Canopy Growth Corp (CGC) 2018 Q1 法說會逐字稿

Good morning, and welcome to Canopy Growth's First Quarter Fiscal 2018 Financial Results Conference Call.

Earlier this morning, Canopy Growth issued a news release announcing its financial results for the first quarter fiscal 2018 ended June 30, 2017. This news release will be available on Canopy Growth's website and filed on SEDAR.

On this morning's call, we have Bruce Linton, Canopy Growth's Chairman and Chief Executive Officer; and Tim Saunders, Canopy Growth's 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.

Following prepared remarks by Mr. Linton and Mr. Saunders, the company will conduct a question-and-answer session, during which questions will be taken from analysts and investors. (Operator Instructions)

I would now like to turn the meeting over to Bruce Linton. Bruce, please go ahead.

Thank you. And good morning all.

Let me sort of frame where we are and how we see the world. And then I'll hand over to Tim to walk through some details.

So effectively, January 1, 2017, the view of our world was [audio gap] into 3 segments. It is, think of it as 6 months tranches, so the half 2017, second half 2017 and first half 2018. And in those phases, what we're working on is to implement (technical difficulty) platforms systems. Then in the second half of 2017, it's about scaling, tuning those up. And then it's about -- as we move through into 2018, it's the scale necessary to be a dominant provider in the key markets. And we're focused on this, as there are really in our mind 5 channels to market, yes. There's going to be the continued medical system which is [male]. There's going to be a

I think we just lost Bruce.

(technical difficulty)

Ladies and gentlemen, this is the operator. I apologize, but there will be a slight delay in today's conference. Please hold, and the conference will resume momentarily. Thank you for your patience.

Yes. Sorry about that, guys. I've gone to a cell because my phone line got cut...

It's all right, yes.

Anyhow, where I was is we're really focused on 5 channels to market, and we want to make sure that we're scaling through these 3 phases. The channels are going to be the continuation of the medical channel as we see it today. There is going to be, as we hear about it, retail through a variety of provincial channels which are all in the build-out. And we're going to see that build-out continue probably for 2 to 3 years. There is going to be a supplemental to that provincial system we anticipate; and Mr. Morneau, our Finance Minister, has indicated, which will be direct registration with sales points like a Canopy environment. There is likely to be pharmaceutical distribution. And those formats probably aren't going to be dried cannabis because it's a smokable product. So they're going to look for liquids and gels. And finally, there's going to be an [intermittent] international opportunity for exports as countries like Germany welcome our exports then welcome our application process to produce and shut down the import market.

So that's where we focus on our implement, tune, scale over the 3 phases.

So that's driven much of our operational activities in the first half of 2017. That's been about scale, giving the implementation, the baseplate. So we took a deliberate step to stress out our platform. And in some cases, we've caused it to break. You may recall, on February 1, we did over $1 million of sales on that day. That was intentionally a stress test, and it did stress things. It stressed specifically areas of our platform related to fulfillment, and it gave us a view of how we needed to structure our platform so that we could evolve forward. Since that day, we've implemented many processes and infrastructural changes. One of the joys of being the leader in the sector is, much more often than not, we're the first to experience many of the challenges facing the sector. And let's be clear: I'd sooner knock the challenges down and lead the charge to 2018.

So one of the, I would say, biggest or most arguably important events that we did is we've created the Tweed Main Street online marketplace. The marketplace is our commonplace in many sectors, but they did not exist in the Canadian cannabis space. So what we did is, rather than continuing to maintain 3 separate e-commerce sites, all the customer databases, inventory management; all the complexities that existed after the acquisitions, we transformed that complexity into a marketplace where many customers are asking to be able to have access to a variety of brands. We launched with all brands under one roof. That also gave us the opportunity to introduce CraftGrow, so now you have a marketplace that has owned brands as well as builds brands.

So we brought together the diversity of products, and in many ways, it's been referred to as Amazon like. I don't want to refer -- infringe on their activities, but certainly we wanted to take as many good pages as we could. And as we committed in a press release today, the process of launching Tweed Main Street did negatively affect the month of April. Tim will get into the details, but when you merge and move, you have to slow down or shut down. And so we're willing to take that hit, and it seemed to be certainly worth it because, as we run forward, it's much easier and much more scalable.

On the next wave, we had a big increase in supply of product in our store. If you look what was in the store in sort of the late April, mid-April, up to now, we've grown what we offer in terms of extractions and the scale of that. And that was a big step, but we've got 5 partners to date in our CraftGrow program. We've got multimillion-dollar investments that we've put together into the development and production of the world's first -- or Canada's first cannabis oil gel caps, which have really sold well. You'll see them in the store. Typically you'll see them in batches. They last about 6 hours, and then they're sold out. We're scaling the production so that it's not a sellout function, but we, who've been in the sector for some time, have seen everything sell out that's new. Then you get scale. So if you look at last week, Tweed store had about 30 products; and had a nice range of oils, dried product, high-THC strains, hybrid [THCBD] strains, high CBD. We also had CBD soft gels and a broad range of seeds, so the store is starting to fill, and that drives customers to select us. And the teams have been working hard so that we can actually have the products on a rotation so that the clients always have the selection, and the effect is we're seeing very positive feedback from the market.

