Categories Earnings Call Transcripts, Health Care

Canopy Growth Corporation (CGC) Q3 2022 Earnings Call Transcript

CGC Earnings Call - Final Transcript

Canopy Growth Corporation (NASDAQ: CGC) Q3 2022 earnings call dated Feb. 09, 2022

Corporate Participants:

Tyler Burns — Director, Investor Relations

David Klein — Chief Executive Officer

Judy Hong — Interim Chief Financial Officer

Analysts:

Vivien Azer — Cowen & Company, Inc. — Analyst

Tamy Chen — BMO Capital Markets — Analyst

Gaurav Jain — Barclays — Analyst

Christopher Carey — Wells Fargo Securities — Analyst

Pablo Zuanic — Cantor Fitzgerald & Co. — Analyst

Owen Bennett — Jefferies Equity Research — Analyst

Adam Buckham — Scotiabank, Inc. — Analyst

Douglas Miehm — RBC Capital Markets — Analyst

W. Andrew Carter — Stifel Financial Corp. — Analyst

Michael Lavery — Piper Sandler — Analyst

Presentation:

Operator

God morning. My name is Kelsey, and I will be your conference operator today. I would like to welcome you to the Canopy Growth’s Third Quarter Fiscal Year 2022 Financial Results conference call. [Operator Instructions] And I will now turn the call over to Mr. Tyler Burns, Director, Investor Relations. Mr. Burns, you may begin your conference call.

Tyler Burns — Director, Investor Relations

Good morning and thank you, operator. Thank you for joining us today. On our call today we have Canopy Growth’s CEO, David Klein; and Interim CFO, Judy Hong. Before financial markets opened today Canopy issued a news release announcing our financial results for our third quarter fiscal year ended December 31, 2021. This news release is available on our website under the Investors tab and will be filed on EDGAR and SEDAR.

We have also posted a supplemental earnings presentation on our website. Before we begin, I would like to remind you that all 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 Growth’s reports that are filed with the SEC and on SEDAR for various factors that could cause actual results to differ material materially from projections.

In addition, reconciliations between any non-GAAP measures to their closest reported GAAP measures are included in our earnings release. Please note that all financial information is provided in Canadian dollars unless otherwise noted. Following prepared remarks by David and Judy, we will conduct a question-and-answer session, during which analysts will be take — questions will be taken from analysts. To ensure that we get to questions from as many analysts as possible we ask the analysts limit themselves to one question.

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

David Klein — Chief Executive Officer

Thank you, Tyler, and good morning everyone. I’ll begin today’s call by offering perspectives on our business in the third quarter, including key achievements along with short and long-term priorities. Judy will discuss our quarterly performance in more detail, the actions we have underway to accelerate our path to profitability and our near-term outlook. The third quarter was one of action for the Canopy Growth team with our efforts based on four key areas. One, driving our Canadian business to profitability. Two, strengthening our premium brand portfolio and product offering in Canada.

Three, increasing our CPG distribution in the U.S. And four, making significant strides in furthering our U.S. THC strategy. These actions tie back to our strategic priorities and have generated highly encouraging wins in the quarter, resulting in net revenue in Q3, growing 7% sequentially led by strong growth from both BioSteel and Storz & Bickel. Now I’d like to provide an overview of the actions that we’ve taken to improve our performance, which will enable Canopy to achieve profitability in the Canadian recreational market. To start, we’re continuing to premiumize our flower portfolio through enhanced cultivation tactics and a new genetics strategy.

We’re on track to in-source 100% of our premium and mainstream flower supply by the beginning of Q1 fiscal ’23. I’m pleased to share that Supreme’s industry-leading cultivation and post-harvest operations have been implemented through our existing Canopy operations. And as a result, the strains we’re harvesting in our Smiths Falls and Mirabel facilities are seeing higher THC levels, enhanced aroma and improved terpene profiles. In addition to the focus on improving our flower quality, we’re taking steps to better adapt to the fast-evolving preferences of Canadian consumers including developing a robust genetic pipeline.

