FINAL REPORT

CONFIDENTIAL
Market Opportunity for AAA Heidelberg in
Medical Marihuana

Presented to:
Yari Nieken
Director
Chlormet Technologies Inc.

March 28, 2014

10 Montizambert Wynd
West Vancouver, British Columbia
V7W 1R8
Contents

Introduction ................................................................................................................................................. 2
Background .................................................................................................................................................. 2
The Medical Marihuana Market................................................................................................................. 3
Strategic Considerations for AAA Heidelberg ......................................................................................... 6
Financial Prospects for AAA Heidelberg .................................................................................................. 8

Base Case Scenario ................................................................................................................................ 9

Bull Case Scenario .................................................................................................................................. 9
Bear Case Scenario ............................................................................................................................... 10

Risks to Our Forecast ............................................................................................................................... 13

Upside Risk ............................................................................................................................................ 13

Downside Risk ....................................................................................................................................... 14

Recent Developments .............................................................................................................................. 14

Appendix 1: Selected Provisions of the Marihuana for Medical Purposes Regulations and
Guidance Documents ............................................................................................................................... 16
Sources ....................................................................................................................................................... 19

1
Introduction
Chlormet Technologies Inc. commissioned Grant Insights to conduct an independent assessment of the
market opportunity for AAA Heidelberg in the Canadian medical marihuana market. AAA Heidelberg is
a private company that has applied for a production license under Health Canada’s new Marihuana for
Medical Purposes Regulations (MMPR).

We base our assessment on a number of sources and analytical techniques. We conducted interviews
with knowledgeable experts (including Health Canada officials). We undertook a thorough review of the
relevant literature and data. Although we were provided with some information on AAA Heidelberg’s
production plans, we did not have access to AAA Heidelberg’s financial statements. As such, our report
focuses on the business case based on our understanding of the evolving medical marihuana market and
AAA Heidelberg’s production plans.

We have developed macro and microeconomic models to forecast medical marihuana demand, prices,
AAA Heidelberg’s potential market share and its likely profit from operations. Our assessment assumes
that AAA Heidelberg is successful in its application to become a licensed producer under the MMPR
regime.

The report starts with an assessment of new market realities under the MMPR regime. These new
regulations set a market structure within which successful applicants will compete for market share.
That market structure sets the context for price setting in the market and the way we expect companies
to compete for market share. We work through the strategic implications for AAA Heidelberg. We
then generate financial scenarios based on market dynamics and the strategic choices made by AAA
Heidelberg. This allows us to forecast enterprise value for AAA Heidelberg’s medical marijuana
operations. We conclude our report with a risk assessment.

Background
Health Canada has struggled to define a suitable regulatory framework for the medical marihuana
marketplace. Medical marihuana has become increasingly popular as a way to alleviate pain associated
with painful chronic conditions such as multiple sclerosis, Crohn's disease, glaucoma, nerve damage and
nausea. Medical marihuana is also prescribed for palliative care. A 1997 review of 6,059 marijuana-
related articles in the medical literature revealed 194 titles on antiemetic (anti-nausea) properties, 56 on
glaucoma, 10 on multiple sclerosis, 23 on appetite, and 11 on palliative or terminal care.

Initially, Health Canada regulated the medical marihuana market place through a diffuse and complex
system of Authorizations to Possess, Personal-Use Production Licenses and Designated-Person
Production Licenses. This resulted in a market structure where over 10 thousand operations were
licensed to produce and distribute medical marihuana. The vast majority of these operations were
extremely small and informal and there were only 5 authorized large scale producers. This regulatory
approach made it extremely difficult to control the production and distribution of marihuana,
particularly into the recreational use market, which is still illegal in Canada.

Responding to criticisms by municipalities, police forces and fire services, the federal Conservative
government introduced changes to the medical marihuana regulatory regime in June 2013 (published in
the Canada Gazette, Part II, on June 19, 2013.). As of March 31, 2014, Health Canada’s Marihuana Medical
Access Program will be discontinued. As of this date all Authorizations to Possess, Personal-Use
Production Licences and Designated-Person Production Licences will expire. As of April 1, 2014, the only

2
legal access to marihuana for medical purposes will be through licensed producers under the Marihuana
for Medical Purposes Regulations (MMPR).1

Producers will be required to be licensed by Health Canada and to conform to MMPR’s. In our
discussions and correspondence with Health Canada, we confirmed that licenses will be issued for a
period of three years and are renewable every year. The new regulations suggest that the medical
marihuana industry will be put on the same footing as the pharmaceutical manufacturing sector. The
regulations are quite onerous in terms of production distribution and security standards. Health Canada
will only issue licenses to producer/distributors that they deem capable of meeting these detailed
regulatory standards.

