with Tim Saunders. My background is largely in the beverage alcohol industry, having spent over 20 years in this space, 15 of that was with E. & J. Gallo Winery, working in a finance capacity for most of my tenure, notably spending my time partnering with various commercial teams across the business. That is where I really cut my teeth as a commercial finance leader. After Gallo, I went on to work for PepsiCo, where I was Division CFO in their beverage business, spending most of my time on revenue management, pricing architecture and operations finance, again partnering closely with the business throughout. A few years later, I joined Constellation Brands and was quickly promoted to Division CFO of Wine & Spirits where I spent most of my time. As for my pathway leading to Canopy, I would say, I became very enamored with this company back in 2017 when Constellation made their first investment in Canopy. And when the second larger investment was made in 2018, I was offered the opportunity to join the Canopy team. Flash forward a few months and I'm now working as acting CFO, awaiting my security clearance from Health Canada, which we expect to receive in the near future. Before I move to my review of fiscal '19 results, I would like to formally thank Tim Saunders for his support during the last several months. Tim has been committed to my success from the day we met, and I appreciate everything that he has done to ensure a smooth transition. Tim is really a class act, and I'm thrilled that he will continue to serve Canopy Growth in a new capacity. Now on to our fiscal '19 results. This has been a historic year for Canopy Growth. We spent years preparing for the launch of the recreational channel in Canada and our leadership position since this historic day last October is evidence that our strategy is working. We generated net revenue of $226.3 million, representing an increase of 191% over fiscal '18. We sold 24,300 kilograms in kilogram equivalents in fiscal '19, up 180% over fiscal '18. Gross revenue in the Canadian rec channel totaled $140.5 million in fiscal '19, including $117.4 million in the product wholesale to the provinces and territories. Gross medical sales generated $78.9 million in fiscal '19, up 6% versus last year. Further expanding on medical, our international medical business grew to $10 million, up 170% versus a year ago. Medical sales in Canada experienced a modest decrease of 3% during the fiscal year. Our online medical store in Canada saw a period of major transformation during the year with established brands, Tweed, DNA Genetics, LBS and certain CraftGrow partners largely transitioning to the rec channel. This product transition, along with supply challenges in specific product categories, which have since been remedied, led to a decline in the medical channel in the second half of fiscal '19. We also had other revenue of $34 million, which includes revenue from our clinics, merchandise and our medical device company, Storz & Bickel. Moving beyond the top line, cultivation and post-harvest processing capacity has been a top investment priority and our investments are paying off. In fiscal '19, we harvested 46,900 kilograms of cannabis, more than double the amount we harvested last year. But more importantly, our current quarter, referring to Q1 of fiscal '20, harvest is on track to achieve 34,000 kilograms, which is more than double what we harvested in Q4 and nearly quadrupled what we harvested in Q3. We're expecting to see further capacity increases as we shift from build and license to operate and optimize across each of our facilities. Turning for a moment to cash flows during fiscal '19, there are 3 themes that speak to our priorities. Number one, we're building capacity in Canada, the U.S. and beyond. In fiscal '19, we invested $644 million in fixed assets. And although our initial wave of investments in Canada infrastructure is nearing completion, we are continuing to invest in various extraction and advanced manufacturing capabilities to further automate our processes and prepare for the next wave of product platforms later this calendar year. We continue to invest internationally, and this is expected to accelerate into the upcoming fiscal year as we build out our CBD platform in the U.S. and increase our investment beyond North America. Number two, we're building organizational scale. We will continue to see investments in our organization for the foreseeable future as we complete the build-out of our Canadian team, expand our global organizational footprint and invest in scalable corporate capabilities, including finance, operations, engineering and information technology. In addition, we will continue to invest in the development of new cannabis products, including clinical research activities being undertaken by Spectrum Therapeutics to prove the science and safety of new cannabis-based medical therapies. As a result of building organizational scale and investing in the development of future products ahead of revenue, we incurred $666 million in operating expenses during the year, of which $283 million is noncash expenses related to stock-based compensation for both employees and acquisition milestones. Number three, M&A continues to be a priority. We invested $380 million in acquisitions in fiscal '19, including the acquisitions of AgriNextUSA, Colombian Cannabis, ebbu, HIKU Brands and Storz & Bickel as well as the outstanding shares of Canopy Health Innovations and BC Tweed, and it could be expected that we will make additional acquisitions in the future. The $5 billion investment from Constellation Brands continues to serve as a critical war chest that will fuel our expansion plans in coming years and has enabled Canopy Growth to exit the fiscal year with the strongest balance sheet in the industry. Let's briefly review adjusted EBITDA, our supplemental non-GAAP measure for fiscal '19. Adjusted EBITDA is defined as earnings from operations as reported before interest, tax, depreciation adjusted for other noncash items, such as stock-based compensation and accounting for biological assets and inventory as well as acquisition costs. We report adjusted EBITDA believing it's a useful financial metric that will help investors assess the operating performance of our business before the impact of investments, acquisitions, income taxes and noncash fair value measurements. Adjusted EBITDA amounted to a loss of $257 million in fiscal '19 as compared to a loss of $36 million in fiscal '18. The increased losses are directly tied to my earlier commentary about investing ahead of revenue to build scale. To further illustrate, our investments in sales and