This will ensure we can deliver a consistent supply of new genetics at commercial scale to support more frequent rotation of new and unique flower strains. Notably, we’re accelerating new product launches by implementing a smaller cross-functional team to improve the efficiency of new product development, which is leading to faster product delivery to the market. And in order to drive improved performance in market our Canadian sales team has been executing focus drives to increase distribution and velocity. Early results are showing increased distribution in Alberta, Ontario and Quebec through the end of January for DOJA flower and Deep Space beverages and gummies.

The team has also revamped the Retailer Engagement Program hosting several education sessions with store managers and bud-tenders to showcase the enhancements in our product quality. In Canada, we’ve maintained number one market share in premium flower with the launch of 10 new strains, including DOJA 91K, 7ACRES Wappa 49 and 7ACRES Craft Collective Jet Fuel Cookies. We expanded our premium product offerings across the Deep Space brand with the introduction of Deep Space XPRESS Gummies, our first gummy with the maximum allowable 10 milligrams THC and a line extension in beverages with the launch of Deep Space Limon Splashdown.

We also began shipping Deep Space Orange Orbit flavor this past month and anticipate bringing three new nostalgia-inspired flavors to market over the coming months. In Q3, we rebranded Tweed and launched Powdered Donuts and Chemdawg flower under the redesigned brand banner. These new higher THC strains have drawn very positive consumer feedback noting high moisture content, aroma and bag appeal, which is due to the improved grow techniques, including hang drying all flower to produce higher quality bud with increased moisture.

Tweed flowers now packaged in the heat seal back to preserve freshness with 90% less material by weight than the original tin packaging and new color profiles by string type that make it easier for consumers to find what they’re looking for. Strong consumer demand for these new strains has helped improve our share of the mainstream flower market over the past few months. In our Edibles Extract business, we launched our new Twd. THC Indica oral spray, a product that delivers the maximum THC potency allowed by regulations in a value-priced format.

This was followed by the launch of Twd. Max THC Sativa and Twd. Max CBD oral sprays in January. These innovations have kicked off the rollout of a revamped Edibles Extracts portfolio that we believe will offer greater value to consumers and significantly strengthen our competitive positioning in the category. On the back of our new product introductions and continued focus on premium and high THC, we see signs of stabilization and are starting to turn the tide in our Canadian market position.

Looking to the U.S. in the areas of greatest opportunity for long-term growth, I’d like to now highlight the momentum of our CBD business as well as review the advancement of our THC ecosystem. The U.S. is our area of greatest potential and we’ve been highly encouraged by Storz & Bickel and BioSteel performance. Storz & Bickel posted record quarterly revenue of CAD25 million in Q3 driven by strong demand for the VOLCANO ONYX

And MIGHTY+ vaporizers. Storz & Bickel is clearly already on an annualized 100 — is an annualized CAD100 million revenue business.

The Storz & Bickel brand continues to be the gold standard for cannabis vaporizers with the VOLCANO hybrid included in a list of the best weed accessories in Esquire Magazine and the MIGHTY+ included in the Forbes Holiday Gift Guide. We expect continued growth from this marquee brand. Canopy’s hydration beverage brand BioSteel also delivered a record revenue quarter driven by gains in distribution of BioSteel ready-to-drink. We’re seeing continued momentum with the recent signing of retail authorizations by Albertsons, Rite Aid, Food Lion, Stop & Shop and Sheetz and over 20 additional authorizations across grocery, convenience and drug chains.

Combined, these authorizations add nearly 15,000 stores across the U.S. Working closely with Constellation Brands we’ve initiated a program to on-board new distributors to help drive the distribution of our CBD brand portfolio into additional U.S. states. As a result, Canopy CBD business has grown 250% year-to-date with our product portfolio now available in brick and mortar and e-commerce sites covering a combined 33 states in the U.S., including Martha Stewart’s CBD, which is the fastest-growing CBD gummy brand in the U.S. Whisl, our CBD vape that we launched in October with retail partners Circle K is already the number one CBD-only vape brand in IRI measured channels.

We’re in active discussions with a number of additional convenience store chains and expect additional whistle retail partners to be on board in early fiscal ’23. The footprint for our Quatreau beverage increased within brick and mortar stores with the door count increasing sequentially 225%. Now, I’m excited to speak on how we’re executing our THC strategy in the U.S. In Q3, we established a cross-functional team of senior leaders across Canopy and Constellation Brands to oversee the advancement of our U.S. THC portfolio. This team developed a robust strategy to achieve our future ambitions in the U.S. THC market.