That suggests that Canada will very rapidly evolve from a market of thousands of informal producers to
one of a much smaller number of sophisticated producers. At this writing, it is not possible to say how
many licenses will be issued. The regulations clearly state that there is no quantitative restriction on the
number of licensees. There have been over 400 applicants for product licenses under the new regime.

However, our discussions with Health Canada (and media reports) suggest that most of these
applications have little chance of success. Many are from personal-use and designated-use producers
under the old regime who wish to continue to operate under the new regime. But the new regulations
dictate a much higher level of capitalization per producer than existed under the old regime. Producers
are required to produce crops indoors to a high level of production standard. Their plants must be fully
secured and well ventilated. They are also required to keep meticulous records on their crop, its
conversion into dried marihuana (and the destruction of by-product) ― only dried cannabis may be
offered for sale. Moreover, producers must distribute their product through bonded couriers directly to
the customer, in child-proof bottles. Appendix 1 outlines the main regulatory provisions relating to
facility and production standards.

The new regime requires a degree of supply chain and logistical sophistication well beyond the means of
those who have, up to this point, grown for their personal use. It is important to note that these
standards are much higher than they are in, for instance, organic agriculture. The regime is much
closer to the pharmaceutical regulatory regime. Therefore the industry is more likely to look like
pharmaceuticals in its market structure and companies’ strategic positioning.

The Medical Marihuana Market

Two market considerations are important to AAA Heidelberg’s prospects as a licensed producer:

1) Organization of firms (the supply side);

2) Market demand.

The Supply Side

It is important to understand that Canada’s medical marihuana market will be organized as a national
market of Canadian operating companies. Although these companies may be capitalized by foreign
sources (and partner with foreign companies) licensed producers will be registered Canadian companies
operating primarily within Canada’s borders. Unlike in other industries (like supply-managed
agricultural commodities) there will be few, if any, inter-provincial barriers to trade but there is also

1
Recently a federal injunction delaying the discontinuance of the licenses was awarded to a group of medical marihuana users. We discuss the
impact of this injunction at the end of the report under Recent Developments.

3
unlikely to be a significant export business from Canada, at least in the short to medium term.2 (Health
Canada has a process for granting export licenses but other jurisdictions are likely to maintain trade
barriers for safety and security reasons).

Over the next 3 years, the Canadian industry is likely to be organized into fewer than 50 licensed
producers. These will be grouped into small, medium and large size producers, whose plant capacity
varies considerably. At the large end, licensee Tweed Inc. has converted a 145,000 square foot
abandoned Smith Falls, Ontario chocolate factory into a medical marihuana plant that it says will
eventually produce 150,000 kilograms per annum and generate sales of $100 million per year. Medium-
sized producers include current licensee MedReleaf that operates a 55,000 square foot facility in
Markham, Ontario. Meanwhile, likely successful applicant, MediJean, has built a 35,000 square foot
facility in Richmond, British Columbia. Applicant Privateer Holdings Inc., a Seattle-based private equity
company, has invested in a $3 million, 35,000 square foot facility in Nanaimo, British Columbia.

Based on our assessment of the market, licensed producers are likely to fall into those with over 100,000
square feet of space (large), between 35,000 and 99,999 square feet of space (medium) and those under
35,000 square feet of space (small). There will be room for firms of different sizes as long as they have
the capacity to conform to Health Canada’s building and operational guidelines. There would appear to
be relatively few economies of scale in the sense of production costs falling significantly as volumes
increase. However, larger producers may have some advantages in marketing and research and
development. In this sense, size will be important to company strategy (see below).

Table 1
Current Licensed Producers, March 2014

Bedrocan Canada Inc.

Canna Farms Ltd.
CanniMed Ltd.
Mettrum Ltd.
MedReleaf Corp.
The Peace Naturals Project Inc.
ThunderBird Biomedical Inc.
Tweed Inc.
Whistler Medical Marijuana Corp.

Source: Health Canada

The Demand Side

Estimating the demand for medical marihuana is not straightforward because there is a sizable black
market that operates alongside the official government market. Official government estimates say that
there are just over 40 thousand Canadians registered to use medical marihuana. But other studies
suggest that the actual number of Canadians using marihuana for therapeutic purposes may be
considerably larger than official statistics suggest. According to the World Drug Report 2011 (see
Sources), 3 million Canadians (12.6 per cent those between the ages of 15-64) are cannabis users. This

2
Bedrocan Canada's is a successful licensee who is joint venturing with Bedrocan BV of the Netherlands. It will initially import product from the
Netherlands but has plans to establish Canadian production.

4
compares to 13.7 per cent in the United States. To be sure, the lion’s share of this usage is recreational,
but there is also large therapeutic black market.

