Entourage Health Corp.

Thank you, operator and good morning everyone. Welcome to WeedMD's second quarter 2019 results.

This call is being recorded. For copies of our financial results, press release and supporting documents issued yesterday after market close or to retrieve a recording of this call, please visit our website at www.weedmd.com.

The recording will be available online this afternoon as of 12:00 P.M. Eastern Time.

We're joined today by WeedMD's Chief Executive Officer, Keith Merker; and Chief Financial Officer, Nichola Thompson. During the call, we will discuss our business outlook and make forward-looking statements.

These comments are made based on predictions and expectations as of today. Actual events or results could differ materially due to a number of risks and uncertainties including those mentioned in our most recent filings with SEDAR.

During the Q&A portion of today's call, kindly limit yourself to one question and one follow-up. Before we get to the Q&A, Keith will start with opening remarks.

Go ahead, Keith.

Thank you, Marianella. Good morning and thank you everyone for joining our second quarter 2019 earnings call.

The WeedMD team is pleased to deliver yet another productive quarter for all of our stakeholders. Before Nichola walks us through the numbers, I'd like to provide an overview of the business and highlight some of our major initiatives.

The second quarter of 2019 included many significant milestones for the company. We kicked it off with the licensing and planting of our industry leading outdoor cultivation platform.

We also successfully launched Color Cannabis, our first adult-use brand, and we made great strides financially seeing significant increases in both our revenue and our gross profit. Our net revenues increased substantially to $8 million and our gross profit margin also increased to 46% as we realized scale in our cultivation and our supply chain.

Our platform now includes a true hybrid low cost greenhouse and an even lower cost outdoor cultivation platform at our Strathroy site. With the ongoing expansion and de-risking of our operations, we are now seeing the benefits of economies of scale, as well as our culture of continuous improvement.

Over at our Aylmer site, our fully licensed facility is being transitioned into a processing and extraction hub, which is now known as CX Industries. So with a total of eight flowering rooms online in the greenhouse during the quarter, we were able to harvest and sell significantly more cannabis than in previous quarters.

As a result of this increased production and the aforementioned operating economies and synergies, our fully baked cost per gram fell from $2.90 to $1.84 for finished product. Our cultivation costs also decreased significantly to $0.96 per gram down 30% from $1.37 in the previous quarter.

Our cultivation ramped up aligns nicely with the launch of our first dedicated recreational brand Color Cannabis. Demand for Color has been strong, and the feedback on our products continues to be extremely positive.

In fact, it's consistently been one of the highest rated brands by reviewers, lot of words freshness, rich profiles and power of quality. That's because our view on how to be successful in this market has not changed.

We continue to significantly increase our capacity without sacrificing our quality. We still hang dry in whole plants, we dry them and we hand manicure our dried flowers, and the results show.

By consistently delivering quality products to the adult-use market, we were able to realize higher prices with our provincial partners with the rollout of Color. On the other hand, more recently, we also actually lowered our medical pricing for both flower and oil to provide greater accessibility for our patients.

And this has resulted in increased market share and sales. In the second quarter, B2B sales represented over 70% of our sales.

I want to be clear, it has always been our plans to take advantage of the wholesale market wallet is strong, as it saves us both time and money in processing and packaging. It also allows us to continually move our inventory as we ramp-up CX Industries for extraction processing, as well as continually improve our supply chain capabilities.

We're very pleased now with our operational progress, and we're becoming recognized for our best-in-class execution. Now we have 20 cultivation rooms online and ready in the hybrid greenhouse, 18 which of our -- 18 of which are our model 10,000 square foot flowering rooms, and two that are used for mother plants and propagation.

10 of these flowering rooms were recently licensed and are now being populated with plants. This more than doubles our production capacity in the greenhouse, with the increased production expected to ways -- make it way to market starting in the fourth quarter of this year.

With each cultivation cycle, we learn more and we strive to continually improve our methods, having 18 separate 10,000 square foot micro-climatized rooms allows us to rotate and bring new strains to market faster and more consistently. This allows our teams to rotate between the rooms as a cross functional labor pool, which optimizes employee engagement and labor costs.

We are able to realize a 58 improved -- 58% improvement in yield over our original design forecasts. Originally, we had forecasted yields of up to 250 kilograms per room for harvest.

This quarter, we saw yield average 396 kilograms per room for harvest, with yields per plant averaging 118 grams. Turning now to the outdoor operations, we've been very pleased with the results that have been achieved so far.

