Categories Earnings Call Transcripts, Other Industries

Canopy Growth Corporation (CGC) Q3 2021 Earnings Call Transcript

CGC Earnings Call - Final Transcript

Canopy Growth Corporation  (NYSE: CGC) Q3 2021 earnings call dated Feb. 09, 2021

Corporate Participants:

Judy Hong — Vice President of Investor Relations

David Klein — Chief Executive Officer

Mike Lee — Executive Vice President and Chief Financial Officer


John Zamparo — CIBC — Analyst

Vivien Azer — Cowen and Company — Analyst

Bryan Spillane — Bank of America — Analyst

Tamy Chen — BMO Capital Markets — Analyst

Pablo Zuanic — Cantor Fitzgerald — Analyst

Doug Miehm — RBC Capital Markets — Analyst




Good morning, my name is Amy and I will be your conference operator today. I would like to welcome you to Canopy Growth’s Third Quarter Fiscal 2021 Financial Results Conference Call. [Operator Instructions]

I will now turn the call over to Judy Hong, Vice President, Investor Relations. Judy, please begin.

Judy Hong — Vice President of Investor Relations

Great. Thank you, Amy and good morning, everyone. Thank you all for joining us today. On our call today, we have Canopy’s CEO, David Klein; and CFO, Mike Lee. Before financial markets opened today, Canopy issued a news release announcing our financial results for the third quarter ended December 31, 2020. This news release is available on our website under the Investors tab, and will be filed on our EDGAR and SEDAR profiles.

We’ve also posted our supplemental earnings presentation on our website for you to follow along during this call. Before we begin, I would like to remind you that our discussion during this call will include forward-looking statements that are based on management’s current views and assumptions and that this discussion is qualified in its entirety by the cautionary note regarding forward-looking statements included at the end of this morning’s news release.

Please review today’s earnings release and Canopy’s reports filed with the SEC and SEDAR for various factors that could cause actual results to differ materially from projections. In addition, reconciliations between any non-GAAP measures [Technical Issues] SEC and Canadian securities regulators. Please note all financial information is provided in Canadian dollars unless otherwise noted.

Following prepared remarks by David and Mike, we will conduct a question-and-answer session. To ensure that we get as many questions as possible, we ask the analysts to limit themselves to one question.

With that, I’ll turn the call over to David. David, please go ahead.

David Klein — Chief Executive Officer

Thank you, Judy and good morning, everyone. I sincerely hope that you and your families remain safe and well and that we can begin to get control of this pandemic. As I reflect upon my first year as CEO of Canopy, I’m extremely proud of all the accomplishments we’ve made in positioning Canopy to be the leading cannabis focused CPG company in the world. I started my first earnings call outlining my early insights into our strategy and also mentioned to all of you that this was going to be a transition year.

Now, in our fourth quarter, we’re at the end of that transition year and our team has made great progress. Throughout the transition, we had to make difficult decisions to right-size our production footprint and say goodbye to teammates. This was typically a very public process. For this fiscal year, we also hired almost 500 people in strategic roles to support our growth agenda into FY22. And as we look forward to the prospects of promising cannabis reform in the US under the new administration and Congress, I’m more excited than ever about achieving Canopy’s vision of unleashing the power of cannabis to improve people’s lives.

Now for the quarter at hand. During the third quarter, we’ve continued to execute against our new strategy, strengthening our competitive position in our core markets, improving our execution and accelerating our path to profitability. There are four key themes that Mike and I will focus on this morning. First, we are building strong momentum in establishing a track record of winning in our core markets. Second, we’re seeing tangible improvements in both our commercial and supply chain execution. Third, we’re further accelerating our US growth strategy as we expect significant cannabis reform during this Congress. And finally, we are firmly on a path to profitability.

So, let’s start these themes together and delve deeper into our performance and strategy. First, we further strengthened our competitive positioning in our Canadian Recreational Business. Our overall share is up 30 basis points to 15.7% in Q3 versus Q2 and we’ve regained the number 1 market share position in the Canadian Rec market during Q3 based on our proprietary market share tracker.

This is led by our share in flower improving 180 basis points to 19.2% in Q3 driven by continued strength in our value flower brand Twd. Our beverages achieved over 34% market share in Q3. Even as new beverage brands have entered the marketplace, we’ve retained the top three brands and our beverages are commanding higher velocity versus competitive set on a per SKU basis. Quatreau CBD beverages were launched during Q3 and the brand has already become the number 1, ready-to-drink CBD beverage brand.

Second, our US CBD business is gaining momentum on the back of highly successful Martha Stewart CBD product launches. Martha Stewart branded CBD products have experienced strong consumer demand today with Martha’s media appearances generating lots of brand awareness despite the crowded space. In just four months since launch, Martha Stewart CBD products have already exceeded the annual sales of over 94% of all CBD brands sold in the US and based upon the current run rate Martha, would rank among the top 3% of all CBD brands.