So production capacity. Well, in the quarter, we announced Smiths Falls and our Bowmanville South operations have increased by -- their capacity by 33% and 200%, respectively. It's just platform for production. We have received our license for Grasslands, so production began in Saskatchewan, and that process is going well. And we think we're near the end of the cycle for a license in Québec with our efforts at Vert Cannabis. We now just await a final inspection, having completed all the build-out and SOPs as we're familiar with.

Finally, we've made some announcements about Fredericton, New Brunswick and Edmonton, Alberta. Both of those were made in the quarter. And it's process by which we will overlay our known methodologies, and we think we can step quite quickly through [licensing] process.

As we go down this, we're really trying to, if you will, develop a playbook that continues to secure a lead in the Canadian market, but we think that lead is really a lead in the warm-up, so we felt it was necessary to keep thinking big and moving through these ideas of get the platform, tune the platform and be ready for 2018. And when I look at things like soft gels: It took us a year to get soft gels into all the formats we wanted, to get the oils through the processors to be approved and have them launched in the market. I'm glad we took the year up until the launch of those that we actually have that as a new product.

And as we think about where we are now, how do we scale, well, we're interactive in partnership negotiations. There is a variety of third parties that we want to work with related to the manufacturing, marketing, sale, everything that federal regulations will allow. We're looking at how do we bring [strength] of our skills and offering to the best in breed from other sectors. And we think that that's going to be a very important formula to scale [up] to global access, and I hope you'll see some of those further come out. One of the first small ones that we announced recently was the K-Cup products in Canada; and how, if they can be permitted under federal regulations, we'll incorporate those into our offering. Ultimately for our company, cultivating cannabis is producing a flower, which means an ingredient. Extraction is the conversion. Customers want to buy brands. They want to buy finished goods. They want to buy indications against medical effects, so Canopy Health continues to grow and accelerate. Rivers, as you will have noted in our disclosure, has had its initial transactions, which increases our capacity. All of these continue to come together. And I think, at the back half of 2017, we'll see a strong effort to tune them and position extremely well for 2018.

So with that, Tim, I'll ask if you could walk through some of the details.

Thank you, Bruce. And good morning, everybody.

So our revenues for the first quarter fiscal 2018 were $15.9 million, which represents a 127% increase over the same quarter last year when revenues totaled $7 million. And it's an 8% increase over the revenues in the previous -- fourth quarter fiscal 2017 when revenues were $14.7 million.

As Bruce talked about just a few minutes ago, at the year-end call, we had commented that Q1 was all about setting the stage for the rest of the year and, going forward, by investing resources to reset the Mettrum operations and consolidate our customer base onto a common online storefront and expanding our oil production capability. Launching the Tweed Main Street online store in the first half of April required moving individual Tweed, Mettrum and Bedrocan e-commerce sites off-line; and migrating over 55,000 customers to a single database and new e-commerce platform, which naturally reduced the sales activity over a period of approximately 10 business days in April. And some of the days after that followed for our customers to acclimate themselves with the new format and log on. Since then and as of today, we've broken through the 60,000-patient level, so continued to grow. In addition, the sales reported in the first quarter were partly due to the lower availability of Mettrum products during the first quarter as a result of Mettrum growing operations being mostly inactive through the last part of the fourth quarter of last year and also through much of the first quarter this fiscal year while being integrated with new standard operating procedures and quality control procedures as well as a new production layout configuration.

The total grams sold during the first quarter was 1,830 kilograms and kilogram equivalents at an average price of $7 96% -- sorry, $7.96 per gram, up from 984 kilos and kilogram equivalents or up 86% at an average price of $7.09 in the same quarter last year.

Then next I'd like to speak to the cost of grams cultivated and sold. This quarter, we are introducing a revised presentation of the weighted average cost per gram in our MD&A, and it's also in the press release, which we hope will provide more clarity as to the components driving the cost per gram and the impact at each major stage. Specifically, the new presentation breaks out the cost per gram to harvest, which is from clone to harvest. And this includes all the cash costs including growing labor, utilities such as hydro and water, nutrients, rent and allocated overheads. Second, the presentation also includes postharvest cost per gram, which includes all the cash operating costs associated with, among other things, trimming, milling, drying, conversion of oils and gel caps, lab services and testing and also allocated overheads. And finally, the presentation also shows a cost per gram for shipping a fulfillment, which includes all those cash operating costs associated with labor for prepackaging and dispensing and order fulfillment; and shipping, along with packaged materials such as bottles, boxes and labels; as well as all shipping costs and allocated overheads. Further, royalties paid under licensing arrangements are also included in the cost per gram for shipping and fulfillment.