The plants are an early flower and with the cooperation of Mother Nature, we should be in a great position come harvest time, which will begin in just over one month. Our patients and customers will be pleased to hear that many of our classic strains such as Ghost Train Haze, Wine Gums or Sweet Sativa, Ultra Sour and White Shark are driving alongside many new strains that we look to bring forward to the market.

As pioneers this year in scaled outdoor legal Canadian cannabis cultivation, there have been many learnings. So while we are excited about the prospects for 2019, we now have the experience necessary to maintain this leadership position in outdoor cultivation and stay ahead of the pack in 2020 and beyond.

This brings us to a very important milestone in the quarter. The announcement of CX Industries, WeedMD has deep roots in Aylmer, it's the community where it all began for the company.

It's home to our first and fully licensed facility, it's home to many of our employees, including many of whom who have been around since the early days with the operation. We recognize that the highest and best use of this property facility and license for the market of today and the future is as an extraction and processing hub.

And we have timed the reinvention of this site to coincide with both the harvest of our outdoor crop expected to provide significant input materials, as well as the rollout of cannabis 2.0 here in Canada later this year. Six industries will stand out amongst the other extraction place for a few key reasons.

Firstly, it has an anchor supplier 40 minutes away at our Strathroy site. In 2020, we will be able to provide more than 75 tons of low cost cannabinoid related biomass input for extraction.

This means being able to control the supply chain and realize the best margins in a 2.0 world. We strongly believe that the vertically integrated model of cultivation and extraction makes sense in the early stages of this industry.

We have certainly supply, certainly price and perhaps most importantly, certainly of quality where others will be at the mercy of the vagaries of the wholesale market pricing and consistency in both supplier and quantity, that sort of quality. Whether it's our dry flower, our oil or our upcoming 2.0 products, we will be able to guarantee our patients and our customers consistent quality at industry leading margins.

Secondly, designed for and with a pathway towards EU GMP certification in 2020, we will be well positioned to open up international markets with CX Industries. And thirdly, we have the capacity, the flexibility and the openness to partner with other LPs, brands and extraction companies to build out this business.

With the upcoming introduction of new cannabis products into the Canadian market, which I’d been referring to as Cannabis 2.0, CX and WeedMD will initially be very focused on a few finished products primarily in the vaporizer category. CX Industries also plans to supply high quality extracts and API's to its future partners, whether they be an edibles kitchen, a bottling line or a processing facility.

Our goal is to keep it very simple, sell it just a few things rather than try to be all things to all people. I wanted to address one final point that I feel is important.

We have made several strategic decisions during the year such as proceeding with CX Industries in Aylmer and focusing on outdoor cultivation in Strathroy. These decisions coupled with an industry-wide delays that have been experienced in licensing, they've had some knock on effects on the timing of some of our other initiatives.

The licensing application and approval for the 10 plus 10 cultivation and processing rooms, which we had originally expected earlier in the year, and which was only just recently received is a perfect example of this. The further expansion across the seven acre traditional greenhouse, which is now forecast to come online in Q1 2020 is another.

That being said, we do believe that we've now put together the right strategy utilizing our asset base to the best extent possible for the long-term success of WeedMD. So before turn it over to Nichola, I wanted to say a quick congratulations to Pioneer Cannabis, a WeedMD investment which opened its first Ontario store this summer in Burlington, Ontario.

Sales have been strong, feedback very positive on both the store format and the layout. And lastly, I want to acknowledge our employees.

Their dedication, engagement and commitment is truly the backbone of our operations and what makes WeedMD what it is today. So to all of our employees, communities, partners, patients, clients, shareholders and other stakeholders that stand behind us, a sincere thank you.

We value your support. At WeedMD, we're playing the long game in an industry that is just getting started.

We remain excited about the long-term prospects for both the industry and of course, our company. I'm now going to turn it over to Nichola to walk you through the financial results for the quarter.

Thank you, Keith and good morning, everyone. As noted by Keith, the strength of our operations and demand for our products drove solid progress through in Q2.

As a result, WeedMD recorded revenues net of excise taxes of $8 million in the quarter. This represents 139% increase in comparison to Q1 and a 282% increase compared to the same period last year.

Year-to-date, WeedMD has recorded $12.3 million in revenue, a 250% increase over prior year. Sales improvements in Q2 were realized through all distribution channels, which is achievable due to increased product availability, this came from an increased cultivation footprint that was licensed just prior to the beginning of Q1 and achieved from approved yield.

During Q2 2019, WeedMD harvested 3,617 kilograms of cannabis compared to 716 kilograms in Q1, a quarterly increase of 405%. In Q2, net revenue from potential adult-use channels increased 256% to $1.9 million from $530,000 in Q1 and accounted for 24% of quarterly revenues.