marketing increased from $38 million to $154 million as we're hiring sales and marketing teams across Canada, tasking 20 company-owned retail stores across the country, investing in brand building for the first time and building systems and processes to analyze the business and study consumers. In G&A, our investments increased from $44 million to $168 million as we've built out our global team, our back office functions, including finance, technology, human resources and legal. Moving beyond operating expenses, other expenses in fiscal '19 included a noncash expense of $203 million related to fair value changes in our senior convertible notes, which has been recorded through the consolidated statement of operations. And these fair value changes are due to the increase in Canopy Growth stock price from the issuance of the senior convertible notes in June of 2018 through March 31 of 2019. Our net loss on a reported basis, which includes all fair value adjustments for biological asset accounting as well as many other noncash items, such as stock-based compensation, was $670 million as compared to a net loss of $54 million in fiscal '18. I would like to take a moment to review select financial operational metrics for the fourth quarter of fiscal '19. Canopy Growth generated net revenue in the fourth quarter of $94 million. Total quantity of cannabis sold during the fourth quarter of fiscal '19 was 9,300 kilograms, up 270% from last year. At the same time, average price per gram decreased from $8.43 per gram to $7.49 per gram as the recreational channel opened up and the business model shifted more toward business-to-business with a wholesale tier at the provincial level. Oil and softgel capsules accounted for 40% of gross revenue in the fourth quarter of fiscal '19, up from 21% in the fourth quarter of fiscal '18. Gross recreational revenue in the fourth quarter of fiscal '19 was $69 million. Gross medical sales totaled $13 million in the fourth quarter and Canadian medical revenue was $12 million. Medical sales in the fourth quarter included international sales of $1.8 million, down from $2.4 million in the prior year period, and this decrease is due primarily to supply constraints. We believe the supply constraints and limited medical sales in Q4 have been resolved by higher finished product inventory levels, and we expect finished product inventories to increase further in Q2 fiscal '20 as a result of the large harvest in the current quarter. Other revenues generated in the fourth quarter of fiscal '19 accounted for $24 million, up from $0.9 million in the prior year. Turning my attention to gross margin. As a reminder, the cost of sales includes the impact of operating costs of cannabis cultivation subsidiaries not fully utilized, including specific zones of Aldergrove and Mirabel green houses as well as costs associated with developing and laboratory testing edible and beverage products, for which markets will be available later in calendar 2019. Gross margin in the fourth quarter of fiscal '19 before the IFRS fair value impacts was $15 million or 16% of net revenue. Comparatively, gross margin in the fourth quarter of fiscal '18 was $7.7 million or 34% of net revenue. The lower gross margin percentage in the fourth quarter of fiscal '19 was primarily attributed to $24 million of operating expenses for facilities not yet cultivating or facilities that had underutilized capacity. In addition, in the fourth quarter, we incurred some nonrecurring costs, including costs related to unusual weather event in B.C.Excluding these costs associated with underutilized assets and nonrecurring expenses, the gross margin before the fair value impacts and cost of sales and other inventory charges was $39 million or 41% of sales. With utilization increasing in these facilities, we expect our operating cost to normalize in the next several months as we work through seed to sale. However, as a reminder, start-up costs related to advanced manufacturing and our new bottling plant will continue to serve as a slight headwind, but will become less material as our revenue increases. We believe we are on a path for reported gross margins to be above 40% by the end of the fiscal year and will increase further in the future with higher efficiencies and increased sales of value-added products as we approach full utilization of the new production capabilities. Finally, to recap, Q4 adjusted EBITDA amounted to a loss of $98 million as compared to a loss of $22 million in the fourth quarter of fiscal '18. The increase in the loss is largely reflective of the investments made through fiscal '19 in the areas of sales and marketing and general and administration expenses as well as research and development. Total other expense was $135 million in the fourth quarter of fiscal '19 as compared to $11 million in the prior year quarter. The increased expense is partially due to a noncash expense of $163 million related to fair value changes on our senior convertible notes, which have been recorded through our consolidated statement of operations. These fair value changes are due to the increase in Canopy Growth stock from December 31, 2018 through March 31, 2019. Our net loss in Q4 fiscal '19 inclusive of fair value impacts of biological asset accounting as well as other noncash items was $323 million as compared to a net loss of $54 million in fiscal '18 Q4. Moving beyond fiscal year '19 and into the first quarter of fiscal '20, I wanted to highlight 2 items. Number one, as previously addressed in our shareholder circular related to the Acreage deal, we agreed to a modification to the investor rights agreement with Constellation Brands. The new investor rights agreement has 2 modifications related to the exercise price of their warrants as well as the expiration date of their warrants, both of which are subject to fair value adjustments, which will be recorded in Q1. As a result, we expect to record a material noncash charge in Q1 related to these adjustments, which will contribute to a material net loss in the period. Number two, our harvest continues to increase quarter-on-quarter, which will support our view on revenue growth in coming quarters. But our Q1 harvest, although substantial, will largely be sold in Q2 and Q3 due to the timing of post-harvest processing, value-add product manufacturing and the timing of laboratory testing and the associated quality assurance lot release process. For my remaining remarks today, I would like to take a moment to speak about the priorities I have established for myself, my team and by extension Canopy. We are passionate about driving performance improvement and executing