Our consumer research shows that one-third of Martha Gummy purchases were first time CBD consumers indicating that we are already achieving our ambition with Martha to bring new consumers into the category. The Martha Stewart CBD collection is now sold in over 580 Vitamin Shoppe locations across the US and we’re focused on further expanding distribution into other brick and mortar locations.

We recently expanded the Martha Stewart product line to include pet CBD products, which are now available on our website as well as our e-commerce partner sites. The launch of Martha CBD pet products resulted in a record-breaking day of press coverage earning over 1 billion media impressions. And just last week, we launched SurityPro, a new line of science-backed CBD Products for dogs formulated to deliver the most CBD per body weight on the market. Both Martha Pet and SurityPro products are based on the industry-leading research conducted by Canopy Animal Health. However, SurityPro takes some more customized approach to support the individual needs and health of each pet and is targeting pet specialty stores and the veterinary channel.

SurityPro is offered in more sizes and formulations to offer precise, controlled and convenient delivery of the recommended CBD amount and contains additional ingredients to further support pet’s needs. And finally our CPG brands, BioSteel, ThisWorks and Storz & Bickel continue to build momentum. BioSteel ready-to-drink sports beverages are beginning to hit the retail shelves in the US and the team has secured agreements with several large national chain accounts.

ThisWorks had a strong quarter driven by Amazon UK and US expansion with our e-commerce business doubling in Q3. We launched ThisWorks Stress Check collection with hand care products in the US late in Q3 and we are now focused on launching a broader range of our Stress Check products in the US and the UK. Storz & Bickel growth continues to be driven by strong consumer pull in the US. We’re seeing sales to our distributors, as well as our direct-to-consumer ecommerce channel, continuing to grow.

In December Storz & Bickel celebrated the 20th anniversary of the Volcano launching an ultra-exclusive 100 unit release of the 24 karat gold signature edition Volcano and releasing a documentary in Rolling Stone magazine. Let’s now turn to improvements we’re seeing in our quality and execution.

First, I’d like to highlight progress on our flower quality improvement program. Over the past several months, we undertook our largest ever cannabis consumer study to dig into what drives satisfaction, quality and willingness to pay for flower consumers. This was done through first conducting a number of qualitative in-depth interviews with focus groups, which was followed up with a quantitative survey of 2500 consumers across Canada.

To highlight a few key learnings. When asked about their ideal experience with flower, consumers claim the THC content affects price and flower quality as the most important contributors to their satisfaction with their flower. What’s interesting however, is that when we dig deeper, there is a whole list of attributes that knowingly or unknowingly drive overall satisfaction like great aroma and taste, whether the flower is hand trimmed, effects that starts when expected or lasts as long as expected. In other words, it’s not just about THC level or price, it’s the overall consumer experience starting with a positive and easy shopping experience.

Then going into the consumption experience from opening the product, seeing fresh aromatic bud, then ensuring great taste and smells while smoking and delivering the effects that were promised. By delighting from beginning to end, our intent is that our brands deliver satisfaction every time. We’ve taken all of these insights to create a roadmap of our future product renovation and innovation pipeline. And our design to value approach ensures that were being purposeful in adding features and benefits that consumers are willing to pay up for, that will drive premiumization of our flower portfolio over time.

Elements of this work are already being incorporated in our product offering. For example, we shifted to using genetic strain names on Tweed products with four new SKUs in Quebec, where we saw initial success in December. And we will have a number of new products across our premium, mainstream and value flower segments entering the market over the coming months. At the same time, our commercial and operational execution continues to improve. Our fill rates have improved materially over the past year reaching 98% in Q3 of fiscal ’21. We’ve accomplished this through a combination of better demand forecasting and supply management. And I would like to thank our commercial and operations teams for all of their hard work over the past year.

Our commercial team has done an amazing job standing up joint integrated business planning processes with our provincial customers. Through joint demand planning routines that align forecasts, leveraging data and category management insights, our demand forecasting has proved significantly. On the supply side, our Canadian operations teams have made tremendous progress in fulfilling our customer orders in a timely manner.

One of the key enablers has been implementing a flexible workforce model that together with cross-functional training provides for more agile and efficient operations as well as reduced costs. As another testament to our progress, the new operating model helped Canopy achieve 99% fill rates with our largest customer, the Ontario Cannabis Store or OCS during December of 2020. We believe our ability to consistently deliver quality supply will be a key competitive advantage for Canopy going forward.

Next, I’d like to spend a few minutes on how we see the US landscape progressing and how we’re accelerating our US growth strategy. With the Democrats now controlling the White House in both chambers of Congress, we expect significant cannabis reform to take place during this Congress. Democratic control of the White House, Senate and House creates a unique window of opportunity for advancing cannabis reform through executive action and legislation.

Just last week, we saw the announcement from Senator Schumer, Wyden and Booker that the Senate is committed to introducing and passing powerful cannabis reform legislation. We anticipate that this legislation will include comprehensive reform to ensure restorative justice, protect public health and implement responsible taxation while ending cannabis prohibition.