So saying all that. In the first quarter, the weighted average cost per gram of cultivation to harvest and postharvest costs, excluding shipping and fulfillment, was $1.28 per gram. This compares to $1.64 per gram in the same period last year and to $1.46 per gram in the most recent fourth quarter. The total weighted average cost per gram to produce, harvest and sell cannabis, including shipping fulfillment costs, in the first quarter was $2.78, as compared to $2.65 in the same quarter last year and $2.90 in the most recent fourth quarter. The weighted average cost per gram decreased from the fourth quarter primarily due to improving efficiencies in the growing and postharvest activities, but the offset was -- partial offset was due to the higher fulfillment costs principally due to premium packaging employed to market, our diverse brands and to the impact of royalties paid on certain strains driven by the sales mix of the associated strains.

Next I'll discuss the gross margin.

The presentation of the cost of sales is new and has been redrawn to better understand the nature of the margin and impact of the IFRS fair value accounting for biological assets. The gross margin is the subtotal to present the cash gross margin before the impact of the fair value changes of the biological assets that's in the inventory sold as well as for the unrealized changes in the fair value of biological assets themselves. The total gross margin includes all of the above. As a result of the new presentation, we no longer present the non-GAAP measure that we previously referred to as adjusted product contribution.

Gross margin before the noncash gains or losses over the 3 months ended June 30 was $9 million or 57% of sales. However, this number includes costs amounting to $1.4 million related to resetting the Mettrum grow operations and centralizing the various shipping and fulfillment activities to Smiths Falls. As well, it includes the operating costs of those subsidiaries not yet cultivating or selling cannabis. If we were to exclude those costs, the gross margin would have been $10.4 million or 66% of revenue. In the same quarter last year, the gross margin before noncash gains or losses was $2.8 million or 60% of revenue. Including the accounting for the noncash changes in the fair value of biological assets, the gross margin was $19.7 million or 124% of revenue. And in the same quarter last year, the gross margin was $3.4 million or 49%.

Now turning for a moment to operating expenses for the first quarter.

Sales and marketing expenses in the first quarter were $6.4 million or 40% of revenue, and this compares to sales and marketing expenses last year of $2.3 million or 32% of revenue.

The company has been committed to building strong brand recognition and investing in customer acquisition program, which we consider to be a strategic investment. Management believes the investment will strengthen both customer acquisition and retention. In addition, the company is aggressively seeking new domestic and international business opportunities to lay the future foundation and has been very active on this front.

G&A expenses in the first quarter were $7.5 million or 47% of revenue and $2.9 million last year or 41% revenue, respectively. These higher admin costs reflect the expansion of Canopy's activities since a year ago and including both domestically and internationally, so these naturally attract higher professional advisory fees, staffing, higher facility costs due to new locations as well as investments made in information technology support and compliance costs associated with being a TSX-listed company. Overall, the increase in G&A reflects Canopy's growth and building a commercial capacity and capability as well as being a public company.

Stock-based comp and depreciation and amortization, both noncash expenses, were approximately $4 million and $5.1 million, respectively, in the quarter. In comparison, stock-based comp and depreciation and amortization were each approximately $0.9 million in the same quarter last year.

As a result of all of the above, in the first quarter of this year, we recorded a loss from operations of $4.2 million. And after income tax, the company reported a net loss of $4.4 million or $0.03 per basic share and diluted share. The net loss in the first quarter includes acquisition costs of approximately $836,000, nonstock compensation and depreciation totaling $9 million; and is included -- includes the net noncash gain effect of the IFRS accounting for biological assets and in the inventory sold amounting to $10.7 million.

In comparison, the net loss was approximately $4 million or $0.04 per basic share in the same quarter last year.

As the new financial statement presentation lays out the cash, and noncash amounts in earnings for readers, we'll no longer present the non-GAAP measure adjusted EBITDA.

Now turning our attention to the balance sheet and cash flows.

At June 30, the company's cash comprised of cash and cash equivalents totaling $115.5 million, representing an increase of $13.6 million from the end of last year. The increase from the end of fiscal 2017 was mainly due to $35.3 million in cash raised by our subsidiary Canopy Rivers which is consolidated in our accounts. And it's partially offset by capital expansion totaling $10.2 million, principally at Smiths Falls, Bowmanville and to a less extent at Drummondville; and to fund our operations. As I said, investments are primarily improvements at our Smiths Falls facility. It includes the conversion and construction of growing rooms, new drying rooms; and expanding fulfillment rooms to centralize all related activities; and to the retrofit and expansion of our Bowmanville South facility; as well an expansion of cannabis oil extract production capacity at Smiths Falls. And further, we're also continuing to make improvements in our information technology to scale the business.