In Canada and Canopy’s agreement to acquire Acreage and Wana along with our investment in TerrAscend upon permissibility of THC in the U.S. are at the foundation of this plan. We continue to be impressed by Wana’s performance on both sides of the border and see this is an example of how Canopy might further leverage brands and products from our U.S. ecosystem into the Canadian market. With an exciting product pipeline Wana has strengthened its U.S. footprint in Q3 with the signing of a license agreement in Nevada, which brings the total number of states to 13.

In Canada, Wana remains the number one edibles brand with 38% share of gummies in attract channels. Similarly, Acreage continues to execute on their strategic plan resulting in a third consecutive quarter of positive adjusted EBITDA. In fact, analyst estimates point to calendar year 2022 adjusted EBITDA of $65 million. Acreage also strengthened its balance sheet with the recent signing of a CAD150 million credit facility, which will help build depth in core markets. In addition, Acreage closed an acquisition in Ohio establishing a market leadership position in the state.

Canopy has clearly established paths into the U.S. THC market with the acquisitions of Acreage and Wana as well as our conditional ownership stake in TerrAscend all upon federal permissibility of U.S. THC. I want to be clear there is strategic intent behind the U.S. ecosystem that we’re creating. We’re not just a Canadian LP. We’re not building an MSO and we aren’t building an alcohol company. We’re developing a robust U.S. THC ecosystem that’s focused on acquiring beloved premium brands like Storz & Bickel and Wana and backing them with unmatched innovation and operational capabilities while leveraging unparalleled distribution to rapidly scale across North America.

We’ll have more to say about this strategy over time as appropriate. But I believe there’s never been a better time to invest in Canopy and that no one is better positioned than Canopy to be the long-term leader in North American cannabis.

With that, I’ll turn it over to Judy.

Judy Hong — Interim Chief Financial Officer

Thank you very much, David, and good morning everyone. I plan to focus my comments on a review of our third quarter results, actions we’re taking to achieve profitability and perspective on the near-term outlook. So let’s start with a review of our third quarter results. Our Q3 results point to a start of revenue stabilization with 7% sequential revenue growth led by strong growth of our U.S. businesses, which is offset by softness in our Canadian recreational business. During Q3, we generated net revenue of CAD141 million representing an 8% decline over the prior year.

Excluding acquisitions, our net revenue declined 17% versus the prior year. Our reported gross margin in Q3 was 7% and our adjusted gross margin was 13%. Adjusted EBITDA in Q3 amounted to a loss of CAD67 million, which improved by 1% versus last year. And free cash flow in Q3 was an outflow of CAD168 million representing a 24% greater outflow versus the prior year, partly due to the timing of working capital. Now, let’s dive deeper into revenue performance in the third quarter starting with the global cannabis segment. Global cannabis sales decreased 20% year-over-year and excluding the impact of acquisition was down 34%.

Our total Canadian recreational business declined 25% year-over-year driven by the following: B2B revenue declined 23% due mainly to declines in our flower sales; our flower sales continued to be impacted by ongoing price compression in the value-priced flower category as well as the limited supply of single strain, high-potency flower products. Now the good news is we’re starting to see new single stream for our product hitting the market with strong reception and we expect additional supply to come into market in the coming months.

Our recreational B2C cannabis sales in Q3 decreased 28% versus the prior year, which was largely driven by increased competition. Our Canadian medical cannabis sales were down 7% as higher average order size was offset by a lower number of orders. Our international and other cannabis business had a few puts and takes during the quarter. We grew our U.S. CBD business by 25% versus the prior year. We also benefited from a bulk sale of flower into Israel medical markets that generated approximately CAD4 million in revenue. This was more than offset by declines in our C3 and German flower business resulting from increased competition.

Turning to other consumer product, Q3 net revenue increased 19% versus the prior year. BioSteel had its record quarterly revenue increasing a 130% year-over-year due to strong distribution gains of ready-to-drink beverages in the U.S. as well as higher international sales of its ready-to-drink and powdered beverage mixes. Storz & Bickel also posted a record quarterly revenue increasing 5% year-over-year, which was driven by strong consumer demand for the new limited edition ONYX VOLCANO, as well as the MIGHTY+ vaporizers. And this declined 2% year-over-year due to lapping of strong prior year sales.