on our mission statement with a commitment to operational excellence. And as successful as we've been, we need to continue to challenge ourselves as a company to build out our success and to enable a truly global platform that will fuel growth as we chart our course over the next several years. So let me share my top 3 priorities for building on these capabilities. Number one, we're going to review our global ERP strategy. Having just rolled out our new ERP system last fall, it may seem unusual to be discussing this so early, but we believe it's important that we take a step back to ensure that we have a scalable, world-class solution to support our business end-to-end not just for today but for tomorrow and beyond. Number two, we're going to strengthen financial reporting and controls. To be a global leader, we must operate around the world seamlessly. We plan to design and implement a set of fully integrated capabilities that will allow us to manage risk, provide improved controls to our business, all while meeting our stock's compliance obligations. As our business evolves, so too will our financial reporting. We are already reengineering our financial reporting processes. We are in the early stages of planning for what is an eventual conversion to U.S. GAAP reporting anticipating that we will no longer qualify as a foreign private issuer in the future. We're also evaluating a reporting methodology which could lead to changes in how we communicate our performance to investors. Number three, we're going to accelerate acquisition integration. Essential to our growth plan is our ability to acquire companies that enhance our reach into global and vertical markets. In our industry, many of these target companies have relatively nascent or immature capabilities from a business and technology perspective. Having a turnkey M&A playbook will improve our ability to acquire and integrate, which will improve our deal synergies, reduce our costs and fuel our growth more effectively. In summary, this plan allows us to create a platform that supports scalable growth, fuels our expansion into the U.S. and beyond, it empowers our employees with the advanced tools and capabilities to develop business insights that allow us to seize market opportunities and provides a continue and repeatable basis for reporting to our shareholders and the financial community. I will provide updates on future calls as we progress toward this agenda. This concludes our review of the financials for the fourth quarter and fiscal year ended March 31, 2019. I would now like to turn the call back to Bruce for some closing remarks.
Thank you, Mike. Excellent summary. So where we are now midway through near the end of Q1, we continue to look at the world quite optimistically. We're seeing indications of change in so many countries, and we feel we're the best positioned company to pursue them. So please, if you have questions, queue them in, and we look forward to responding.
[Operator Instructions] Your first question comes from Chris Carey with Bank of America.
So I just wanted to start with a bigger picture question then I have a follow-up on near-term dynamics. So on the big picture, just, I guess, taking a step back on the results this quarter, clearly Canopy continues to invest globally to establish these long-term competitive advantages, and I think that makes a lot of sense, especially given peers don't really have anywhere near the same capability given your scale and balance sheet, right? But I guess as you continue to enter new markets, you will, of course, need to keep investing. So in that context, I think maybe it would be helpful to get your perspective on this natural tension between investing into the long term versus the need to have some of the near-term discipline? And how do you think that strategy impacts your financial model over the next 3 to 5 years?
Yes. So it's a good question. So part of the reason Mike put out as one of his reporting prior years is to be able to give some segmented reporting because we do need to be able to show you exhibit A, which is going to be Canada. How is it running on medical, how is it doing on rec, what's it looks like on a total business, back out some of the costs, which aren't really directly related to cannabis income, medical programs, expenses of that nature. And then as we go into other geographies, we mentioned, I think, in our press release earlier this week about on approaching Colombia where we have a partner who will be producing our gel caps because as we get more IP, we can move up the value chain, use other parties' manufacturing capabilities and really put together our differentiated outcomes in the research. Maybe the final part is we have signaled to the market that we're quite interested in some form of instrument, which will allow us to take and rotate the invested capital in Canada, call it $1 billion plus and turn that into some form of an instrument, which, under the right scenario, should also become a scheduled type instrument so that if we got a federal permission and a foreign geography for another license that we'd actually be able to take that asset, put it on, have the cash rotate back in. And we've advanced quite a few of the models on that. I don't think it's something you'll see turned up instantly, but there is quite a lot of interest in how we could actually get that capital back into rotation versus stranded.
Okay. And then just on the follow-up. So your ability to kind of hit this $1 billion annualized run rate revenue by your fiscal Q4 2020. How much of that is dependent on the launch of new product forms in Canada? And maybe how much will you need from revenues outside of Canada to help you get to that number?
Yes. So that is a figure that was put out by Constellation, which we certainly feel is achievable. It's principally a domestic-driven opportunity. It doesn't -- our growth in revenue plans, we haven't built a material sum coming out of, say, hemp-derived products in America. We're looking at Canada as a market that principally drives the biggest number top line growth over the next 3 quarters. And what we see in the market, the biggest risk and uncertainty we have was, one, is the launch date, so we now know that and then our ongoing continuous risk assessment is approvals by the regulator. So, so long as Health Canada continues to approve the platform necessary to produce the products, we think we have the technology and the platform created. But with those things together, we think there is a substantial business in Canada with a little bit support from other geographies.
Next question comes from Vivien Azer with Cowen.