Demand for Color has been exceptionally strong with consumers and we look forward to building on the momentum that has been created within our brand. Sales of licensed producers accounted for 72% of Q2 revenue while direct to patient represented 5%, 93% of total revenues were derived from dry cannabis product category.

During Q2, WeedMD sold just under 2,000 kilograms of dry cannabis, up 152% from 793 kilograms in Q1. The average selling price in the quarter was $3.76 per gram versus $3.82 in Q1.

The slight decrease was as a result of higher proportions of extract grade cannabis being sold to other licensed producers and third-party extractors. The decrease was offset by an increase in the average selling price in the provincial adult-use distribution channel to $4.50 per gram from $3.78 in Q1 as recognition of the quality cannabis produced by WeedMD.

The company reported gross margins of 46%, a 31 point increase from the 15% reported in Q1. The improved margins are result of cost synergies, realized with having all eight cultivation rooms operating through the first half of 2019 as well as our continued improvements in processes and yields.

Gross profit before changes on fair value improved by $3.2 million or 649% from Q1 2019 and increased by $2.2 million, or 149% over Q2 2018. The weighted average cost per gram inclusive of all costs, direct and indirect to produce and package for Q2 2019 was $1.84 compared to $2.90 for Q1 2019 at $3.59 in Q2 2018.

The quarter-over-quarter improvements was 37%. On August 2, WeedMD secured a license amendment allowing us to plant and cultivate another 10 cultivation rooms and 10 processing rooms.

As a result, our team is in various stages of preparation and planting of those rooms, which we expect to be harvested in Q4 2019. Similar to Q1, Q3 is another ramp-up period.

In the quarter, general and administrative expenses increased by $771,000 to $4.4 million, however declined as a percentage of sales from 109% to 55%. The main drivers of the increase in general administrative expenses were an increase in headcount as we continue to scale for growth, and a result of a reduction of overhead absorption by production, Aylmer facility is being transformed into an extraction processing facility.

Net adjusted operating income is income adjusted to exclude the realized, unrealized fair value on inventory and biological assets. We believe the adjustment to exclusive fair value amounts provides a better interpretation of actual operating results for the period.

Net adjusted operating loss for Q2 2019 improved by $2.7 million to $3.4 million from a loss of $5.3 million in Q1 2019. The improvement over Q2 was a result of improvement in gross profit before margins and fair value of $3 million driven by increased sales and improved gross margin offset by increases in general and administrative expenses.

With the fair value adjustments included, net income for Q2 was $12.6 million at $10.2 million year-to-date. At the end of Q2, cash and networking capital totaled $38.3 million compared to $35.7 million at the end of Q1.

Q2 inventory was valued at $12.5 million, which includes 2,489 kilograms of cannabis valued at $7.8 million, various forms of oil extracts valued at $4.3 million and $0.4 million in consumable inventory. Biological assets are valued at $17 million.

Biological assets consisted of 57,000 plants, 36,400 in the greenhouse valued at $6.1 million and 20,600 valued at $10.9 million in our outdoor cultivation area. Property, plants and equipment increased by $11.8 million for Q1 2019 at $52 million from December 31, 2018, of which $11 million were non-cash additions related to the reclassification of the 2017 deposit and 2019 non-cash consideration for the purchase of the Strathroy facility.

The majority of capital expenditures for the quarter included $6.6 million for the Strathroy expansion, $1.2 million for the neighboring property, $2 million for the outdoor cultivation construction, processing equipment of $1.5 million and software of $0.5 million. Year-to-date capital expenditures included the purchase and improvements of the Strathroy facility.

In closing, we have strong momentum in all key areas of our business. We've made significant progress with our production platform and expect improved profitability as we move into 2020.

We are confident in the strides we've made and fully expect to realize greater shareholder value as we continue scaling for growth. That concludes my Q2 financial updates.

Marianella, back to you.

Thank you, Nichola and Keith. Ariel that concludes our opening remarks.

We are now available for the question period. Ariel, please proceed with your instructions to callers.

Yes, good morning and congrats on a solid quarter. Thanks for taking my question.

Just wanted to maybe get your commentary, Keith on what you're seeing in the wholesale market. Now, you obviously had that strong sales into that marketplace in Q2, and I'm wondering whether that's just sort of a line that could have a little bit of volatility to it.

You have the inventory clearly, and obviously building up with the biological assets. So just want to get a little bit more feeling, what your thoughts are in sales into that wholesale market?