Now, let’s now move to gross margins. Reported gross margin in Q3 was 7%. Our adjusted gross margin was 13%, which excludes the impact of CAD3 million of inventory step up charge from the Supreme acquisition as well as the CAD5 million charge related to inventory write-down resulting from strategic changes to our business. Gross margin in Q3 was further impacted by the following: first, we continued to see pressure on gross margins from lower production output and price compression in the Canadian rec business, notably in the value-priced flower category. Second, as we scale up our U.S. businesses, including our CBD products as well as BioSteel, we are still experiencing under-absorption of fixed cost. We’re also facing higher supply chain costs such as freight that many in the industry are currently facing.

And third, decreased contribution of higher margin C3 revenue also negatively impacted our overall gross margin. These factors were partially offset by payroll subsidies in the amount of $7 million that was received from the Canadian government pursuant to COVID-19 relief program. Now, turning to operating expenses, demonstrating continued discipline, our overall SG&A expenses in Q3 decreased 19% versus the prior year. G&A expenses declined 47% primarily due to reductions in staffing and professional fees as well as the benefit of payroll subsidies.

Excluding the payroll subsidy benefit, G&A expenses declined 27% versus last year. R&D expenses in Q3 declined 53% versus the prior year principally due to a more focused and disciplined approach to R&D investments. Sales and marketing expenses increased 20% year-over-year primarily due to higher marketing investments behind BioSteel and our U.S. CBD brands. The Supreme acquisition also increased our sales and marketing expenses when compared to the prior year. Now, turning to free cash flow; our free cash flow in Q3 was an outflow of CAD168 million, which represents a 24% increase over the prior year.

Capex declined to just CAD1 million, which was down 98% from the prior year. The increase in cash used in operation during Q3 compared to a year ago reflects increased interest paid as well as the timing of working capital. I’d like to now take this opportunity to speak to the efforts underway to improve our profitability. Taking a step back, as an organization we built the structure and operation that can support a significantly higher revenue base than we’re currently generating. And while we remain optimistic about the long-term prospects of this industry as well as Canopy’s position to succeed, we recognize that we need to adapt to the realities of our business today.

We’ve already made significant progress rightsizing our footprint and realizing cost savings from our previously announced cost savings program. Through the end of the third quarter of fiscal ’22, we’ve generated approximately CAD85 million of cost savings across both costs and SG&A. Our combined sales and marketing, G&A and R&D expenses are down 17% or CAD63 million lower year-to-date in fiscal ’22 when compared to a year ago. And even excluding the payroll subsidy benefit, our SG&A expenses have decreased by 8% year-to-date and this is inclusive of additional expenses that came with the Supreme acquisition.

Now that being said, as consumer preferences continue to shift and the Canadian market structure remains challenged by low barriers to entry and onerous regulations, these cost savings are not enough for us to achieve profitability in Canada. So key component of our path to profitability is further simplifying our businesses and optimizing our expenses and work is well underway to finalize our near-term revenue, operational and expense plans necessary to achieve profitability in Canada as soon as possible.

Let me offer a bit more detail on our SG&A expense structure. Our sales and marketing expenses, comprise of around 40% in advertising and promotional spending and 60% in sales and marketing overhead. We’ve made deliberate decisions to continue making strategic investments in these areas in our core markets. With a sizable portion of these investments currently being spent against emerging growth brands in the U.S., including BioSteel, Martha Stewart CBD, Quatreau and whisl.

These strategic investments account for approximately a third of our total selling and marketing expenses. We also have our corporate-owned retail stores that carry a significant portion of our selling and marketing expenses. These expenses account for nearly 40% of our total selling and marketing overhead spending in Canada. Now we plan to continue to make strategic investments where we see high potential for pay off but in a more targeted way and in a market like Canada where advertising is severely restricted we’re focusing more on the ground game to win with retailers.

Now when you turn to R&D we’ve already shifted our R&D focus away from long-term clinical trials to areas where we see near term commercial benefit and we plan to further tighten our focus and invest in R&D that is core to our strategy and has a tangible pay off in the near term. Digging into our G&A expenses, the biggest areas of spending are public company cost, finance, IT, legal and regulations. We’ve built some of these functions with an expectation that our revenues would scale quickly and require sophisticated level of support.