So, Mike, my first question to you, please. I really appreciate the detail on the gross margin. Given the commentary around the shift in kind of revenue into 2Q and 3Q based on what you cultivated in 1Q and the target to get that north of 40%. Can you offer any kind of incremental color on the cadence of that over the course of the year? It sounds to me that our expectation should be reset materially lower for the first quarter as we kind of push out gross margin improvement. If you comment on that, that would be great.
Yes. Thanks for the question, Vivien. Yes. So there has been a lot of activity going on at our big anchor facilities, BC Tweed as well as Mirabel and we are on the tail end of the renovation, retrofitting of those facilities. And given the grow time, it takes time to kind of claw your way back. So we would expect that as we get into Q3 to Q4, that you start to see those normalized margins that we've been talking about for some time now. There will be a bit of a headwind, albeit relatively smaller than the headwind we've seen on the grow houses, but as the bottling capabilities are stood up, there will be some fixed costs that will hit ahead of production, ahead of revenue, but all things being equal, I think it's going to be a much more modest impact than what we've experienced in the last 2 quarters with the grow houses. So we remain very optimistic that we'll get to the 40% by Q4. And as we start to see the benefits of the new platforms, in my view, that's where we get the runway to that high 40s that we've talked about for quite some time.
Perfect. That's really helpful. And then for both of you, Bruce and Mike, this is a follow-up to that. Can you comment on how that like influences your view on the EBITDA and getting to positive EBITDA? Obviously, the story has changed pretty materially in the 2.5 years that, Bruce, I've been covering the stock. But there was a time when you guys were talking about getting the EBITDA positive once you had adult-use revenues hitting the P&L, now I fully appreciate that with the incremental capital that you've gotten from Constellation Brands, you've made some adjustments to your investment priorities that are impacting EBITDA, but the magnitude of the increase in your EBITDA loss has really dwarfed anything we're seeing from your peers and you guys are not the only one trying to scale up those domestically and internationally. So any help on kind of the glide path to EBITDA profitability would be great?
Yes. And you're right, it does dwarf our peers and it all comes back to the war chest that we talk about which we think is going to turn into a competitive advantage over time as we're building this global scale. But I'll bring it back to Canada. Our focus in the near term is to demonstrate Canada performs as a stand-alone model that we can take around the world. And in FY '21, we believe we're on a path to show EBITDA positive performance. And with the announcements, with the new regulations coming out with the platforms and the capabilities that we stood up from a production perspective, we're confident that as we get into fiscal '21, you'll start to see that positive EBITDA performance for Canada as a stand-alone business.
Next question comes from Peter Sklar with BMO Capital Markets.
Mike, there was a number you -- a harvest number you threw out there 34,000 kilograms. I didn't quiet catch that in the pace of your commentary. Can you just talk a little bit about what that represents and when that will sell-through?
Sure. So 34,000 kilograms is our current forecast for Q1 harvest, and this is really driven by the fit out of all of our grow houses. Recall, if you go back and look at the last couple of quarters of harvest, I think, in Q2, we had about 15,000 kilograms. In Q3, we harvested around 7,500 kilograms. Q4, 14,400 kilograms. You sort of get a sense of the depth that incurred as we were putting those facilities through the retrofitting. So 34,000 kilograms is, I would say, the beginning of what I would consider to be our new normal of harvest capacity. And I would also say that our operations teams are committed to progressing that number even further, and that's going back to my remarks of transitioning from establishing the facilities and getting everything up and running to really focusing on optimization. We've got a lot of runway in front of us to further optimize these facilities. And going back to Vivien's question, and earlier questions around gross margin and EBITDA, getting these facilities optimize is going to be a critical value lever for driving that bottom line. Because as the throughput increases, your fixed costs are relatively fixed, you might have some marginal costs on that higher throughput with some additional hourly labor. But as you guys know, these facilities are highly fixed cost in nature. So that's really where the power of that leverage is going to come through.
And, Peter, serving the modeling of it, typically the way I look at is like 2/3 of the sales in the next quarter come from the harvest in the prior quarter. So when you see that number, you can start to work it into -- if we got the right product mix and the stores are opening up, that harvest number from this quarter is a big key factor for the next quarter.
Okay. So really just putting it altogether it's this -- now that you've achieved this higher level of harvest, that's why you are optimistic about the margin improvement in Q3 and Q4, is that correct?
Yes. It's utilization of the platform. So as the building fills, we get the yield off the building. And as the product formats become more sophisticated, you sell a lot less. When you measure everything in milligrams, you sell less cannabis with more adjacent ingredients to create more value and you get to put it into the form factors of vapes to beverages to chocolates. That mix, combined with our platform utilization turns into a great outcome. And why it is like is, like what we've observed in the last 5 years the creation of opportunity that I don't think we are ever going to see for anybody on these phone calls in your life time. This is a once-in-a-lifetime window. And so this model that we've developed and how we're deploying it globally with tuning it in Canada. I think, we are very well positioned and the capitalization we have allow us to have multiple years of advantage if we spend properly now which we are. And so that's kind of a path we're driving.