At June 30, inventory amounted to $65.5 million and biological assets were $9.3 million, together totaling almost $75 million. At June 30, the company had 10,715 kilograms of dry cannabis; and 2,683 liters of cannabis oils in various states, from concentrated resins to finished oils. Included in the dry cannabis quantities was 1,235 kilos available for sale in the company's online stores. 2,975 -- 2,974 kilos are in process of finish or waiting approval for sale, and 6,500 kilos -- and 6,506 kilos are held for extraction. And with the commissioning of the AES industrial capacity extraction equipment in recent [months] for soft gel caps that's now available for sale, the extraction inventory is expected to be converted to oils and capsules over the next few quarters.

So as -- I apologize for the long harangue, but this concludes my review of the financials for the first quarter. And I'll turn the call back to Bruce for closing remarks.

Thanks, Tim. I really appreciate the format evolution, and I think the listeners on the call will find it quite helpful for comparison purposes. I'll turn it over now if there are questions so we can move into that step.

(Operator Instructions) Your first question comes from Martin Landry from GMP Securities.

First question is on your -- I mean I really appreciate the breakdown you've done on your cost per gram to harvest, the postharvest cost and the shipping and fulfillment. So I mean it begs the question then we're seeing your cost per gram for shipping and fulfillment going from $1 to $1.50 over the last 5 quarters. You did touch a little bit to it, but so is -- you did mention premium packaging and royalties. Is that really what drove that cost higher?

Exactly, Martin. The -- we -- or the -- we have the Bedrocan. You've got Leafs By Snoop. The DNA Genetics products are all under license. And those all have -- well, except -- especially with DNA and Leafs By Snoop, there are premium packaging that are associated with those, but all of them attract royalties as well. So that's -- if you think about it, Leafs By Snoop wasn't introduced until October of last year, so there was no comparison on the prior year. Bedrocan was, too, still emerging, coming out of -- sorry, to really grow around that time. So the proportion of those sales make up a bigger portion of our total product sales. So yes, royalties and the premium packaging are the biggest drivers in that cost.

Okay. And I think I've heard you, Tim, talk about patient count being over 60,000 patients. Just wondering at what point -- when was that patient count you were referring to? What's the date...

(inaudible) As of Friday. (inaudible).

Yes, [so that and Montana], the -- in the period during the quarter, we really didn't have our foot on the accelerator for adding patients because we were doing those steps that we discussed. Where we are now is we're back on the accelerator and feel pretty confident that we have traction and can keep the store full, which will be a big advantage and -- to bringing people in so they can buy what they want and stay with us because the variety is there.

Okay. And then last question, you do talk about in your MD&A that your general and admin expenses have gone up because you've used a bit of consultants and advisory services. And then in your opening remarks you were talking about a lot of activity on the international front. I'm just wondering, aside from what we've seen and heard about Germany and Australia, are there other markets that you see are moving rapidly and that present good opportunities for you?

Yes. So anywhere that it's federally and state or provincial legal, we are active in. Think of that now as approaching a half dozen countries. And so things that Tim's describing in general terms are having an international tax plan, when you're doing RFPs, making sure you're fully compliant with EU laws, other jurisdictions. But certainly we're seeing EU; Australia, as you mentioned; South America opportunities opening up and establishing our framework of how we want to conduct business there, which is to essentially either enter into a partnership that becomes a wholly owned subsidiary over certain milestones or establish a wholly owned subsidiary off the get-go. And it's essentially that model so that we can drive the bus in each of the countries and consolidate back up effectively.

Okay, so is it fair to say that EU is occupying most of your time right now in the international front?

I would say it's occupying 62%, but there's quite a bit of activity in other areas.

Your next question comes from Daniel Pearlstein from Eight Capital [Inc.].

Could we start with a little bit more clarity on the integration of Mettrum? This is, I guess, this is the first full quarter of the Mettrum operations within, under the Canopy, so could you talk a little bit more about, I guess, the phases of -- through coming out of the recall? And then you touched a little bit on some of the operations, but if you could really dig into what are some of the processes that are being put in place or focused on the cultivation that you -- that attributed to the potential increase in production capacity that you recently press released?

So maybe Tim and I will tag team on this. So we struck the deal knowing what had gone on in terms of myclobutanil. We knew they needed a reboot. We took over Feb 1, and that became a reboot on varieties of areas from customer care to grow. That also required certain parts of the infrastructure to be tuned in so that they met our standards so that people weren't battling pressures in terms of [pests] and, or spores. We did that through the quarter, and Tim will speak to the numbers, but now we have an integrated and trained grow team, a customer care team. Everything is sort of run now as we run the trains. And it feels like culturally the transition for the folks in that place has gone very well and that they embraced the methods and procedures. So Tim, maybe you can put some detail around that, as far as numbers.