We believe that this legislative package or a combination of reform measures could allow Canopy to enter the US THC market during calendar 2021. Our government relations team is working very closely with key members of Congress to pave the way for cannabis reform that addresses both the much-needed social justice reform and provides a boost to the post-pandemic economy by creating jobs and generating tax revenues.

In addition, it was announced yesterday that Canopy is a founding member of the newly formed United States Cannabis Council or UCC — USCC. This is an important milestone for the industry as the overwhelming feedback we heard in our conversations with elected officials and regulatory bodies as how disjointed and fragmented the industry currently is in its advocacy efforts. The USCC will provide one united voice creating alignment across the nation’s top cannabis operators, as well as cannabis organizations and will address important issues such as regulations, access for veterans, diversity and inclusion, decriminalization and expungement of non-violent cannabis records, sustainability and many other key topics important to Canopy and others in our industry.

As we anticipate cannabis reform to gain momentum in the coming months, we’re also accelerating our efforts to lay the foundation to win in the US THC market once it’s permissible. Canopy already has an efficient pathway to the US through our Acreage arrangement.

I’m pleased with the new leadership now in place at Acreage with CEO, Peter Caldini bringing a strong background of success in CPG and healthcare industries. Acreage’s renewed strategic focus, combined with an attractive footprint, positions the Company well to deliver strong top and bottom line performance in the coming quarters.

It’s Canopy’s intent to utilize our arrangement with Acreage to assume a controlling position immediately upon federal permissibility. In addition, pending closing of the announced plan of arrangement with Canopy Rivers, our conditional stake in TerrAscend will increase to approximately 20%, which provides additional optionality to strengthen our US businesses. We’ve also been investing in our US infrastructure to set up the US organization, including our manufacturing footprint. Let’s now turn to our medium term targets, including our expectations to achieve positive adjusted EBITDA during the second half of upcoming fiscal year ’22. Mike will walk you through the details, but I want to highlight a few points.

First, the cannabis industry is a growth industry, and I firmly believe that we will deliver superior top line growth over the next few years. Second, our cost saving program is well underway and I’m confident we can achieve savings of CAD150 million to CAD200 million over the next 12 to 18 months. Third, we’ll continue to invest in consumer insights in R&D, which we believe will be key to creating a differentiated product portfolio that delights our consumers and command superior margins over time.

Lastly, our medium term targets do not assume our entry into the US THC market which could provide further upside. At this point, I’ll turn it over to Mike to review our Q3 financial results and provide details around our financial targets.

Mike Lee — Executive Vice President and Chief Financial Officer

Great. Thank you, David and good morning everyone. I’m pleased with our Q3 performance, which again demonstrated that we are building a track record of solid revenue growth, profit improvement and reduced cash burn. To further highlight our results, we generated a record quarter of revenue at CAD153 million. Gross margin improved versus last quarter. Our adjusted EBITDA loss narrowed to CAD68 million and free cash flow narrowed to an outflow of CAD135 million.

Now, let’s first cover Q3 results in detail and then I’ll discuss our financial targets. Starting with net revenue. We generated CAD153 million of net revenue or 23% growth year-over-year and an increase of 13% over the previous quarter. Total Canadian recreational net revenue increased 9% versus the prior year. Recreational B2B net sales were flat versus year ago, but increased by 2% relative to Q2 driven by several factors such as store openings, particularly in Ontario, market share gains led by our flower products and 2.0 products, which delivered 9% of gross revenue in Q3.

These growth drivers were partially offset by a negative mix shift towards the large pack size offerings in our flower business which was relatively undeveloped last year. So, to better illustrate what’s happening within flower, it’s best for us to examine Q3 relative to Q2 to further understand the price, volume and mix impacts within our flower portfolio. Starting with volume, we grew B2B Rec flower gross revenue by 15% during the quarter with volume increases in nearly all of our package sizes, with the exception of 5 gram and 15 gram which decreased slightly.

Across these packages, average price decreased approximately 1%, some of which was driven by geo mix as more of our revenue came from Ontario, which has a lower average price than their average province. Conversely size mix improved by 1% as the growth in our 3.5 gram and 7 gram packages grew faster than our 28 gram package further highlighting mix management as a critical lever in our business.

In summary, our flower price mix analysis suggests that the market is showing signs of stabilization. Let me now provide additional market share metrics based on our internal share tracker. Our recreational market share increased to 15.7% during Q3, up 30 basis points versus Q2. And this includes market share improvements of 60 basis points in Alberta and 120 basis points in British Columbia. Market share in Ontario decreased 80 basis points in the quarter, but we’ve seen a rebound in January where our share increased by 150 basis points and we now have the number 2 market share position for the month of January, which we’re very proud of.

Our share of the Canadian Flower market increased 19.1%, up 180 basis points versus last quarter. And finally, our share of the Canadian Beverage market was 34% in Q3. And notably the total beverage category sales grew by over 25% during the quarter and now accounts for nearly 2% of total cannabis sales based on our market data. Rec B2C sales increased 33% with same-store sales growing 26% versus Q3 of last year and we note that B2C sales are better reflection of demand trend as the B2B sales that we report can be impacted by the provincial Board’s ordering patterns, inventory levels and timing of new product launches.