However, until our growth catches up with our aspirations we need to reclaim a more entrepreneurial mindset, which means being more nimble and scrappier with our resources while also identifying opportunities to further simplify our processes or structure to generate additional G&A savings. So as you can see, recognizing that our overall expense structure is built for a larger revenue base and our near-term projections we are taking measurable steps to ensure that we can be profitable in Canada while investing for growth in key strategic areas such as our U.S. THC strategy.

So, now I would like to provide some perspective on our near-term outlook. From a topline perspective, in Canada we note that retail store closures caused by elevated COVID-related staff absences has likely had a modestly negative impact on retail sell-through, as well as inventory replenishment orders. And this could potentially present headwind to our Canadian recreational B2B and B2C business in the current quarter. We do expect sales declines to begin to moderate in Canada as we focus on stabilizing and growing our share of premium and mainstream segments of the Canadian recreational markets.

In Europe, we expect our medical sales to be down on a year-over-year basis due to increased competition in our German flower business as well as divestiture of the C3 business which closed on January 31. As a reminder, C3 generated net revenue of nearly CAD16 million in Q4 of last year. Our U.S. CBD business in the current quarter is expected to be up modestly year-over-year as we lap last year’s sales that were boosted by the sell-in of Quatreau beverages. We expect BioSteel revenue to continue to benefit from additional retail authorizations and resulting product load-ins.

For Storz & Bickel, we expect sales growth on a year-over-year basis as the brand continues to benefit from strong consumer demand for recent innovation while we’re closely monitoring our global supply chain. From a margin standpoint, the divestiture of high margin C3 business during the current quarter can be expected to present a modest gross margin headwind. We expect increased volume throughput and positive mix shift in Canada to contribute to gradual gross margin improvement, though price compression remains a key watch out. And headwinds from startup costs in the U.S. should begin to abate as we scale up our CBD and CPG businesses.

This could be offset by continued increase in supply chain-related costs in the near term that we’re closely watching. And finally, we now expect our full year fiscal ’22 capex to be in the range of CAD45 million to CAD60 million, which is down from the prior range of CAD100 million to CAD150 million. The decline in capex is primarily due to the deferral of certain projects and the elimination of capex-related to the planning and construction of a new facility for C3. With the sale of C3 now complete, it’s been removed from our budget.

So in conclusion, we expect actions we’re taking will drive improved execution, accelerate topline growth and allow Canopy to achieve profitability in Canada while also continuing to make strategic investments in key growth areas. We plan to share additional details around our path to profitability once we complete our annual planning that we have underway.

This concludes my prepared comments. Kelsey, David and I will be happy to take questions from analysts.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Your first question does come from Vivien Azer from Cowen. Please go ahead.

Vivien Azer — Cowen & Company, Inc. — Analyst

Hi, good morning.

David Klein — Chief Executive Officer

Good morning Vivien.

Judy Hong — Interim Chief Financial Officer

Good morning.

Vivien Azer — Cowen & Company, Inc. — Analyst

So very encouraging to hear about the distribution gains in the U.S. I think we’ve all been waiting for that and nice to see that come through. David, I don’t know if it’s premature, but can you comment at all on the velocity that you’re seeing? I know there is a number of new product offerings that hit the market. So any one you would want to comment on that gained distribution will be helpful. Thanks.

David Klein — Chief Executive Officer

Yeah, Vivien. So the — so a lot of the distribution is fairly new distribution, right? So it is a bit early and what we see is velocity levels that are kind of consistent with our planning algorithm, but there’s a lot of variability. In some areas we see really, really strong velocities that would be consistent with any competitive products on the shelf. And in other areas we see that the velocity is not so strong.

So, working with our distribution team supported by our friends at Constellation, where we’re working our way through the — to try to understand lessons learned in terms of where velocity is exactly where we need it to be and where maybe it isn’t so that means maybe we need to do some more in-store activation or we need to do some more work with brand development in a given region or in a given format. But I would say where we would want to be or where we would expect to be at this point, but I think there is a lot of work to do that should flow through our results over time.

Operator

And your next question comes from Tamy Chen from BMO Capital Markets. Please go ahead.