Okay. And my other question is, I believe, your recreational sales, if you look in kilograms not revenues, but kilograms, declined Q4 versus Q3. And is that because like you just didn't have the production in Q4 or rather is just that the retail flow -- like the retail demand isn't out there because Ontario and Alberta just haven't been building their store base?
That's one of those questions is a bit of both we're talking that -- it's a couple of percent down, but it's really been about product mix that we had. Because this is -- second quarter we had about -- 2 quarters or 3 quarters that get ready for the first launch quarter, and we had to keep supplying through so that whole of half product and while the prior question on the available product for Q3 matters or Q2 matters. But obviously when Alberta needed to pause in their opinion the additional licensing of stores and Ontario got going in April, that kind of made the platform static. What we're seeing is a lot more stores opening up obviously in Alberta. There is quite a bit of discussion and rumor about will Ontario do some more sooner. So the channel is growing, and we are pretty upbeat that, that channel is going to have more and more interesting products and it's going to be a big channel by the time we get to Q3, Q4. So a little bit of a blend.
Next question comes from Oliver Rowe with Scotia Capital.
So your International sales this quarter were pretty low, and I know that, that business is a bit lumpy by nature. But it seems apparent that we haven't hit the inflection point for growth in these markets yet. Many countries prescribe cannabis as a last resort and only for very serious indications for that to relaxing to see regulatory change. So from your seat, I'm just wondering how quickly you see that change happening and sort of what we could expect to see in the next couple of years in your international segment?
Yes. So it's a bit textured in that the U.K. is still at that stage where they are making extremely challenging for patients typically very ill young children to gain access and then it is extremely costly. And so what they are effectively doing is fighting in the media with sick children and that obviously won't work for a long time, so it's starts to open up. If you move across the opportunity, you will get to Germany as the most available. And frankly in the period we're reviewing, it was a function of not having the product to export because you can't just say I'm going to send this to Germany. It needs to be actually the product, which has been fined and registered and we didn't have sufficient. We think that we do now and that we're in a position where that should grow because the demand is there. We also have places like Denmark coming online, which means the export potential will be from a Denmark production facility into, say, Germany or the Czech Republic. And so our transiting of cannabis will become a bit more textured, and not just Canadian and I expect to see that over the next quarter or so. But really the markets seem to be growing. It really has been our ability to keep up with the right product mix and now we're further working to have things like gel caps and oils approved as exportable products. Not done yet, but it has been an aggressive project to get there. So I think, you might see the mix of products improve, not just the available product.
That makes sense. I just have a follow-up. I know you just mentioned there that you have to get certain products availability for export. I know the export markets are offering you about 2x better price than the recreational market. So why are you not just focusing on getting products through that channel to realize those prices?
Yes. It was a bit of a juggling act. I would say that the regulators probably were little bit more supportive recently of approving things from Canada over our ability to grow and target that amount. It has been improved because of the platforms items we described. It was a small window where we're probably juggling 8 balls, and I would say that we didn't get to sort of utilize everything the way you would optimize for cash, but I think we're pretty much there right now. On a receiving side in Germany, it's an interesting thing and that we have a capacity constrained to some extent where what we can receive has to sell-through before we can put more and we don't have like a 10-ton vault there. We have a limited capacity vault. So we're always adjusting the choke point, but I think the choke point will be more that than it would be product mix or available product.
Next question comes from Graeme Kreindler with Eight Capital.
I just wanted to go back quickly to the 40% gross margin target you are expecting by the fourth quarter optimistic to reaching that. You had some competitors mentioned on recent calls. The expectation that there could be some significant downward pricing pressure on the flower side of the market with more capacity coming online, especially from smaller producers. So I was just wondering if that target there takes into consideration, any headwinds on the flower side considering or probably remain a significant part of the market near to medium term?
Yes. It does. Our expectation of how much and how quickly it comes onstream, I think, might be informed by our experience. I would also say that there is a very different -- big difference between growing some bug quality versus producing an API extract kind of level and getting things into a form factor that actually rely on a bottling plant or vape technologies we've created or the chocolate factory area that's licensed. So I think if you're going to be measuring things on grams, there maybe some pressure and I don't think it's in the time period you've described on grams. But when you start measuring things in milligrams, I think, the milligram formatted products medical to rec are actually going to have a very solid opportunity for margin increase.
Okay. And a follow-up on the subject of higher-margin products and to follow-up from the last set of questions around the export. The press release mentioned a pretty lengthy process to get export approval. So I was just wondering if the regulator has started to streamline any of those processes? Or if they are taking input from you or other producers in order to help that go a bit faster?
I think the regulator's objective is to make sure that every patient in Canada has full access to product and the provinces have what's necessary. And then exports have to go where the receiving country requests and Canada issues an export. I think it's becoming smoother, but it isn't -- I don't think it's ever going to be something in our short-term window, maybe the next several years where it's automatic. We'll see where we get with CBD. But if you start including the ingredient THC, it does become a complicated process. Really what you can do now as we have scale production, the quantities, which we can put through. It doesn't matter if you're doing 250 kilograms or 25 kilograms, essentially the overhead rates are about the same. And so I think we're finding ways to just put a little bigger volume through each approval.
Your next question comes from Doug Miehm with RBC Capital Markets.