It is, therefore, an open question as to how large the true medical marihuana marketplace is in Canada.
Although licensed producers will only be allowed to distribute to registered users, the number of
registered users is likely to expand considerably over time.

There are several reasons for this. First, the new regulations will legitimize the medical marihuana
industry and improve its reputation for quality, reliability and safety. Second, Canada’s baby boom
population is entering its senior years when rates of chronic disease and painful conditions typically
increase. For instance, over 50 per cent of the cancer diagnoses are for people over the age of 55.
Glaucoma incidence rates increase significantly from about 2 per cent for those aged 50 to around 10
per cent for those aged 80 and over. Finally, the baby boom cohort is much more likely to have tried
marihuana in the past. The incidence of marihuana consumption peaked in the 1970’s during the baby
boomers formative years. As such, the market resistance to trying marihuana therapies will wane as
baby boomers age.

Health Canada has indicated that it expects the number of users to increase to 308,755 by 2024. We
think this is a conservative forecast given the chronic disease incidence rates, the aging of the baby
boom cohort and the likely growing acceptance of marihuana therapies to treat diseases of aging. We
incorporated these factors in a demand model that runs to 2024. In our model, we expect registered
users to increase to 472,365 by 2024 (Table 2). Both we and Health Canada assume that the average
registered user goes through 30 grams per month. We also think Health Canada’s nominal dollar
forecast for prices is reasonable. We differ only in our view of the number of users, which means that
we forecast industry revenues of $1.95 billion compared to Health Canada’s estimate of $1.27 billion.

In the very short term, there is likely to be some volatility in the market. Health Canada is concerned
that the licensees under the new regime may lack the capacity to replace the roughly 120 thousand
kilograms of dried cannabis that was produced by individual licensees. That volatility will be reflected in
prices, which are likely to spike in the short term until the market supply settles.

Table 2
Forecast for Market Size: Users and Volumes, 2014-24

Year Users Volume (grams)

2014 41,384 14,898,240
2015 52,538 18,913,546
2016 66,697 24,011,040
2017 84,673 30,482,388
2018 107,494 38,697,863
2019 136,465 49,127,537
2020 173,245 62,368,169
2021 219,937 79,177,357
2022 279,214 100,516,881
2023 354,466 127,607,738
2024 450,000 162,000,000

User Growth rate 27.0%

Grams per User 360

Sources: Grant Insights, Health Canada

5
Strategic Considerations for AAA Heidelberg
Whether one believes Health Canada’s conservative (in our view) forecast or our somewhat more
optimistic forecast, it is clear that Canada’s medical marihuana market is set for a considerable
expansion. The key question is how firms will compete in this emerging market and therefore how
successful they are in securing market share.

Clearly, the first order of business is to secure a production license and to be in good standing with
Health Canada. In most regulated market places, incumbent license holders have a considerable market
advantages over aspiring license holders. This creates an opportunity to earn what economists refer to
as “rents”, above normal profits related to the exclusivity of market participation. Regulators may not set
out to create these rents, but they do so in the process of restricting entry into the marketplace.
Regulators prefer a relatively small number of reliable suppliers over a chaotic market with high
volumes of entry and exits.

All this suggests that there are so-called first mover advantages for firms that are successful in the first
round of license issuance. The market is likely to go through a 2-3 year period of maturation under the
new regime. This period is likely to separate the serious players from the hundreds of pretenders.
Once Health Canada is satisfied that the license producers can adequately satisfy market demand with
reasonable prices, it is likely to take a more cautious approach to new license issuance.

Once a license has been secured, AAA Heidelberg needs to establish its bona fides as a reliable market
supplier. This is both from the point of view of its customer base and conformance to the MMPR
regime. In the early stages, the focus will be on customer acquisition and satisfied customers. AAA
Heidelberg will also need to establish an efficient and effective production and distribution model. For
regulators, the important thing will be to comply with all regulations, maintain a good security record as
well as meticulous records of all aspects of the business.

In the longer term, AAA Heidelberg will need to differentiate itself from other market participants. This
differentiation will be important for two reasons. First, it will want to capture and retain market share
based on a unique value proposition. Second, a unique value proposition will allow AAA Heidelberg to
increase its average price per gram. Companies are likely to position themselves along a continuum
between those that emphasize low cost production and low prices and those that emphasize unique
products, high value, great service etc. As in the beer market, producers will segment between those
offering low cost products and those who appeal to customers that are willing to pay more for other
product and service attributes.
Exhibit 1
Competitive Positioning of Companies

Companies compete
on quality. Lower
volumes and higher
prices.

Companies compete
on price. Higher
volumes, lean supply
chain.