I mean, in terms of the impact in the quarter, it was a little over $1 million that we spent in terms of realigning all the activities. And so that's about the size of the cost in the quarter, but that's all pretty much behind us now. We're seeing product flowing back through Smiths Falls now. The shipping and fulfillment activities were also moved and centralized in Smiths Falls, so pretty well, from an operations standpoint, this is it's now considered integrated.

Okay, that sounds great. And then maybe as a follow-up to that: As the platform is becoming more stretched across the country or just more diversified, is there any specialization of any of the facilities that you're seeing in terms of product or strain or, I guess, focus, either if it's the Bedrocan or the Mettrum campus or even Smiths Falls and Tweed Farms? Are you seeing more specialization in any of these facilities? And then I assume that everything is kind of still run mainly through Smiths Falls, but could you give a little bit more detail around how you see operations across the country being, I guess, different from one another?

So obviously, you have the primary point of variances indoor versus greenhouse grow. And so we're tuning in on both of those. As you have seen in our numbers, our cost per gram of production continues to decrease. And I would argue that the quality increases. And so we're scaling indoor grow and greenhouse. Smiths Falls is the campus at which we focused on getting it right, and when I say getting it right: oils production and GMP certification for encapsulation, shipping and fulfillment. But you can imagine, as we contemplate the rest of the next 12 months, we're thinking about how we replicate fulfillment across a variety of locations so that anybody who's our client under both systems will enjoy ever-shorter ship times because you start to work your way through logistics. And then we'll probably have a second campus for extraction because extraction, over time, is going to be a big quantity where you don't want to necessarily ship bulk materials for that purpose across the country. But once you've nailed it and dialed it in, during the second time, we expect it's quite a lot faster and easier. And so that's something that we'll step through over the next 12 months.

Your next question comes from Vahan Ajamian from Beacon Securities.

A couple of quick questions. So you mentioned that the consolidation of the 3 online stores into 1, Tweed Main Street, impacted about the first 10 or so days of shipments in the quarter. Is it possible to ballpark a dollar figure to the impact?

Tim might put that out there, but think of it as April having less volume of sales than March. And each month we've ever operated seems to have been in continuous growth, and it wasn't just that it was a merge of all the things. After it went live, you work through still some hiccups so that it tuned in. If you went to our site 2 weeks ago, even the image and the presentation of the product was less elegant than it is today. And so I would say that probably all of April was not smooth and easy for orders, but there was really a specific window of 10 days where it was impossible or not really a transactional platform.

Yes -- no, that's exactly right. There was -- there were no customers being onboarded for those 10 days, no orders being processed. And then when you introduce a new store, people being people, it just takes a while to figure in and figure out that they need to log in. How does it -- how is it laid out? So I think that there were some days that followed as well that would have slowed the order process, but by the end of April, pretty much everybody was accustomed to how it was working and so it was back in business.

Vahan, the key thing is, once the marketplace is built, it doesn't mean it's filled with goodies. And so if you watched our store, as many people have, April, May, June, there were comments about the insufficient variety or things that people wouldn't want in terms of different strengths and formats. We've been dialing that up, and you'll notice now it's looking like a marketplace.

Yes.

Yes, we've definitely seen the increase, especially on the Tweed banner of products that have been available over the last several weeks, so that's been great to see. So I guess there were 2 sort of structural issues that impacted sales this quarter, the first being this new launch of Tweed Main Street we just talked about and the second being Mettrum obviously not being fully up and running. So I guess, in terms of looking forward here, it seems like most of these issues have been addressed, and I guess the sequential increase in sales was about 8% this quarter. It's, I mean, historically been in the 20s. I don't know if we'll get that high, but is it reasonable to expect an uptick this quarter and going forward relative to the 8%?

Yes. I think that you're going to find us having the variety that we do and now pushing again on patient acquisition. It will, though -- it should pick up. And I would only temper that in that there's a lot of folks out there who really are aggressively looking for patients, where we're trying to do a great job of serving them and have them tell other folks why they should come to us without getting too crazy on referral programs. Because I do think that could be a pressure in the sector.

Got you. And final question, on R&D expenses. It seems pretty low this quarter, $133,000. Is it a lot of a reclassification between what's R&D and what's SG&A? Or should we expect them to tick up, or staying more or less here going forward?

No, I think it's always been in the sort of the range of hundreds of thousands of dollars, as opposed to -- it can fluctuate easily with -- by $100,000 or $150,000 from quarter to quarter. So yes, you're right. It's a little bit low -- on a low side, but it's in the range of a couple hundred thousand worth. That's the typical run rate.