Couple of questions. Just with respect to the rollout later this year. How would you see that the provinces are set up relative to what we saw last year in terms of the value-add products and the capabilities in that regard?
Good question. And in a word much better, right. Like last year at this time, we were still trying to talk about what's the start date. Now we're talking about whether or not they wired their buildings to have fridge plug. So for example, when you go to New Brunswick, those stores and the provinces are actually put in the capital so that they've contemplated the ability to have chilled fridges. They have more storage capacity. When you look across the private sector ones I think they react quite quickly. So I wouldn't say it's even, but I would think that there is probably half the provinces in which we'll be able to launch quite quickly with a full range of products and the others which will be catching up based on the fact that they could be making a lot more rate-of-return on their buildings if they had all the products in. And so not uniform but way better than where we were. And I think the products that they are talking about are critical to be in a store. If you look at the e-commerce rate for liquor sales, it's not super high. But if we have a beverage on a store floor and say, Nova Scotia liquor, which I mentioned it many times sort of I was down there in the last few months. You essentially walk in the front door of the liquor store and then at the back of the store in sort of a semi-separate areas where they sell the cannabis. If you pick up a bottle of wine and walk through to the cash at the back, you can pick cannabis and pay for both at the same spot. And so we're quite optimistic that some of those platforms are going to be able to show substitution effect in accelerated sales. But overall, I think, half or more are going to be quite quick to launch.
Okay. And then the other question I had is just with respect to the testing process, which, I think, you briefly mentioned. Are the hurdles in your mind different as it relates to the value-add products and edibles, et cetera versus what we've seen before? And do you believe there are any different implications for that process versus what we saw last year?
Yes. So I think like you we are still waiting to see what the final criteria and testing process would be, but it's narrowing in. And that's -- we are frankly -- I think, when they're looking at this, it's going to be part of what we've observed in the U.S., where we tested a great range of CBD products and about 80% of them were more than 10% in that respect. So I think the regulators are going to be looking very, very carefully that you can actually confirm both the cannabis dosage and the quality of the product that you're mixing with whether it's food-type product or food-testing platform. It certainly doesn't feel like it's going to be a stretch to deliver, but it isn't nail down yet as a final step.
Next question comes from Michael Lavery with Piper Jaffray.
I just wanted to touch on a couple of your newer platforms coming in and understand some of the timing there. First for the U.S. for the CBD initiatives and hemp products[ Technical Difficulty ]by the end of fiscal '20. Can you just give us a sense of how that builds in and maybe why it's not something sooner? And then second on the second wave of products coming in Canada. Obviously there is some regulatory issues around all the timing. But how much should we expect pipeline fill in calendar fourth quarter even if there is mid-December date there really sort of the green light. How should we think about how that looks in terms of you getting product out of the door?
Yes. So there is a certain amount of stuff that I'm going to keep a little bit close to the vest and that we think there is a competitive advantage in what we're doing. But take New York for example, in Kirkwood, we've assembled the property and the facility we're going to go in. We have issued the RFPs. We are focusing on local trades with contractors and engineers so that we can actually implement the platform that we already know how to implement. So that site will then become a processing CBD. We've contracted hemp in several states across the U.S. for production. We've defined all of our brand launch lines, think health and wellness principally. And we have found in our finding a variety of contract manufacturers who are putting the form factors together for us where we want to launch so as we don't want to have SKUs run out. We don't want to have anybody have a fear of what's in the product and we want certainty that it's controlled. So even meetings with the USDA, what's the permissible spray? When did they test it? How do we make sure that the product when it's harvested from the field doesn't contain things that downstream are going to become viewed negatively in a state. And so what we're doing is assembling a scale reliable platform that is not going to leave any big box or C-store operators with an embarrassment, but rather an ongoing sellable SKU. And so it takes a little bit of time to do that at scale. Typically, we try to push and deliver things a little earlier than our schedule rather than promise and fail. So, I think, we're operating in that mode right now.
And on the Canadian products coming in later this year?
So on those, it feels like we're landing finally where we want to be, right. Like we've been talking about beverages for 3 or 4 years. I think if you look back in the decks we've been using, we had a tweed and tonic with a clear bottle and a cap on it for a long time. We have a chocolate factory operating in what used to be a chocolate factory that became a marijuana factory and it has both now. We have done a lot of work on brands, form factors and launch. So I think you're going to like what we have for everything from how vape products work and how our margin model has been thought through on that through every other form factor. We are, I think, well ahead in terms of the facility, the space, the license for cannabis to be present. All we need is the final agreement that we can launch and typically that's going to be 60 days from the time of their exit, so mid-December. The principal challenge in 4Q is mid-December also has a late December event, which can be Christmas or Hanukkah depending on who you are. And so there is a shipping window that's going to be limited and how much can get into stores. So our logistics will contemplate how maybe we can direct ship to stores that can take it versus warehouses that have the inventory and then crank it up in queue for us calendar Q1. But those are sort of the things that we're already mapping out and here is only June.
Next question comes from Brett Hundley with Seaport Global.