Sure and thanks for joining Neal and for your question, and it's a good one. As I pointed out, it has always been our plan to put our product through the wholesale market as we ramped up our internal capacity supposed to take extract grade cannabis through CX as well as obviously building up our infrastructure and capabilities on the supply chain side with respect to dry flower and delivering finished products.

And both of those pieces are coming, coming along very nicely. Great improvements, especially on the supply chain side that we've seen and you've seen that increase with products that we delivered in Q2 versus Q1 for instance.

Certainly the wholesale market, what we're seeing here in Q3 has not changed significantly from previous quarters, it still remains strong. Although, I think that we all probably agree that over the long-term, this is not the right strategy, at least we internally agree, WeedMD is not the right strategy for us, and which is why as our capabilities increase on both of those fronts for extraction and processing and packaging, ultimately, we will diminish the amount of sales that go through the wholesale channel.

I would envision Q3 not being too dissimilar from Q2, but again as we head into Q4 and especially into 2020, we will look to minimize the sales going to the wholesale market and obviously increase our deliveries through the retail channels both on the medical and the consumer side. So I hope that answered the question.

But ultimately, what we're seeing right now has not been any significant change with respect to demand and pricing in the wholesale market.

Yes, that's great. Thanks very much.

And then maybe I'll sneak that follow-up if I'm allowed in sort of to delve into the Q4 commentary that you made there. With respect to the 10 additional rooms and your outdoor grow, I know that you said, outdoor grow harvest will start little over a month, probably in October and those rooms as they go through the cycle.

Do you anticipate having a good portion of that product ready for sale in Q4, it's going to be harvest and going through the processing et cetera and more likely available for sale in Q1 of 2020?

Yes, another great question. And we can ask the farmers Almanac or Mother Nature to give us an appropriate answer to this.

So, I mean, the truth is Neal the truth is that we're farmers, we're growing, this is pure agriculture, we're outside. And if you talk to any farmer in any farming business that they're at the whim of Mother Nature.

And so in a perfect world, Frost is well delayed. And we're allowed to harvest as per our optimal harvest scenario, over a period of about six weeks, starting in early October.

But of course, as we all know, you have to plan for the worst as well in business. And so we've also got contingency plans in place where we'll have to harvest at any earlier date in a much more compressed period of time.

And ultimately, the yields and ultimately the amount of product that we're able to deliver in Q4 is going to be contingent on that harvest schedule. So it's very difficult in our practice for us to for me to sit here and say, yes, we'll get 80% of that product out to the market in Q4 would be not doing anyone, I think it would be doing such all disservice.

So our goal is to get not insignificant amount of the product both from the outdoor and from the new harvest to marketing Q4 and have a great Q4. But I think that in any scenario, a lot of that product will be actually delivered in Q1 and even through into Q2 depending on how much product we actually garner from these endeavors.

Okay, thanks very much, Keith. Thanks.

You’re welcome.

Hi, good morning. Thanks for taking my questions here.

Apologies for the delay. I just had a question regarding the net selling price per gram particularly in the provincial channel.

I was wondering what is the company feeling in terms of how that could trend into the future especially with the recent launch of the Colors brand whether that could potentially play favorably with respect to the net pricing on the flower side, and then how that could trend moving forward with the introduction of your products? Thanks.

Thanks for the question, Graeme. This is Nichola here.

In Q2, we did experience a bump in our provincial average selling price, up to the $4.57 and that that is directly related to our Color brand and our the quality being recognized of our indoor greenhouse growth. So we do expect that price to continue.

And we are very pleased to be able to bring that to the market.

Yes and furthermore, Graeme, it is a good question. I mean, it was funny in the early going with the provinces, many of them took the stance that anything grown in a green door would be of a certain quality.

And I think that there's been learnings across the board both from the supplier standpoint and obviously those folks at the purchasers and a greenhouse is certainly not a greenhouse is not a greenhouse, what we've built in Strathroy is a top-end hybrid greenhouse that we're able to produce a product that is indifferent from something that would be produced under the most climate controlled indoor conditions, for instance. So that's why we were enabled to increase our pricing and we chose to align it with the rollout of the Color brand.

And we certainly feel that, given the feedback that we've received through the provincial partners that that we found the right price, we certainly could have gone higher to be honest with you, but we have to make decisions from a marketing standpoint as well. And our feeling was that we did not want to be in the ultra premium category for instance, we want to move product and we feel that the pricing that we've achieved from on a retail level is the right is the sweet spot for our product right now.