6
Even in this early stage, licensed medical marihuana producers are likely to introduce as many as 30
different strains into the marketplace. These strains differ in their chemical composition. The two key
chemical components in medical marihuana are tetrahydrocannabinol (THC) and cannabidiol (CBD).
These components have different therapeutic properties and side effects that make them more or less
desirable depending on the conditions being treated. Notably CBD is a non-psychotropic
phytocannabinoid, meaning that users are able to benefit from its therapeutic properties while avoiding
the “high” associated with THC. (Think of cough medication being offered with varying levels of
codeine.)

Based on interviews, we understand that AAA Heidelberg plans to operate an 8,000 square foot facility,
which puts it in the small end of the industry. Smaller firms are more likely to position themselves as
quality producers, focusing research and development to create unique strains of cannabis.

If AAA Heidelberg chooses this strategic positioning, it would be well advised to think through how it
intends to use product and process innovation to distinguish itself in the marketplace. That involves
research and development to create unique patentable strains targeted at specific market segments.
(We interviewed a patent lawyer who told us that patents may be granted if strains are created through
unique bioengineering processes). AAA Heidelberg will also want to participate in clinical trials to
demonstrate the efficacy of its unique strains over those of competitors. AAA Heidelberg will also need
to conduct outreach to physicians to highlight the medical properties of their unique formulations. This
is how pharmaceutical companies compete. Their patent portfolio is the source of their competitive
advantage and allows them to refrain from price competition that destroys margins and shareholder
value.

As we discuss below in the Risk section of our report, at one level marihuana is simply a commodity
that can be produced as easily and cheaply as home brewed beer. That suggests that pricing may
actually be quite volatile and that price competition may be fierce. It behooves AAA Heidelberg to
position itself to avoid price competition and commoditization of its products. To be sure, barriers to
entry will help as it will be difficult for new entrants to add to supply. Similarly, the ongoing criminality
of marijuana possession will help legitimate producers avoid price competition.

7
 Table 3
Model Assumptions (Base Case)

Startup investments Market Structure - Pricing

Initial capital outlay $2 million Firm share of retail price 75%
8,000 square foot facility

Production Assumptions (base case) Selling, Administration and Administration Costs

Crops per annum (e.g. Sativa strain) 4 Marketing expenditure as % of Sales 15%
Maximum square feet planted 6000 R&D expenditure as % of Sales 15%
Light Intensity (Watts/Sqft) 40
Yield - grams per watt applied 1 Tax rate 25%
Yield - grams per year 960,000
Yield - lbs per year 2,116 Corporate Overheads
Utilization : 50% yr 1, 100% thereafter Administration 1
Security 1
Operations Marketing 1
Harvesting Research and Development 1
Lbs - Harvest / Person / Year 500
Hrs worked / Year 2000 Average Salary per annum $60,000
Wage per hour 30
Persons needed 4.23 Valuation Variables
Harvesting cost per pound $ 120.00
Harvesting cost per gram $ 0.26 Discount Rate 10%
(opportunity cost of capital)
Electricity
Watts per sqft / harvest 40 Free-Cash-Flow multiple at end 5.0 x
Hours per harvest 1,440
Price per kwH $ 0.097
KwH per harvest 345,600
KwH per year 1,382,400

Other consumables ($/lb) $ 200.00

Source: RAND Corporation, Gettman, Grant Insights

Financial Prospects for AAA Heidelberg

We generate financial scenarios for AAA Heidelberg based on our understanding of its production plans
and secondary source information on marihuana production costs. Specifically we relied on papers that
detail production costs in the United States by Gettman and the RAND Corporation (see Sources). We
developed a model of AAA Heidelberg’s financials under the assumption that its medical marihuana
operations are a new line business requiring capitalization from scratch. Our base case model
assumptions are summarized in Table 3.

Based on our secondary sources, we believe an operation of this size can be run with very few people.
An efficient 8,000 square foot plant growing on 6,000 square feet of space and applying 40 watts of
light per square foot should be able to produce 2,116 pounds or 960,000 grams of dried cannabis at full

8
capacity. Lighting, as opposed to plant density, is the limiting factor once there are sufficient plants
covering the growing area. At that point, additional plant density contributes very little to total yield.

On the planting/harvesting side, we project 4.2 full time equivalent (FTE) workers being paid $30 per
hour. We assume that fixed overheads include an additional 4 full time staff for administration,
marketing, security and research and development (R&D), at average wage rates of $60 thousand per
annum. We also assume that AAA Heidelberg’s medical marihuana will initially settle on the high side.

The cost structure we have adopted for AAA Heidelberg assumes a certain degree of operational
expertise and technical efficiency. Although there will certainly be some variance depending on
management execution, the economics of the current state of the industry indicates that market factors
(price and market share) are likely to be far more significant to the financial prospects for AAA
Heidelberg than managerial competency.

