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Canopy Growth Corp. is still three to five years away from profitability, the company acknowledged on Thursday, after releasing quarterly financial results showing a decline in revenue, stubbornly low gross margins and a massive net loss due to a one-time accounting change.

The results fell far short of analyst expectations, sending Canopy’s stock price down 14.5 per cent on Thursday and spurring a broader sell-off in cannabis stocks that brought the Solactive North American Marijuana Index to its lowest level so far this year.

Canopy’s inability to increase revenue despite being the leader in a growth-stage industry points to operational problems and difficult choices the company faces about what products to focus on. Canopy subtracted $6.4-million from its revenue, for instance, because it expects cannabis oil and softgel products to be returned unsold.

The lackluster results, the first since Canopy fired its chief executive Bruce Linton, also highlight structural problems across the industry, including the shortage of retail stores in key provincial markets such as Ontario and Quebec. And they point to the haphazard manner in which Canopy, like many other marijuana companies, transitioned from the medical market into the recreational market over the past 10 months.

Canopy reported Wednesday night that quarterly revenue fell to $90.5-million, down 4 per cent from the previous quarter. It also reported a net loss of $1.28-billion, most of which was attributed to a one-time charge related to revaluing warrants held by Constellation Brands Inc., which holds a significant stake in the company.

The results received negative coverage from most analysts that follow the company, several of whom suggested Canopy has a long road to profitability. Bank of Montreal analyst Tamy Chen wrote in a note to clients that “margins and cash flows could further deteriorate.”

“While Canopy is already making upfront capital investments for value-add products, the cost to manufacture these formats are substantially higher than current products, which would result in significant working capital investment and [operational expenditures],” Ms. Chen wrote.

Ryan Tomkins, an analyst with Jefferies International Ltd., was even more blunt in a note: “While strong harvest figures should allay crop failure worries, elsewhere we see little to reassure investors that significant [sustainable] sales growth and profitability will be visible in the near future.”

On an analyst call on Thursday, Canopy’s top brass offered candid insight into Canopy’s race to establish a dominant position in the Canadian recreational market, and the ways in which that speed has come back to haunt them, in the form of greenhouse retrofits and an industry-low gross margin of 15 per cent.

In the fall of 2017, Canopy partnered with a vegetable company in British Columbia to turn 3 million square feet of greenhouse infrastructure in B.C.’s Lower Mainland to cannabis production. The BC Tweed greenhouses, which Canopy acquired outright the following summer, would power the company’s push into the recreational market, once the doors to legal adult use opened in October, 2018.

“There were basic things we needed to improve that we knew were the case in the greenhouses, but we didn’t want to miss that opportunity for additional inventory creation and sales in the first quarter of legalization to get that strong market share,” Rade Kovacevic, Canopy’s president, said on the analyst call.

Canopy did enter the recreational market with a huge amount of product, selling far more than its closest competitors in the first full quarter of recreational sales. Over the subsequent two quarters, however, it had to take large portions of its facilities in B.C. off-line to properly convert them from vegetable greenhouses to facilities more suitable for growing cannabis. Canopy made a similar choice with its facility in Mirabel, Quebec. These greenhouses only came back into full production in recent months.

Canopy says its slim gross margins came from having to run the facilities while they were not producing product.

It was not just ill-equipped greenhouses that led to operational inefficiencies. Across its production chain, Canopy spent the past year rigging up temporary solutions in order to get products to market, increasing costs.

"In Smiths Falls, in order to get prerolled joints to market, we shut down growing rooms, and we changed those rooms into a facility that could, on a semi-manual, semi-automated basis, create prerolled joints,” said Canopy’s CEO Mark Zekulin, who is now the company’s sole chief executive since Mr. Linton’s firing.

“These are the natural things we did in an early market to make sure that we got product online and served our customer need, but that led to inefficiencies, and that will slowly get fixed as the rest of Smiths Falls comes properly online," Mr. Zekulin said.

Canopy is far from the only cannabis company that has resorted to makeshift solutions to establish a foothold in the recreational market, fill contractual obligations to provincial wholesalers and try to meet sky-high expectations from investors. Stories abound of producers asking employees to stay late to manually add excise stamps to packages; many firms still lack automated packaging lines, while others are converting licensed growing space to manufacturing space to conduct basic logistical operations.

Canopy’s stumbles in the past two quarters, however, have been amplified by the high expectations it set early on.

“Obviously our competitors have now begun to ramp up their own supply, which means they’re able to increase revenue from a lower base … and [take] some market share back,” Mr. Zekulin said.

But Mr. Zekulin said his company is poised for growth. Canopy harvested 40,960 kilograms last quarter in its newly retrofitted greenhouses, which is by far the largest harvest in the industry. It is also investing heavily in value-added products like beverages and vaporizers, which will become legal in the coming months.

“We are well aware that our business will, in the future, be increasingly judged by financial metrics including achieving positive earnings,” he said.

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