Turning to medical. Our global medical net revenue increased 10% over the prior year period as increases in Canadian medical and C3 were partially offset by a decline in German flower compared to last year. Summarizing our global cannabis business, Canopy generated net revenue of CAD99 million or 9% growth over the prior year. Our strategic businesses also continued to perform well, delivering 61% growth versus prior year. Storz & Bickel revenue grew 52% year-over-year, benefiting from more effective distribution in the US and strong consumer pull.

ThisWorks sales increased 32% compared to last year due to continued growth in e-commerce and sales of the Stress Check hand sanitizer launched in the UK and the US. And BioSteel saw strong sales growth over the prior year due to expanded distribution in the US, and we note that over half of BioSteel sales during the quarter came from the US.

With this, let’s move on to gross margin for the quarter. Reported gross margin including restructuring and other related charges, was 16%. Adjusted gross margin which excludes restructuring and other charges was 26% in Q3, representing an improvement of 700 basis points from 19% in Q2, and relative to Q2, our gross margin improvement is driven by improved revenues resulting in better asset utilization, while cost savings initiatives had limited impact in Q3 as most of our initiatives started in December.

Next, I would like to briefly cover operating expenses. Overall SG&A decreased 15% versus the prior year driven by a 15% reduction in sales and marketing, a 23% reduction in G&A, and a 33% reduction in R&D. And these decreases are a direct result of the improved cost discipline we’ve instituted across the business, as well as our new strategy and new org design coming to life, and with these cost reductions, our head count decreased by 29% over the last 12 months, even as we hired new employees to strengthen our capabilities in key areas of the business. Next, I would like to cover free cash flow. Our free cash flow in the third quarter was an outflow of CAD135 million, which represents an improvement of over 62% versus the prior year.

Our working capital decreased year-over-year due to reduced inventory levels and capex declined to CAD48 million, which is down 72% from Q3 of last year, and over 47% from the prior quarter.

I would now like to provide some details around our reported net loss of CAD829 million. First, included in our net loss is the previously announced restructuring charge related to our end-to-end supply chain review and as a reminder, over 85% of the charge was non-cash.

Second, our net loss includes expenses reflected in the other income and expense section of our income statement and several of these charges are tied to non-cash fair value adjustments related to our various financial instruments, most of which are the result of the rise in Canopy’s share price during Q3.

And the main drivers include fair value adjustments for our convertible debt, the Acreage instruments and the Constellation B warrants. Partially offsetting these losses is a sizable gain on the TerrAscend investments which have appreciated in value since Q2.

Now I would like to speak to our path to profitability and the medium-term financial targets that we communicated today. The key targets that we intend to deliver include the following. Delivering 40% to 50% compounded annual revenue growth during the next three fiscal years ending fiscal ’24, achieving positive adjusted EBITDA during the second half of fiscal ’22, achieving a 20% adjusted EBITDA margin in FY ’24, generating positive operating cash flow in FY ’23 and finally, generating positive free cash flow in FY ’24.

And before we delve into these specific targets, I would like to provide some context for the drivers of Canopy’s current EBITDA loss in FY ’21. Year-to-date our adjusted EBITDA is a loss of CAD246 million and the key drivers of this loss are as follows. First, we are investing in R&D, which is core to our strategy of building a differentiated portfolio that will position us ahead of our competitors and our R&D expenses of CAD55 million is greater than the combined R&D spend of the top five Canadian LPs.

Second, we’re investing in building our US infrastructure, which continues to be one of our top core markets and a key strategic priority. And third, our Canadian operations were built to support significantly higher revenue, which we believe will be realized as Ontario and other jurisdictions complete their retail build out, but in the short term, this is obviously served as a sub-optimal cost structure with high fixed costs.

So with this in a backdrop, we intend to achieve these financial objectives through consistent top line growth, margin expansion and SG&A efficiencies while continuing to invest in product innovation, research and consumer insights. First, on top line growth, we expect 40% to 50% compounded annual sales growth between fiscal ’22 and fiscal ’24 driven by the following. Approximately 40% growth in the overall Canadian Rec market in FY ’22 from a continued increase in retail store openings. We also estimate 25% to 35% compounded annual growth from the Canadian Rec market between FY ’22 and FY ’24.

Our Canadian Rec sales growth is expected to be driven by the growth of the overall market and market share gains. We expect to grow our Canadian medical sales through market share gains in a stable to declining Canadian medical market. Growth of our international medical business is expected to be driven mostly by the growth of the German medical market. We expect to see growing sales contribution from our US CBD focus brands driven by distribution expansion and new products. And growth from our strategic business units, BioSteel, Storz & Bickel and ThisWorks will be driven by distribution expansion and product innovation.