If I could just package 2 quick questions together. The first is, if the U.S. Senate follows health passage of the spending bill for the forward year, would your lawyers consider that a triggering event for the Acreage deal? And then separately, New York State has been really wet this spring. Do you have a sense for how CBD or hemp plant yields are impacted during late plantings? And can you share with us kind of what the situation is with regards to your company or I guess, partner farms?
To the questions, one, I would say is actually -- so recent news, we're still trying to figure out exactly where that came, right. Like it was yesterday's vote, I think the one you're referencing with regard to the DOJ budgets?
That's exactly correct.
So that was last night's reading and discussion and calls around 9:00 at night because it does need to be supported by the Senate, but I don't know that, that makes it federally permissible. I think what it makes is federally unenforceable. And so we will see where we get, but I think it's just a progression towards where we wish to be. But this is one of the things that we are monitoring extremely closely and we have people living in all the right ZIP codes so that they can be on that for us. As far as the second one, we're still getting the green light that the harvest will occur. Yes, it has been ridiculously east coast rainy. We do have hemp that we acquired from prior years that is into processing step, and we do have contracts in other geographies. Obviously, New York wants to see product produced in New York and processed in New York and branded to CBD in New York. But we certainly don't have any flags to throw yet at this time.
Next question comes from Ryan Macdonell with GMP Securities.
Mike, welcome to the conference call. So my first one is maybe for you, Mike. You talked about how global and ex-Canada is really starting to be a large portion of your spend. Could you share with us in the quarter approximately what proportion of SG&A was attributed to outside of Canadian operations? Was it on the order of 20% as much as 50%?
I'll let Mike see if he can dig around and get you a specific break. I don't think we haven't covered off. But I'll link it back to an earlier question on things like exports. And I mentioned how it gets textured. Someone was asking, is the export process from Canada to Germany accelerating? It is what it is, but maybe in a quarter or two, our export process for Germany in some proportion relies on the Denmark authority. And so we do have fully competent resources in Europe to handle that kind of transaction where we grow it, we certify it, we execute the legal framework, paperwork and move it where it doesn't rely unnecessarily on a function at head office. So, Mike, I don't know if you have any more breakdown.
Yes. I'd say, when you think about our infrastructure outside of Canada, our SG&A, I put at the 10% to 15% range, but clearly an area of investment. The difficult thing in unpacking that is we are adding infrastructure in Canada to support the build-out of the global business for things like shared services, legal, finance, et cetera. But in the coming months and quarters, you will see more investment going into the U.S., going into Latin America, going into Europe as we build out those functions.
Excellent. Thank you very much for that color there. And maybe kind of following up on that, the thing in international, with regards to the U.S. you talked about the rollout of CBD products there. Maybe can you share with us what sort of categories you find are interesting? And also any comments you have around ingestible CBD products in south of the border?
So turn a little bit sideways, what we really like our states to step in so we don't have to wait for FDA to govern the dosage. You'll see many products out there that are full spectrum hemp and, let's say, 25 milligrams where they won't say CBD and they don't get into the details. So what we like is in New York state, we think we're going to have everything from the potential of a beverage to certainly skincare products and moving along that could in fact become ingestibles because at the state level, we expect them to regulate and they appear right if they regulate before FDA so long as we don't make health claims. And so I think you're going to find 5 or 6 states are going to govern very well that will allow companies like Canopy to put up infrastructure. Process to finish goods that can be topical for ingestible, drinkable as well and have the dosage on them. And so long as we do that, we will be in compliance with the state license and not offset with the FDA. So we don't think we're stuck in the topical swim lane only, but we think it's good category.
Next question comes from Owen Bennett with Jefferies.
First question, I just wanted to come back to the U.S. hemp CBD. So you spoke about the $1 billion sales run rate at the end of the year being largely Canadian driven. So U.S. hemp CBD obviously offers possible upside to that should it come online in 4Q. So I was just curious in terms of how much of the contribution can we expect U.S. hemp CBD to make in its first full year even in a very conservative scenario?
So in the first part of your question, you are correct that we are not leaning on revenue or sales from that category in order to actually see a high-growth company. We're investing a few $100 million into U.S. processing assets that are great for hemp. But they'll also be functional and I think scalable for cannabis should that become permissible activity. As far as the forward look, CBD doesn't resolve everything that's on the planet, So that perspective that you just say the letter CBD and everything is good. So whatever that really of the top number is, we don't buy into that. But I have seen analyst reports that this is substantial health care product set, and we think with what we're doing we should end up with a leading market share. And I don't want to lean to a number, but we're building for scale and trust. And if you're running a big box chain, a corner chain, you do not want another supplier, who is going to embarrass you.
And then just a follow-up, could you please give some more details on the usual weather event on over one-time activities impact the margins in the quarter? And how confident are you these one-time activities won't need to be repeated as we move through the year and obviously trying to get that 40%?
Yes. So couple of things there and Mike will chime in on some. When you're retrofitting and secure pricing greenhouses you're not operating them, so if you get a heavy snow load in a sudden basis, it can actually become a problem, it did. We had to get heat cranked up and things done, but when the greenhouses are full and operating, they're designed where the snow load doesn't become a topic because it actually continuously melts off, check that box good there. As far as the other ones, Mike, I don't know if you want to comment. There was some specific things related to leases and such, which, I would say, are functions of startup or recreational when you're trying to figure out who, what, where, when fast and have options.