Yes. And do remember that Canopy Health is now funded and operating as a separate entity. And so much of the IP work in terms of both what we file patents against and how we pursue it is now being done under Canopy Health, which is not reported in the same fashion as it's a minority position.

Your next question comes from Neil Maruoka from Canaccord Genuity.

First question, just on some of the accounting changes. We know that, when you're valuing biological assets to inventory, it's noncash, but when revaluing in the -- to inventory sold, is there a cash component to that, or is that all noncash? If, Tim, you can provide a breakdown of that line fair value changes in to inventories sold. And then final question on that, similar to last quarter, did you have any revaluation of the Tweed Farms production in Q1?

No. So the short answer on Q1 for Tweed Farms, no. That was all a Q4 change. No, the way the -- it works with the inventory is that it's starting base for cost is the fair value of the plants when they are harvested, and they get moved into inventory. So really all of that sort of starting point is the noncash element. And then after that, [you really are in] cash costs associated with the -- all the postharvest activities, where there's trimming, drying, processing, all of those things. Those are all cash costs layered on top of it. And then at the end of the day, then you do a -- there is another valuation adjustment, sort of just the typical NRV adjustment, where you compare against the sale price and consider discounts that might be provided, compassionate pricing that might be provided. But so when you look at the inventory balance, its starting point has its origins in a fair value or noncash approach. And then as that inventory moves into -- or gets sold, there is that fair value component that sits down below. You'll see it here, the fair value changes in biological assets and inventory at $11 million as sort of the fair value component. And then the cash component of that is up top, in the inventory production cost expensed to cost of sales. So that's where you split between cash and noncash. It was always hard to see before because we had just disclosed the inventory expense, which is both cash and noncash. And it was -- so we did a lot of work and tried to carve that out and being responsive to people's ask for or more clarity on the cash, noncash pieces.

Okay. And could you provide a breakdown of that fair value changes to inventory sold?

Well, that's the $11 million. You'll see that comes off the balance sheet and then to the income statement. So in terms of the inventory, on the -- you were talking about what's on the balance sheet...

No, no, just on the income statement.

Yes, it's the $11 million. That's the fair -- that's the noncash [for value piece].

On noncash, okay. And maybe just on your cash cost. They look very competitive this quarter. How well can you get this given your projected indoor-versus-greenhouse production ratio?

Well, I'd say it's certainly we're getting economies of scale and particularly when you get to the -- you'll some fluctuation in the -- with the summer harvest at Tweed Farms, when the -- you get probably the biggest harvest of the year. So you'll see that more coming out in September and also in the quarter. The third quarter ended December, you see the impact of that. So it's we'll keep tweaking it, so you'll see probably sequential improvements, but we've seen that now for the last 4 quarters.

Your next question comes from Jesse Pytlak from Cormark Securities.

Just kind of going back to the earlier commentary on how the [full crux] for the first 6 months has been on building the platform and kind of stressing it, and so now you're kind of in a phase of fine-tuning it. So just with respect to that, like are you finding any gaps or shortcomings still that you need to further tune or kind of how comfortable where you are today with your platform?

Well, we spend all our time looking for gaps. So as an example, the extraction equipment is now commissioned and running. Now what you want to do next is make it running 24 hours a day, and you want it automate processes to reduce labor pre fulfillment. So if -- we prepack all products so that it prepared so that, if you order by 3:00, the target is to ship by 5:00. We have steps now to automate the prepack, which reduces the labor demand by, say, 8 headcounts. All of those things are in the implement tune mode or scale, but the base line is operational and it's how do we crank it up. So I would say we feel very good, but what we want is multiples of the throughput. But the baseline is working.

Okay, that's helpful. And then, I guess, just kind of turning to Germany, can you comment at all just how the market has been developing for you there? Like how often are you shipping? Or are the ship volumes growing? Or kind of how that -- what's the trend being with that?

So the demand has been growing fairly rapidly since March 1, when material changes occurred there in terms of access for patients. Shipping, it should be more often, would be the way I would phrase it. We are now catching up on which products are scheduled because you don't just ship anything you want. You have to ship what is a permitted product, and the permitted product has a process. The products have to be produced in the facilities which have been GMP reviewed or approved, which includes Smiths Falls for us and the farm. And so I think you're going to see a little bit longer run on the import market in Germany because there's a bit of pushback right now on the second phase of the RFP which was to happen in mid-September, maybe a bit later, but we're liking what we're seeing. And Spectrum, as our brand evolution over there, would be the brand that we would use if we're permitted to grow. Right now, we're shipping Tweed.

Your next question comes from Alan Brochstein from 420 Investor.

I think I'm going to start with Tim and then let you finish, if that's all right, Bruce.

Good, [fair enough].