The second driver to our path to profitability is market — margin expansion and SG&A efficiencies, driven by our cost savings program that is underway. And we expect to achieve cost savings of CAD150 million to CAD200 million over the next 12 to 18 months with the majority coming through in FY ’22. On cost of goods sold, we are targeting savings of CAD100 million to CAD120 million from four main areas. Network optimization including Canadian facility closures that we announced in December will result in annual savings of CAD50 million to CAD60 million.

SKU and cultivar rationalization, which will unlock efficiencies across our operations and deliver savings of approximately CAD15 million, organizational changes, which will further optimize our operating model to be more focused on end-to-end productivity will generate savings of CAD15 million and finally, we expect CAD20 million to CAD30 million from logistics optimization and other supply chain initiatives.

We also expect to generate SG&A savings of around CAD50 million to CAD80 million. And this includes organizational design efficiencies and other related savings of CAD20 million to CAD30 million. Indirect procurement savings of CAD10 million to CAD20 million, office space and facility optimization of CAD10 million to CAD20 million and savings of CAD10 million from our planned divestiture of Canopy Rivers.

I’d like to emphasize that implementation of a number of these workstreams is already well underway and from a gross margin cadence perspective, we expect Q4 gross margins to be in the high 20s. Further, we expect gross margins to gradually improve during the course of FY ’22 with the full year FY ’22 gross margin of approximately 40%. So with the combination of strong top line growth, lower cost of goods sold and operating expense reductions, we expect Canopy to achieve positive adjusted EBITDA during the second half of FY ’22 and 20% adjusted EBITDA margin by FY ’24.

Finally, we expect further moderation of our negative free cash flow through a disciplined capital allocation. We expect capex to be low — be below CAD200 million in FY ’21 and FY ’22. And beginning in FY ’23, our capex becomes mostly maintenance capital and for modeling purposes we’re assuming 5% to 6% of net sales. A key priority for Canopy is maintaining balance sheet flexibility and with CAD1.6 billion of cash and short-term investments at the end of Q3, we believe we have a strong foundation. We’re also continuing to assess various financing options to further enhance our financial flexibility to take advantage of potential opportunities in our core markets.

Before I close, I would like to offer a few key factors to consider as it relates to our Q4 outlook. First, from a net revenue perspective, we expect our Canadian Rec business to continue to benefit from additional store openings in Ontario and our improved order attainment.

We expect modest headwinds from renewed COVID restrictions, particularly in our owned retail businesses as well as provincial boards and retailers looking to carry fewer weeks of inventory. Second, our strategic businesses should continue to benefit from expanded distribution and strong consumer demand in the US.

Third, we are continuing to monitor the global COVID-19 pandemic and the extension of lockdown measures in Germany is likely to provide a continued headwind in our international medical business. And lastly, as I highlighted earlier, we expect gross margin to continue to improve in coming quarters with Q4 gross margins likely approaching the high 20s. In conclusion, we are executing against our cost savings program with several initiatives already underway to capture savings quickly and we believe the foundation is in place to accelerate our top and bottom line growth and achieve profitability during the second half of next fiscal with further improvement anticipated in the out years.

This concludes my prepared comments. Operator, David and I would be happy to take questions from the analysts.

Questions and Answers:



[Operator Instructions] The first question is from John Zamparo of CIBC. Please go ahead, your line is open.

John Zamparo — CIBC — Analyst

Thanks, good morning. I just wanted to get a bit more clarity on what you view as necessary to be able to operate without restrictions in US THC and presumably cannabis has to be removed from the Controlled Substances Act. David, you’d referenced in an interview recently that you revised Cole memo combined with SAFE banking and executive action would put you in a position to operate in US THC in ’21 and it seems like you’re reiterating that today. It does seem like that’s a bit more optimistic view than some of your peers.

So just would like to get a bit more color here and ultimately it is up to Canopy to interpret what is and isn’t considered Federal permissibility or is their input from Constellation and then the exchanges. Just anything else on incremental there would be helpful. Thank you.

David Klein — Chief Executive Officer

Yeah, John, good question. We’re working literally daily with Constellation, with our government relations team, with our partners at the exchanges and banks to work our way through this. Because I think the important thing will be if it’s not in the form of some bearing of legislation, such as the Booker, Wyden, Schumer work and it comes — and we were to hit the place where we had some executive action in terms of regulatory change, it would really be dependent upon the wording in a lot of the regulatory documents, right. So, we’re working very closely with our lawyers and with our partners to make sure that we are very careful in how we proceed here. But we remain pretty bullish on our ability to be able to step into the US at the right time.

I also want to point out two things, really. One is, we’re not just sitting around waiting for US permissibility, you’re seeing a lot of good progress being made at Acreage, a lot of good activity going on at TerrAscend and we’re continuing to build our route to market in production capabilities around our CBD business which will be helpful post permissibility. So, I think there’s good action going on today. I think there is — we’re going to watch very carefully what happens from an executive and regulatory action fronts and make sure that — that if we actually meet the hurdles that make our teams comfortable that we then proceed and clearly will be quite supportive of the work that the Senate and the House are doing to push legislation forward.