That's right, Bruce. I don't think anything is material in nature, but I would just say just as we're working through that retrofit to challenge to grow and operate at the same time that you're retrofitting, so we just had a number of small unusual activities occur during the quarter. Nothing systemic, nothing to be concerned about.
Next question comes from John Zamparo with CIBC.
This is actually Krishna Ruthnum on for John. I just wanted to follow up with regards to the pet CBD market, something that you mentioned in the past. Just to see whether you have an update on when products will be available and whether that will be in this calendar year?
So we're looking at a couple of launch locations certainly for the ones we wish to launch in the U.S. We want to make sure that they are safe for the animal and valuable for the owner who pays for them. With that criteria and brands like Martha Stewart associated, I would say, our cautious window for launch is as late as Q1 calendar, Q4 fiscal. There may be other products in Canada that could come on sooner. And again what we're trying to do is make sure that what we launch is easily supported by very large industrial players in the pet food space. So that we have brands and we have colleagues who could play with us that would see what we are doing as the best way and that appears to be the path we're on. It's been a -- we're dealing with how do we interact with the veterinary and pet carriers in both Health Canada and the FDA. We're trying to follow those kind of rules and platforms, and it feels like we're well down the path. But I wouldn't want to tell you that it's calendar Q4, it's more likely calendar Q1 and Q4 fiscal for the pets.
And I just wanted to follow up a little bit further on just your thoughts on the initial sort of rules around derivative products. And then whether you feel you have a competitive advantage relative to the other LPs in Canada?
The rules, they work. There is going to be some unusual aspects like people are accustomed to an ABV equivalent so that when you have a volume of something you associated with the strength, I think there is going to be a better room for improvement there. Because of when they're coming out, I think, you're going to see cans of products rolling off sooner than glass bottle products or clear bottle products just because of timing on those consumables. So I think the launch will come up. Part of the way that we end up with an advantage is we've been using of our balance sheet and our visibility and views. And so we began building our bottling plant, for example, before there was a certainty that you're going to have a drinkable product, which is why it's going to be ready-to-make beverages in the launch window and if you have, what we think a really well thought of beverages with great brands. And if they are on the shelf and available and people try them first and like them the best. This can become kind of a lifetime category and so we feel very good about it. I did mention earlier in the call, we have zones for vape filling and choco making that are already licensed for cannabis, they exist and have been constructive. And they're built through a food-grade standard that meets Health Canada criteria for controls. So I think being ready, having products early and having research is going to give us a serious shot at being globally relevant and what others do, I guess, that's what they'll do.
Next question comes from Bill Papanastasiou with Cannacord.
I just had a question regards to the top line. It looks like core cannabis revenues were down quarter-over-quarter, however your direct-to-consumer sales were slightly up. I was wondering how should we look at this line, given the Ontario market coming online? And maybe you can share some color on the magnitude of it in Q1 2020?
Yes. I think these things aren't instant on/off. We expected the top line for cannabis has an opportunity to start climbing as the stores are there and they go, but it is not like a rocketship. The rocketship is as more and more stores open, more and more medical opportunities come as more and more proof arrives. And as we get into Q3 fiscal for us in Q4. So it's just -- this feels like it's now on to a bit like it's picking up momentum business and building up margin business, but it's not flip a switch and they both go to the top.
Next question comes from Aaron Grey with Alliance Global Partners.
So I just have one quick one on the medical market. So you mentioned before that the patient count was down to about 70,000 from 83,000 and talked about the transition in terms of brands, and I think you also mentioned some supply chain issues. So could you just kind of talk about your confidence in kind of bouncing back there? And then also what you're kind of seeing overall in the medical market and whether or not those kind of patients are being serviced just given the allocation of product that you're seeing within yourselves and other kind of peers with the medical -- with the adult-use market looking online?
Good question. I feel actually quite confident that we're going to see growth in medical. And I think it's going to happen because we had it obviously when you move brands like Tweed and Leafs By Snoop out of your medical store and then to the rec store that will migrate 10,000-ish of our customers. But we've been putting a large push on what I would call is onboarding patients, acquisition through clinics. And in the background, we're running these clinical trials. And I think that if we start reading data that shows that works a lot of people are going to jump up. And we just take that at the high-level. And if you take our Spectrum brands, so there has been a lot of push that the actual spectrum branded product is growing like it is moving up as a medically selective product. So this to me feels like do the research, do the blocking and tackling, the brand portfolio is now well established. It's going to grow is our expectation fully. Good. I think we have time -- 2 minutes left. If there is any others, otherwise thank you everyone for your time. This is another quarter, another year and it's only a once-in-a-lifetime opportunity that we see. So we're certainly not tracking on the Amazon model, but you see the value of investing when people transform their behaviors and we're at the front of that. So thank you for it, and look forward to next quarter.
This concludes Canopy Growth's Fourth Quarter and Fiscal Year 2019 and Financial Results Conference Call. A replay of this conference call will be available until September 21, 2019 and can be accessed following the instructions provided in the company's press release issued earlier today. Thank you for attending today's call, and enjoy the rest of your day. Goodbye.