The inherent uncertainty of the regulatory climate creates market risks that are difficult to diversify. It
is not known how many licenses Health Canada will eventually issue, whether licenses will be renewed,
and, if so, for how long. Health Canada was disinclined to divulge this information to us. It is unclear if
additional conditions will be imposed on producers as the market and technology evolves. Provincial
regulations remain a wild card and may also alter the economics of the business.

To account for this uncertainty, we build three different market scenarios (base, bull and bear) for AAA
Heidelberg. These scenarios show how different market structures will affect the prospects for AAA
Heidelberg.

Base Case Scenario

In the base case, we assume that Health Canada issues licenses at the same pace as registered market
growth. This implies that each new license holder gets a fixed volume of the market, but does not
expand significantly beyond that initial volume, as new suppliers and capacity is added to the market at
the same rate as market growth.

We assume that the market price is fairly steady in this scenario in line with Health Canada’s 10 year
price forecast of $7.60/gm in 2014 rising to $8.80/gm in 2024. This works out to an annual 1.5 per cent
increase in nominal prices (equivalent to an annual 1.2 percent decrease in real prices once consumer
price index inflation (CPI) of 2.7 per cent is taken into account).

Bull Case Scenario

In the bull case, we assume that after AAA Heidelberg receives its license, Health Canada slows down
the rate of license issuance significantly. This would give existing license holders a significant first-
mover advantage.

In this scenario, successful license applicants will carve out a fixed portion of the market for themselves,
and be able to maintain this market share as the market grows. Under this scenario, AAA Heidelberg
would be able to re-invest significantly into the business and grow sales volumes at the same rate as
market growth. Here, we assume that there is still enough competition amongst producers, such that
the market price would grow at the same rate as the CPI of 2.7 per cent.

9
Bear Case Scenario

In the bear case, we assume that Health Canada seeks to maintain a highly competitive market through
an aggressive license issuing program. If this happens, we can expect competition to drive market prices
down towards the marginal cost of production. In this scenario, we assume that AAA Heidelberg
manages to operate at full capacity for 2 years, but loses business at a rate of 10 per cent per year
thereafter. Table 4 shows what this policy would inevitably commoditize the business.

Table 4
Market Price Scenarios

Year Bear Base Bull

2014 $7.60 $7.60 $7.60
2015 $6.93 $7.71 $7.81
2016 $6.31 $7.83 $8.02
2017 $5.75 $7.94 $8.23
2018 $5.24 $8.06 $8.45
2019 $4.77 $8.18 $8.68
2020 $4.35 $8.30 $8.92
2021 $3.96 $8.42 $9.16
2022 $3.61 $8.55 $9.41
2023 $3.29 $8.67 $9.66
2024 $3.00 $8.80 $9.92

Growth Rates -8.9% 1.5% 2.7%

CPI Inflation 2.7%

Sources: Grant Insights, Health Canada

10
Table 5
Pro Forma Net Cash Flow
YEAR
Year 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

CF - Investments
Capex Premises -$1,000,000
Lab and Production Equipment -$300,000
Security Cameras -$300,000
Computers -$6,000
Tracking Software -$6,000
E-Marketing platform -$200,000
Others -$188,000 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Total Investment Cashflow -$2,000,000 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0

Sales
Production
in Grams 480,000 960,000 960,000 960,000 960,000 960,000 960,000 960,000 960,000 960,000 960,000
in Lbs 1,058 2,116 2,116 2,116 2,116 2,116 2,116 2,116 2,116 2,116 2,116
implied prod. growth 100% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Price / gm - retail $7.60 $7.71 $7.83 $7.94 $8.06 $8.18 $8.30 $8.42 $8.55 $8.67 $8.80
Price / lb - retail $3,447 $3,498 $3,550 $3,602 $3,655 $3,709 $3,764 $3,820 $3,876 $3,934 $3,992
Price / gm - Wholsale $5.70 $5.78 $5.87 $5.96 $6.04 $6.13 $6.22 $6.32 $6.41 $6.50 $6.60
Price / lb - wholesale $2,585.47 $2,623.66 $2,662.40 $2,701.72 $2,741.62 $2,782.11 $2,823.20 $2,864.89 $2,907.20 $2,950.14 $2,993.71

Total Sales $2,736,000 $5,552,812 $5,634,818 $5,718,035 $5,802,481 $5,888,174 $5,975,132 $6,063,375 $6,152,921 $6,243,790 $6,336,000

COGS
Harvest Personnel $126,986 $253,973 $253,973 $253,973 $253,973 $253,973 $253,973 $253,973 $253,973 $253,973 $253,973
Electricity - Lighting $67,046 $134,093 $134,093 $134,093 $134,093 $134,093 $134,093 $134,093 $134,093 $134,093 $134,093
Other consumables $211,644 $423,288 $423,288 $423,288 $423,288 $423,288 $423,288 $423,288 $423,288 $423,288 $423,288