I’d also like to point out that in our arrangement with Acreage that a triggering event is defined as straight up legalization in the US or at the discretion of Canopy, right. So, we have a little bit of flexibility there. We’re just going to — we’re going to be very careful that we — that we don’t violate any laws as we move forward?

John Zamparo — CIBC — Analyst

Okay, that’s great. Appreciate the color. Thank you.


Your next question comes from Vivien Azer of Cowen. Please go ahead, your line is open.

Vivien Azer — Cowen and Company — Analyst

Thank you. Good morning. Question is on the guidance. Good morning. And David, I think in particular for you and I go ways back in alcohol and your work at Constellation and I’ve always known you to be appropriately conservative in offering external guidance. However preceding your entry into the Canadian cannabis industry like the space and have a great track record on that side. So, I was just hoping that you could offer some color on how you thought about embedding conservatism into these financial targets and where do you think you’ve kind of express that most appropriately, either from a geographic or a segment perspective? Thanks.

David Klein — Chief Executive Officer

Yeah, good question, one of the things that I talk to the leadership team at Canopy about is, we need to develop a little bit of credibility because it’s somewhat lacking in the space at least it was a year ago. And so, we’ve tried this year to ensure that we deliver as expected, as we’ve gone through the year and we’ve done an okay job of that. There’s a lot more volatility in cannabis than there is in a large alcohol company. But, I think we’ve done a nice job of staying on track as it relates to our this year FY ’21 being a transition year and so forth.

And so, as we look forward we — we very carefully vetted where we see the Canadian market going and we know that there is significant growth just from the channel shift in the Canadian market and so, our first assumption was that we would hold share as that market grew but then gain share as we continue to execute well and I’m happy to say that, those things are happening like we are seeing the legal market grow at an increasing pace in Canada and we’re seeing our execution from a sales execution and our operational execution standpoint deliver up to the expectations of our provincial and retail partners.

So, I think Canada is well — you know the targets aren’t easy to achieve. We see a very clear path to achieving the Canadian targets. The next area really is the United States and in the US, we brought the Martha Stewart CBD brand to the market in early September, and we wanted to demonstrate that we could actually bring consumer-preferred CPG like brands to market and breakthrough and really proud of the performance of the Martha Stewart branded products and as we’ve said, we believe Martha is one of the top selling brands in the CBD space, in edible space in particular in the US. I will say that while we’re getting better and better each week literally on data collection in Canada, data collection in the US is still a little sparse.

But we think that we have a good path to growing a very solid CBD business in the US and we’re kind of extrapolating our current trends into future product offerings, and ultimately our sales targets. The other area in the US that we’re seeing really strong growth is through Storz & Bickel as distribution has grown for Storz & Bickel and I personally believe it’s the best vape device on the planet and we get that response from consumers all the time. It also happens to be not super well known, so we’re working on that in a typical CPG fashion to expose people to this really well constructed high performing brand.

And then the last area in the US that we’re looking for growth is in our BioSteel business. With access to Constellation Brands Gold Network which is their Beer distribution network, we see tremendous upside to BioSteel beginning in FY ’22, quite honestly, in fact, products are beginning to be available at retail literally as we speak in terms of the ready-to-drink hydration product. So, I think we were reasonably conservative and literally we built out our forecasts almost on ECV basis taking into account velocity, points of distribution and velocity.

And then we’re assuming we continue to grow along with the German medical market. So a lot of moving parts, Vivien. But we feel that we’ve got our arms around enough of the detail to have a high degree of comfort in being able to put these numbers out. We’ve been working on this for a while, right. But we held off a little bit putting these numbers out because we wanted to see how long we would be affected by COVID and what those impacts would be and so, yes, maybe you took a little longer than everyone would like for us to come out with this kind of future estimates of where we will be, but we feel real confident. Mike, I’d ask you to dive in as well.

Mike Lee — Executive Vice President and Chief Financial Officer

Yeah, I’d just build on that when you go beyond the top line and look at the guidance around cost structure. This too has been a long-standing body of work for most of calendar ’20 starting with the end-to-end supply chain review that we announced last spring, but even delving into each function across the organization to really make sure that every function was aligned to our overall strategy and making sure that we were achieving best in class benchmarks in terms of cost structure, making sure that we had good spans and layers in place, making sure that we’ve got the right band in place across the organization.

So, we’ve been retooling the organization behind the scenes for a better part of seven to eight months. We haven’t talked a lot about it publicly other than announcing some of our restructuring, but the work has been done and that gives us the confidence on the cost structure side of things. Now, all of that being said, there is some risks out there and this is why we were pretty broad on our direction around the top line and providing a three year CAGR because some years are going to be stronger than others. We do have a high fixed cost structure.