So Tim, you called out a lot of costs today that were kind of short term in nature or, when we look at the company a year from now, will be behind. And I just want to make sure I'm not missing any and wonder if you could just kind of just big ballpark the overall costs that aren't really recurring. And the ones that I heard you come up with were running facilities that aren't producing yet, Mettrum integration and getting Tweed Main Street up and running but -- and maybe international also.

Yes, those -- it's not so much the costs associated with the Tweed Main Street store and like that, but certainly I talked about the $1.4 million that's included in that line inventory production cost expense. There's -- the $1.4 million is about $1 million of that really is more in the nature of onetime. It's a -- this is the reset for Mettrum with -- you've got idle staff, nonproductive, growing operations. The other costs, these are our prelicensed applicants like Vert. And the rTrees, for most of the quarter, was waiting for license, but they'd only started growing operations in July, after the quarter. So those expenses just flowed through. And they'll factor in. And as they start to produce flower and the like, can become part of the normalized inventory production costs, but I wouldn't characterize that as nonrecurring. There's about $300,000 or so related to those operations. But then otherwise, we continue to grow, but these are all investments, again, for the future. This is for the long term, not just the next couple quarters. This is really trying to lay the foundation both on sales, marketing and branding but in terms of the infrastructure too, supporting the scalability of the company, supporting operations coast to coast and internationally too. So these will all continue to be foundational costs that we'll continue to incur.

Okay. Then my second question is are you able to kind of (inaudible) insight on customer loss? I understand you've had a net gain, but between the downtime maybe on the Tweed Main Street platform as well as what's been going on with Mettrum, are you able to kind of break out the adds and the declines, the least not the exact number but to the extent that, that's going on?

There was definitely some churn. We should think about how we put that out there, but I would suggest it was principally on the Mettrum clients. And a lot of communications in that front went into both informing them how the evolution was going; and to make sure that when we switched to the Tweed Main Street, you'll notice on the left-hand side that we put a method to look at all products the same way as Mettrum was presented. So the Spectrum applies as a way of selecting product across all products produced by any vendor. And so that was quite helpful in making them have available product which was similar in format or strength but not necessarily produced in the Mettrum facility. So that was a driver on getting the marketplace in -- up and going and keeping churn down.

But the 10 days of not being able to order for some people, would that result in losses?

Well, it made some people send me e-mails and call me. And our call center was busy, but the effect is that, once you're registered, it is there is a bit of stickiness there. And once you started coming back on and as we built the inventory, people who went from disappointed but received communications, I think, are feeling pretty good about it. And so there was some churn but certainly not a major step back.

Okay. And then my last question is kind of big picture question for you, Bruce. And that is, you guys are definitely differentiated from the other large producers who [didn't have not] the diversity in terms of both geography and indoor versus greenhouse. How do you see that playing out, as the country moves towards legalization, to your advantage?

Our constitution, unlike yours, actually describes [beer] sales in it. And I think that you're going to find cannabis sales probably have a provincial bias to production in that province, so I think there'll be some advantage to us being a multi-jurisdictional producer. I also think that, when people want to buy a product, a big difference in what we're doing is we're moving through how do we make finished goods rather than ingredients. And I think in Canada dried cannabis as a sale point will -- or sale item will probably be lower than in other jurisdictions. And so I think our branding, our geographic access and quick shipping as well as maybe point of sale will probably be quite advantageous. And the brands and the media -- so Tweed is our forefront brand when we go direct. That brand has been built quite strongly with the medium engines and the associations with key actors. So we're preparing to have a big market share and we don't want to disappoint people by running out, so the greenhouse part helps quite a lot on that. And we're pushing hard to expand that as part of our platform as well as more [indoor growth]. So I would say stay tuned through the second half of 2017.

Your next question comes from Victor Bonilla from Carlson Capital.

Just thinking about the balance sheet. So there's about $65 million of inventory against only $7 million of inventory expense. That's about 850 days of inventory. Why so much? Is that related to the $11 million write-down this quarter?

No. Okay, so I'll have to provide clarity here then. So that $11 million is not a write-down of inventory. This is just simply -- under IFRS, the inventory expensed for this period would be in aggregate about $16 million, or $16.88 million to be precise. And it combines both the $11 million that you see as a -- in the cost of sales plus the majority of what is in the up above in the inventory production cost expensed to cost of sales. So there's no write-down in this quarter. This is it just simply the IFRS accounting for the fair value component that -- of that inventory expensed. Likewise on the inventory numbers, as I talked about earlier, the origins of the cost base for the inventory before, up to the harvest point, includes our fair value adjustments. So it's there's 2 different things going on there, but the -- just to be clear: There was no write-down in the quarter.