Total COGS $405,677 $811,353 $811,353 $811,353 $811,353 $811,353 $811,353 $811,353 $811,353 $811,353 $811,353

Gross Profit $2,330,323 $4,741,459 $4,823,465 $4,906,682 $4,991,127 $5,076,820 $5,163,779 $5,252,022 $5,341,568 $5,432,436 $5,524,647

Selling, General, Admin

Personnel 4 4 4 4 4 4 4 4 4 4 4
Salaries $240,000 $240,000 $240,000 $240,000 $240,000 $240,000 $240,000 $240,000 $240,000 $240,000 $240,000
Others (marketing) $410,400 $832,922 $845,223 $857,705 $870,372 $883,226 $896,270 $909,506 $922,938 $936,568 $950,400
R&D $410,400 $832,922 $845,223 $857,705 $870,372 $883,226 $896,270 $909,506 $922,938 $936,568 $950,400

Total SGA $1,060,800 $1,905,844 $1,930,445 $1,955,411 $1,980,744 $2,006,452 $2,032,540 $2,059,013 $2,085,876 $2,113,137 $2,140,800
Total Expenses $1,466,477 $2,717,197 $2,741,799 $2,766,764 $2,792,098 $2,817,806 $2,843,893 $2,870,366 $2,897,230 $2,924,490 $2,952,153

Operating Profit $1,269,523 $2,835,615 $2,893,019 $2,951,271 $3,010,383 $3,070,368 $3,131,239 $3,193,009 $3,255,691 $3,319,299 $3,383,847
Net Taxes paid -$317,381 -$708,904 -$723,255 -$737,818 -$752,596 -$767,592 -$782,810 -$798,252 -$813,923 -$829,825 -$845,962

Net cashflowfrom operations $952,142 $2,126,711 $2,169,764 $2,213,453 $2,257,787 $2,302,776 $2,348,429 $2,394,757 $2,441,769 $2,489,474 $2,537,885

Total Net Cashflow -$1,047,858 $2,126,711 $2,169,764 $2,213,453 $2,257,787 $2,302,776 $2,348,429 $2,394,757 $2,441,769 $2,489,474 $2,537,885

11
Chart 1
Price Forecast, Market Share and Cashflow Under Different Scenarios

Base Case
Price per gram forecast Market Share Projected Cashflow
6.0% Net
$10.00 CashFlow
$3.0 $3.0
$9.00

Millions

Millions
5.0% $2.5 $2.5
$8.00 $2.0
$2.0
$7.00 4.0% $1.5
$1.0 $1.5
$6.00
$0.5 $1.0
$5.00 3.0%
$0.0 $0.5
$4.00
Price / gm ‐ Wholesale ‐$0.5 Operating Cashflow $0.0
$3.00 2.0%
‐$1.0
$2.00 Investment Cashflow ‐$0.5
Price / gm ‐ Retail ‐$1.5
$1.00 1.0% ‐$2.0 Net Cash Flow ‐$1.0

$0.00 ‐$2.5 ‐$1.5

2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
0.0%
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Bull Case
Price per gram forecast Market Share Projected Cashflow
6.0% Net
$12.00 CashFlow
$30.0 Operating Cashflow $25.0
5.0%

Millions

Millions
$10.00 Investment Cashflow
$25.0
$20.0
4.0% Net Cash Flow
$8.00 $20.0
$15.0
$15.0
$6.00 3.0%
$10.0 $10.0
$4.00 Price / gm ‐ Wholesale 2.0% $5.0
$5.0
$0.0
$2.00 Price / gm ‐ Retail $0.0
1.0% ‐$5.0
$0.00 ‐$10.0 ‐$5.0
0.0%
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Bear Case

Price per gram forecast Market Share Projected Cashflow

6.0% Net
$8.00 CashFlow
$2.5 $2.0
5.0%
Millions

Millions

$7.00
$2.0
$1.5
$6.00 $1.5
4.0% $1.0
$1.0
$5.00
$0.5 $0.5
$4.00 3.0%
$0.0
‐$0.5 $0.0
$3.00
2.0% ‐$1.0
Price / gm ‐ Wholesale Operating Cashflow ‐$0.5
$2.00
‐$1.5 Investment Cashflow
$1.00 1.0% ‐$1.0
Price / gm ‐ Retail ‐$2.0
Net Cash Flow
$0.00 ‐$2.5 ‐$1.5
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024

0.0%
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Source: Grant Insights Model

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These market scenarios have predictable implications for AAA Heidelberg’s performance and enterprise
value. Essentially, the enterprise value is geared to the market structure. Assuming a cost of
capital/discount rate of 10 per cent, enterprise value over a 10 year time horizon could be as low as $3.7
million in the worst case scenario or as high as almost $80 million in the best case scenario.