So, our margins are somewhat sensitive to changes in volume, but we do believe that we’ve built this with the bottoms-up approach that is a balanced point of view that gives us the confidence that we can deliver on these. So, more to come, but, we feel like we’re definitely headed in the right direction and I would also emphasize that we’re going to grow into this that in Q1, Q2 of next year, we’re likely to continue to see EBITDA losses as we scale up the business and when you think about breakeven points, that CAD250 million revenue per quarter starts to be that magical number, where we start to get across the breakeven point from an EBITDA perspective. So, with that scale is going to continue to be really important.


Your next question is from Bryan Spillane of Bank of America. Please go ahead, your line is open.

Bryan Spillane — Bank of America — Analyst

Hey, good morning everyone. Maybe just a question about the medium-term goals and maybe just two things I was interested in. One is just the product mix that you’re assuming. So, do beverages, how do you see that the mix evolving with beverages and Rec 2.0 products versus or — and maybe David, if you could just give us some perspective on where we stand now and beverages in terms of market penetration, trial repeat, like you mentioned with Martha is it bringing new consumers in, just an update there as well would be helpful.

David Klein — Chief Executive Officer

Yeah, when we think about how the product mix is going to evolve over the next 12 to 18 months, still going to be a very dominated flower pre-roll business, we’re modeling it around 79% to 80% in terms of overall flower pre-roll mix, vape we have modeled in at high single-digits. Again, this is our product mix projections. Beverages and edibles again continuing to grow, but on beverages, a little bit muted in that until consumption lounges and consumption occasions open up.

We’re largely governed by the points of distribution that exist through dispensaries and look, the flower and pre-roll business is still going to be a big part of the business for the next year to 18 months and hence, we’re really focused on driving share, driving quality, making sure we’re cost competitive. But also making sure that we’re competitive in the market in terms of retail prices, because it’s going to continue to be important and it’s just foundational to our overall Canadian business.

And then on drinks, Brian, in terms of performance in Canada. There are a couple of things that are holding us back, one is the equivalency rules which limit the quantity that someone can take away from a retail store. But even with that, we think that we’re — because we’re limited in the amount that an individual can take away, we’re not getting into new consumers the way we would like. We think that over the next several months, we’ll see movement in that regard in terms of equivalency where people will be able to purchase maybe up to 24 cans of a beverage and we think that will help us when we start talking about bringing in new consumers into the space.

That said, our brands are still sitting even with a lot of competition coming into the space. We have the top three brands in the marketplace and our drinks are commanding higher velocity per SKU than the competitive set. And we feel good about what we’re offering, but we think that the near-term unlock will be a change in the equivalency rules in Canada.


Your next question comes from the line of Tamy Chen with BMO Capital Markets. Please proceed with your question.

Tamy Chen — BMO Capital Markets — Analyst

Good morning. Thanks for the question. I wanted to ask on the medium-term targets. How did you or did you factor in price compression, particularly in the flower segment in Canada within that 40% growth you expect the market to have in fiscal ’22 and then the figures you provided onwards. And then subsequent to that I’m just wondering if you can help us understand when you did this projections and arrive at these targets, what level of market share in Canada — what level of expansion in that market share did you expect or do you expect for you to achieve in order to hit these targets? Thanks.

David Klein — Chief Executive Officer

Thanks, Tamy. I’ll take this one. The price mix is something we’re looking at almost on a monthly basis as we get our data. And it’s been quite interesting over the last three to four months because the flower pricing has started to stabilize. As I mentioned in my remarks, we’ve seen 1% to 2% price compression across most of our price categories looking at Q3 versus Q2. Mix continues to be opportunity for us with some of the smaller sized packages, like the 3.5 gram and the medium sized 7 gram, but 28 gram overall pricing hasn’t moved a lot in the last several months, our math says around 1%.

So when we looked at our algorithm for next year, we wanted to be conservative. So, that we built an algorithm that gave us confidence in being able to achieve, not just the top line, but also the margin, because as you guys know excise taxes and things like that can be somewhat regressive in the category.

So, we’ve built in high single-digit price compression across the market and we think that’s a safe assumption. Some of that might be in vape because vape continues to reset a little bit as many are tracking. But, from a flower perspective, Tamy, it’s stabilized. I don’t think we’re out of the woods yet, but it has stabilized. In terms of market share, we haven’t made any aggressive assumptions on share. It’s assuming flat share with some improvements tactically across certain categories like on vape where we’re under-indexed relative to where we’d like to be. But we’re not making aggressive market share assumptions across the board.

Mike Lee — Executive Vice President and Chief Financial Officer

And maybe one thing that I would add maybe just circling back a little bit to Bryan’s question. One of the things that we’re continuing to do in our projections is to build in continued investment around innovation and R&D activities. because we think that it’s a big unlock for us. We have, what we believe is, the best in industry science capabilities and some of the NPD, the cannabis 2.0 products and may be arguably the cannabis 3.0 products that we have in the pipeline are pretty exciting. And while we didn’t build in upside as a result of the output of this work. we fully expect that it will provide maybe a little bit of buffer for the projections that we’ve put out there.