We will be bringing to market other products that will increase in price from what we're seeing today. So some more premium products, and also some products that will be discounted from what we're seeing today in the market.

So for instance, we’ll be rolling out later this quarter our ready to roll format, which is a pre-milled product that will come in a pouch and will be at a lower price point. And that's, I think that the provinces as the purchasers here in the adult-use side want to see that gap filled because I think there's a lot of folks in the LP space who all want to chase after the premium piece.

I think that there's some great sweet spots for us to fill in other -- in other spots in the pricing spectrum, and also maintain great, great margins for the company while pushing through a lot of volume.

And Graeme, I would just like to add with the addition of those new SKUs in the lower price points, we are making sure that our margins will stay strong, and that they will have reduced packaging costs, less labor to be able to bring some market. So we're making sure that even though it might be at that lower price points that we maintain improved margins.

Okay, great, very helpful. Thank you for that.

And just as a follow-up here, I was just wondering, can you disclose at all, what the CapEx budget is going to look like over the next six or 12 months, given the various initiatives across the various cultivation methods in addition to the extraction initiatives as well?

Sure Graeme. So our key initiatives for the rest of 2019 are, as Keith mentioned, the CX Industries, and we have to complete the build of the processing facility for the outdoor cultivation.

And then there will be some continued work on the greenhouse that has happened over the quarter end in Q3 already. So our overall estimated expected capital expenditure budget for the rest of this year is $8.8 million.

Okay, thank you very much.

Thanks. Thanks for taking my question.

Keith, just want to follow-up on I think last quarter, I think you're always and maybe this has been consistent last few quarters, your projected output in 2020, I think was 150,000 kilograms with the delay in the licensing, where do you see that number trending to or is it something that you catch-up later in 2020?

Yes, hey Steve, a good question. So it's the key moving parts here.

There's two pieces that got us to that number for our 2020 projections. One was the traditional greenhouse piece for the seven acres that is yet to be completed in Strathroy and then the expansion of the outdoors, the Phase 2 of the outdoor which took us from 27 acres here in 2019 of production to 100 acres in 2020.

And so we're very confident in the expansion of the outdoor, we've already got plans in place to build out security and fencing in all those pieces that we need to put in place for 2020 which actually is the bulk of the increase in yields. And then the seven acres with some of the delays, we've experienced, I say delays, it's actually a combination of delay and deferral.

Given that we had to focus our resources on the outdoor and on CX and on the outdoor processing facility that Nichola mentioned, which wasn't in the original sort of 2019 plan, but it had to be built out as we pivoted towards the opportunity in the outdoors. So that's going to be the critical piece is that seven acres, and that was anticipated to have about 30 tons of all of that output per annum.

So I'm not sure we're going to change that guidance at this point, some of it will be contingent on our experiences in the outdoor this year and how we feel about next. And I don't think it would be significantly different given that that seven acres is forecast to come online in Q1.

So I think that's sort of the best I can do right now. And I hope that that, that helps.

Sure. That's a good answer.

And if you could just with the public issues with one of the competitors who I won't name but certainly has there been any, I think change in dealings with the regulator from your -- maybe not just WeedMD, but just from what you're hearing in terms of their diligence or things, is it more difficult to get approvals or is time horizon longer, I guess in general, or is it something you can comment on or not?

Yes, I can give you some general comments. I think that we took a group.

I mean, the reality is anyone who's really trying to build something in this industry right now, including the regulators are all stretched, we're all running at full steam and have them bandwidths that are very stretched. And so with Health Canada, they're no different.

And they came into, the spring with a mandate of licensing, many new folks were looking for licenses and obviously preparing for cannabis 2.0, which has a whole bunch of regulatory bits and pieces behind it as well. And then, of course, they were struck with some of the issues that we've seen that you mentioned and so they took what was already limited bandwidth, and they stretched it even further having to deal with issues like that.

So it's not that I can say that we've experienced greater due diligence per se but we definitely have experienced longer response times and I understand it from the standpoint of understanding all those things that I mentioned previously with respect to just simply bandwidth. So it's just another challenge for them to deal with and does it impact the industry from a timing perspective, when we’re looking for licenses and answers to questions and so on, so forth, absolutely, it does.

Okay, thanks for taking my questions.

You bet.

Great, thank you, Ariel. And I want to thank everyone who joined us today for the call.

I hope that -- hope that you got your questions answered and we look forward as WeedMD to continuing to deliver the results that our shareholders and our stakeholders have come to expect. So again, thanks everyone.

Have a wonderful day. Cheers.