Table 6
Enterprise Value Matrix
Scenarios
Cost of Capital (discount rate) Bear Base Bull
6% $4,441,787 $22,112,139 $111,497,415
8% $4,073,433 $19,195,022 $93,904,614
10% $3,744,801 $16,748,247 $79,435,256
12% $3,450,527 $14,685,506 $67,483,607
14% $3,186,104 $12,937,880 $57,570,283

Source: Grant Insights

We believe the most likely outcome is an enterprise value of $16.7 million. Even though Health Canada
is tight lipped about their license issuance plans, they reveal much about their approach through their
public pronouncements on market prices. Our base case scenario merely adopts Health Canada’s
current market price forecast, albeit under somewhat higher volumes. If they approach license issuance
the same way as the federal and provincial governments manage supply managed commodities, then
Health Canada will target an average market price and adjust licenses (or quota) to clear the market at
the desired price. That seems most likely to us and therefore we incorporate this assumption into the
base case.

Risks to Our Forecast

Of course any forecast, especially in a rapidly evolving and newly created market, is fraught with risk—
both on the upside and downside. We summarize the main forecast risks.

Upside Risk

The main upside risk is that marihuana policy is one of the most rapidly evolving areas of Canadian and
international public policy. The thrust of recent policy has been towards liberalizing marihuana
consumption within a formal regulatory setting. So licensees in medical marihuana are natural
beneficiaries if governments continue to move toward liberalized markets.

Governments around the world, most notably in Washington State and Colorado, are reassessing their
approach to recreational use of marijuana. Politicians regularly speak about a more liberal approach to
marihuana. The Liberal Party of Canada’s leader, Justin Trudeau, has come out openly in favour of
legalizing marijuana. More importantly, the Harper government has indicated that it may consider

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decriminalizing possession, essentially the first step toward outright legalization. Even Republicans in
the United States have shown a willingness to consider liberalization.

The recreational marijuana marketplace is probably 5-6 times as large as the therapeutic market.
Therefore any move to formalize the industry along the lines of, say, the brewing industry, would have
significant implications for the size of the market and, therefore, our estimate of the enterprise value of
market participants like AAA Heidelberg. Our analysis is based merely on the Canadian medical
marihuana marketplace, which could end up being the tip of the iceberg.

Our analysis also ignores what might happen if international trade is liberalized. In that case, we would
expect to see a globalized legalized marihuana marketplace emerge, very much as it has done for beer.

Downside Risk

Clearly the most pertinent downside risk is regulatory policy and practice specific to medical marihuana.
We believe that Health Canada is making policy on the fly and has yet to truly decide how it will
regulate the medical marihuana marketplace.

Health Canada policies on license renewals, in particular, is a wild card. Our analysis has assumed that
AAA Heidelberg will maintain its license over the forecast horizon. It is extremely difficult to say what
ongoing regulatory requirements will be introduced and how this might impose additional costs, thereby
reducing margins.

The regulatory environment is very fluid. Our analysis has shown that the marihuana marketplace is
very dependent on regulatory policy and practice. The regulatory risks are significant and need to be
managed.

Recent Developments
On March 21, 2014, Federal Judge Michael Manson granted a temporary injunction application from a
group of medical marihuana patients. The injunction delays the winding up of Personal-Use Production
Licenses and Designated-Person Production Licenses until a constitutional challenge can be heard. The
group wanted the injunction because of concerns that the new licensing regime would limit availability
of medical marihuana (especially particular strains) and lead to higher prices.

The constitutional challenge of the new regime may not be heard for 9 months to a year. We agree
with the Federal government lawyer in the injunction case that there is no constitutional guarantee of
“cheap” medicine or access to specific strains of marihuana. Our analysis has shown that marihuana will
continue to be a relatively cheap source of pain medication. The economics of large scale controlled
production are likely to trump the access arguments.

The granting of the temporary injunction is more of a reflection of Health Canada’s slow moving and
opaque process for issuing production licenses to commercial producers. This approach has
unnecessarily created anxiety in the user community about price spikes and a lack of availability. If
anything, Health Canada is likely to respond by expediting its license issuance program under the new
regime. They will want to show that their formal market approach can work for users before the
constitutional challenge is heard.

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From a practical perspective, the enforcement of Health Canada’s new regulations, farmed out to local
police, was expected to be relatively muted. Various police forces have a “priority-based” approach to
medical marijuana grow-ops, targeting cases involving gangs and violence. Implicitly this means they
would have largely left personal licensees alone. Technically, these producers would be in violation of
the new regulations, but Health Canada is completely at the mercy of local police forces to pursue these
cases and they seem disinclined to do so.