David Klein — Chief Executive Officer

And Tamy, just to clarify that high single-digit price compression is reflected in our margin goals as well. So we’ve already factored that in as part of our cost agenda.


Your next question comes from the line of Pablo Zuanic with Cantor Fitzgerald. Please proceed with your question.

Pablo Zuanic — Cantor Fitzgerald — Analyst

Thank you. David, just going back to the US. I appreciate your conviction that you will be able to sell cannabis in the US before year-end. I mean, if that’s the case and looking at the context of the Canadian stocks in January, actually outperformed the US stocks. Why not lock other deals right now with other MSOs right because, sure, we would say, way to take control of Acreage year end and then use that as an acquisition vehicle, but by then, valuations will even be higher for the US stocks of course, right? So, just that’s a question.

The only thing I will add also maybe a reminder why Acreage and TerrAscend are the right assets for you in the US, and I guess there was only a 20% stake, you have Jason Wild doing business with Bruce Linton at Gage cannabis, Acreage it’s a bit of a retrenchment mode? So, just some color there would help. Thank you.

David Klein — Chief Executive Officer

Yeah. So, some good points there, Pablo. So I think as it relates to the US, we think that Acreage has put itself on a really strong path, especially with its concentration on the Northeast. If we think that we have permissibility or legalization actually in New York State, you know a massive market likely in our view will be only second to California over time. And so, we like that positioning there and as I said in my prepared remarks, we like Peter Caldini, we think is a really strong operator, and so we don’t rule out — we don’t rule out Acreage actually looking at other potential acquisitions in the US to expand their footprint.

And as it relates to TerrAscend, we think that’s just a really well-run business and we’re highly respectful of what Jason Wild and Jason Ackerman, have been able to do in that business and we think that those businesses in and of themselves can create a lot of value for us at some point down the road.

In the interim, we’re somewhat limited in what we can do in the US, but that doesn’t mean we’re not doing things like, building out our routes to market, building our production infrastructure and keeping our eye very closely on the market developing products specifically for North American consumers that will test out in Canada and be able to bring to the US. So, we feel like we have a lot of good things going on that will unlock value for our shareholders even if we can’t be in the plant-touching business during this calendar year. But if we can, we think then that’s a super exciting position to be in.


Your next question comes from the line of Doug Miehm with RBC Capital Markets. Please proceed with your question.

Doug Miehm — RBC Capital Markets — Analyst

Thank you and good morning. First question again, it has to do with the US and in the event you have the ability to launch on the THC front. Can you maybe walk us through your capabilities in terms of getting product to the market and expected demand would be significant and we saw the issues in Canada with the early launch. I know it’s different because of the MSOs, but perhaps you could go into a bit of detail there.

David Klein — Chief Executive Officer

Yeah. So again, I think our ability to quickly enter the US comes as a result of the arrangement we have with Acreage and so immediately upon permissibility we would trigger our rights to purchase 70% of Acreage, we would then be able to deploy our balance sheet and our know-how to help them rapidly take advantage of the US market. And look, I think there is a nuance here when we start looking at the ability to compete in the US. Early on in Canada, we learned that just being on the shelf was enough, right and that kind of carried a lot of LPs for the first year and I see a little bit of that happening in the US.

Ultimately in my view, the game is going to be won by whoever produces the best experiences for the end consumer and that’s going to be using all of the kind of CPG bag of tricks, if you will, like having a really robust supply chain that includes interstate commerce by the way that has strong routes to market that has experience, innovating and understanding the consumer and building brands. And we think that Canopy with our capabilities combined with our partners in the US, combined with the capabilities that a beverage alcohol behemoth like Constellation has, we think that creates a powerful competitor in that US marketplace upon permissibility.


And this concludes our question-and-answer session for today. I turn the call back to the presenters for any closing remarks.

David Klein — Chief Executive Officer

Yeah, thanks again for joining us today. Despite the challenges faced over the past year, our business transformation is on track, our new strategy is in place, our organizational change is complete and our operational cost savings program is now underway. Our products are winning consumer mindshare and I hope all of you get to experience our amazing products. For those in the US, send a Martha Stewart CBD gummy sample to your loved ones and give your pets Martha and/or SurityPro CBD pet products. For those in Canada, pick up our newly released Twd strawberry gummies and everyone should check out our BioSteel ready-to-drink drinks when you see them in your local store.

Thanks again for your interest in Canopy. Our Investor Relations team will be available to answer any additional questions. Have a great day.


And this concludes Canopy Growth’s third quarter fiscal 2021 financial results conference call. A replay of this conference call will be available until May 10, 2021 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.


This transcript is produced by AlphaStreet, Inc. While we strive to produce the best transcripts, it may contain misspellings and other inaccuracies. This transcript is provided as is without express or implied warranties of any kind. As with all our articles, AlphaStreet, Inc. does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company’s SEC filings. Neither the information nor any opinion expressed in this transcript constitutes a solicitation of the purchase or sale of securities or commodities. Any opinion expressed in the transcript does not necessarily reflect the views of AlphaStreet, Inc.

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