Well -- and maybe just let's step one step back. Right now, what, are there maybe 175,000 patients in the medical system? And a bunch of doctors who are really getting comfortable with the format of things like gel caps. So let's assume, by next year, at this time, the market for medical patients has maybe doubled, but also, so-called 300,000 patients, next year, at this time, they'll also be incremented with adults who cannot gain access maybe by coming directly to our store. And what's that, 3 million people? So the number of days of inventory changes quite differently if you think that there's maybe 3.3 million, 4 million potential customers, when currently there's 175,000. And so I wouldn't want to miss the fact that, if you put this product into certain states, it becomes highly stable and available for future sale.

Your next question comes from Jason Zandberg from PI Financial.

Just wanted to find out if I could get some details on the recent harvest at Tweed Farms in terms of comparing and contrasting it to what you experienced the last harvest. I know it's a different time of the year, so obviously there is going to be a yield difference based on that. But just whether there was some, yes, improvement on what the yields look like, what that THC volumes were. Any sort of comparing and contrasting to that last harvest would be helpful.

Yes. So the only compare that you could do is winter on winter. And I would say that we increasingly are, I would say, happy with how we're producing down there in that we're managing everything from the humidity in winter or the porosity of the soil based on prior cycles. And so each time feels like an improvement in comprehension of the building and the crop, and the output would reflect that. And we're feeling and seeing the same despite a very humid summer in Ontario, unlike where you are. We're feeling that we've really -- we're really dialing in the crop again this fall. And I know those aren't exact numbers, but you're running a building where, each production cycle, you expect to see more and you see better. And I would say that it feels like the team is [flowing] that through, yes. I think you'll see it in the store, if you look at the store. When you're seeing products which are sun grown, you start to see the range of available products.

Okay, okay, no, no, that's helpful, but I guess just generally you are seeing an improvement in every cycle with Tweed Farms in terms of -- and I guess I realize that it's time of year dependent, but...

We really are -- greenhouses: When you first get a greenhouse going, it is a new thing and a painful thing. That was several years ago. I would suggest now we're getting much more comfortable with dialing things in. And we've made some infrastructural changes, whether it's screens and controls, on that. It is now a managed environment, and it feels like a processing platform that we like and would like more of.

(Operator Instructions) Your next question comes from [Stefeno Solmaz], private investor.

Bruce, I'm just looking for -- I'm wondering. What is the current total licensed square footage?

Wow. So let's just walk through, a license gets allocated to an address. So 1 Hershey Drive is the venue where we have our first license. We're using about 168,000 currently, but we're constructing another -- renovating another couple hundred thousand square feet at that facility. So call that maybe 350,000, which either is licensed or can be licensed activities. We added doubling the facility down in Bowmanville. Total number square feet, I'll have to scratch my head and think that through. Bedrocan is about a 60,000-square-foot facility. We have another smallish one up in Creemore which gets you tens of thousand, but it's on a large plot of land, and so we're working through how to expand that. The facility at the farm is about 340,000 square feet of glass in a processing building. And it's on some land that you could add another couple hundred thousand square feet there. The facility in Saskatchewan is about, we'll call it, a few tens of thousands built out that got the initial license, but once you have a license, accelerating and expanding the balance of the building, it's quite sensible because it's an addition to a licensed capacity rather than an achievement. And so you can imagine that's a big push right now to think through how we take the whole building on which is, call it, 60,000-ish square feet. And the one in Québec is a small facility that existed that we tuned up and [put SOPs in] -- but it's on about, I'm going to say, 90 acres, which could be built out to be larger. And then we've announced about 140,000 square-foot-ish facility in Alberta that we brought the Goldman Group together with us and are moving through the application process and about a 50,000-ish square foot facility that could expand in Fredericton. So when you add that all up, you'll pretty quickly get into the million-plus square feet current and/or soon.

That's right.

Okay. And just to take -- expand on that: Are there any -- are you guys looking into any other potential acquisitions? Or are -- from this point on, are you looking more to expand on the lands and licenses that you have such as, I believe, Mettrum? You have a 20 acres of the leased land with Mettrum. Are you looking more at -- yes?

So we have -- I'd say yes to both. So we see everything that's for sale or could fit in. So we look at a bunch of things, but my eagerness to buy more [upfront] is modest. When we think of acquisitions now, it's about vertical integration. And Canopy Rivers has pulled the trigger on a couple or a few of these so that, rather than acquiring the whole asset, you get the flow of product on a preferential basis for a portion of the output. And so I think our activities of acquiring will be a bit but more international growth; indeed acquisitions; and more finished products. Things like devices might need acquisitions to get them into our portfolio.

At this time, we do not have any questions. I will turn the call over to Mr. Bruce Linton for closing remarks.

Well, thank you, everybody. It was a congested morning for results, and we'll manage that through, but I appreciate your time on the call and look forward to describing our tuning exercise as we go through the next quarter or 2. Bye.

This concludes Canopy Growth's First Quarter Fiscal 2018 Financial Results Conference Call. A replay of this conference call will be available until November 14, 2017, 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.