The temporary injunction serves to smooth out supply disruptions in the marketplace, as it provides for
a longer transition period for the commercial licensees to scale up and prepare product for market.
Given that no new personal growing licenses are being issued, the long-term viability of commercial
growing is not significantly affected by this development. Commercial growers continue to be best-
positioned to supply new users in the market. In the short-run, current medical users continue to have
personal alternatives for the product, but may be incentivized to switch over time as commercial
growers bring high quality product to market at lower prices.

Hence, we do not believe these recent developments materially affect our analysis.

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Appendix 1: Selected Provisions of the Marihuana for Medical
Purposes Regulations and Guidance Documents

Facilities

Marihuana must be grown indoors in a secure facility.

If the site is a stand‐alone building, or a space within a building that shares walls,
then physical barriers and signage posted at the perimeter and entrance to the
building/space can assist in ensuring that the site is secure.

The main purpose is to prevent unauthorized access and to act as a definite demarcation. Physical
barriers are required for securing all areas within a site where cannabis is present.
Physical barriers should provide sufficient resistance to impede unauthorized
access to the premises where cannabis is present.

Minimizing the number of entranceways to the site and areas within a site where
cannabis is present will assist in securing and monitoring the space; however, it
should remain consistent with fire and building safety codes. Securing all entrances
to the building, site or areas within a site where cannabis is present would prevent
unauthorized access.

The facility must be properly ventilated.

Security

Visual monitoring of the perimeter of your site, as well as areas within

the site where cannabis is present requires the installation of closed circuit video
equipment (CCVE).

Cameras need be in sufficient number and appropriately located to cover the area
to be monitored.

Need to keep all cameras recording 24/7, and have appropriate back‐up mechanisms in
place can achieve the appropriate coverage to detect illegal activity, unauthorized
access and any attempts to breach the security of your site and of the areas within
your site where cannabis is present.

Back‐up mechanisms must ensure that all visual recordings and records of a
detected occurrence be retained for two years. These back‐up mechanisms may
include storing the visual recordings on multiple media devices

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Production Controls

The microbial and chemical contaminants of dried marihuana must be within generally accepted
tolerance limits for herbal medicines for human consumption, as established in any publication referred
to in Schedule B to the Food and Drugs Act.

Analytical testing for those contaminants and for the percentages of delta‐9‐tetrahydrocannabinol and
cannabidiol referred to in these Regulations must be conducted using validated methods.

Marihuana must not be treated — before, during or after the drying process — with a pest control
product that has not been registered under the Pest Control Products Act for use on marihuana for
medical purposes.

Dried marihuana must not contain any residue of a pest control product in excess of any maximum
residue limit specified for the product under section 9 of the Pest Control Products Act.

Dried marihuana must be produced, packaged, labelled and stored in premises that are designed,
constructed and maintained in a manner that permits those activities to be conducted under sanitary
conditions, and in particular that
(a) permits the premises to be kept clean and orderly;
(b) permits the effective cleaning of all surfaces in the premises;
(c) permits the dried marihuana to be stored or processed appropriately;
(d) prevents the contamination of the dried marihuana; and
(e) prevents the addition of an extraneous substance to the dried marihuana.

Dried marihuana must be stored under conditions that will maintain its quality.

Record Keeping

A licensed producer who receives cannabis must record the following information:
(a) the name of the person from whom it was received;
(b) the address of the site at which it was received;
(c) the date on which it was received; and
(d) an indication of whether dried marihuana or cannabis other than dried marihuana was received, as
well as the following information:
(i) in the case of dried marihuana, the quantity and, if applicable, brand name, or
(ii) in the case of cannabis other than dried marihuana, the substance ordered, its quantity, description,
intended use and, if applicable, brand name.

A licensed producer who imports marihuana must retain a copy of the declaration required by section
78 and of the export permit issued by a competent authority in the country of export.

A licensed producer who exports marihuana must retain a copy of the declaration required by section 86
and of the import permit issued by a competent authority in the country of final destination.

A licensed producer who receives a verbal order must record the following information:
(a) the date on which the order was made and the order number;

17
(b) the information referred to in paragraphs 121(2)(b) and (c) of the regulations; and
(c) the name of the individual recording the order.

(1) A licensed producer who fills an order must record the following information:
(a) the given name, surname and date of birth of the client for whom the order is placed;
(b) the given name and surname of the individual placing the order;
(c) the quantity, brand name and lot number of the dried marihuana sold or provided;
(d) the date on which the order was received;
(e) the date on which the dried marihuana was shipped; and
(f) the address to which the dried marihuana was shipped.

(2) A licensed producer must retain a written order) or a written record of a verbal order.

(3) A licensed producer who refuses to fill an order must retain a copy of the written notice.

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