Tamy Chen — BMO Capital Markets — Analyst

Hi, good morning. Thanks for the question. Could you give some more specific examples on the progress you’re seeing in your Canadian flower business? So for example, what level of THC you’re seeing, terpene content on the new strain, how the consistency is? And I’m also wondering if I look at the current point of sale data on DOJA for example, it’s been gradually increasing the shelf room, month-over-month but the absolute dollar amount is still not enough to move the needle. So I’m just curious what really needs to happen to accelerate that? Is it just you need to get up the learning curve and grow more of it or when you talk to provinces, do you find they’re saying there is many LPs and they can’t make more room to take on additional DOJA products. Thanks.

David Klein — Chief Executive Officer

Yeah. So first of all on the flower question, yeah, for the premium brands in our portfolio that we’re most excited about, I would say that we’re seeing consumer demand in the mid 20s THC range. So, and that’s up from where we would have been talking about even six months ago or nine months ago. And so that I think highlights the fact that this — that the flower business in Canada is fast-moving and we need to stay on top of evolution of strains and so forth. But I think we’re seeing that mid 20s — we’re starting to do a lot of work around terpene profiling so that — that we can find a good way to speak to our consumers around terpene profiles related to some of our specific strains.

And look, to get to the question around — once you start to produce that kind of flower which we now are you need to be able to then produce it consistently of scale. And as we said in our prepared remarks, we feel pretty comfortable that we’re going to be in that position by the beginning of our next — our Q1 for fiscal ’23. And you’re right to call out DOJA. DOJA in particular, the 91K strain has done really well for us. I would say the — anything that what’s held back DOJA, if anything has been our ability to keep 91K — the 91K supply with the — at the right level of THC.

So I think it’s less about provincial boards and more about you have to offer the right products. And then as Judy called out in her script Tamy, we’re upping our ground game a little bit. We’re spending more time with bud tenders. We’re spending more time at retail because I think that’s how we can make sure that our value proposition is consistently put in front of those consumers. So really excited by the way about the growth at DOJA and where it can go.

Judy Hong — Interim Chief Financial Officer

And Tamy, I would just add a couple of things to David’s response. One is, when you look at our premium brand portfolio and the broader portfolio strategy is continuing to really focus and tighten our portfolio even more. So there are a couple of premium brands in our portfolio frankly like house plants that we’re not necessarily focused on. So I think that is going to show up from the market data standpoint, some of that share dynamics that you’re seeing. The other thing is just the timing of when those products actually get onto the shelves too, right?

You talked about the distribution drive that we’re seeing and DOJA flower making traction in some of the provinces. And I think you will continue to see that flow through. If you just look at our sales in Q3, our premium and mainstream mix is now 50%. This was 30% plus a year ago. So we’re really making good strides in terms of improving mix, how quickly that really flows to retail and how quickly that shows up in the retail data. I think that would — that’s going to take a little bit of time.

Operator

Your next question comes from Gaurav Jain from Barclays. Please go ahead.

Gaurav Jain — Barclays — Analyst

Hi, good morning. Thank you for taking my question. So, I have a question on gross margin for the quarter. So you disclosed that you have a 14% in adjusted gross margin and a CAD7 million payroll subsidy from the government. If I assume that your consumer products revenue is coming, I’d say a 30% gross margin, that would suggest that your global cannabis revenue has a negative gross margin. So can you just help us understand why that is the case, and what will it take for that to become a 20% gross margin kind of business?

Judy Hong — Interim Chief Financial Officer

Yeah, I’ll take that question Gaurav. For us clearly, gross margin and improving gross margin remains a very focus — key focus area for Canopy. And as I said in the prepared comments, when you look at our gross margin we are continued to be challenged by lower production output as well as some of the price compression that we’re seeing in the marketplace. And when you look at our Canadian operations and driven by the lower production output we have the under-absorption of fixed and indirect costs that are flowing through our gross margin performance.

We’ve also talked about some of the higher supply chain costs that we’re incurring that many of the companies are facing in the industry as well. And then I would say in addition, we do have a sizable non-cash expenses in our cost of goods sold in Canada that flows through. The numbers in Canada alone we’ve got around CAD36 million of D&A expenses that are part of cost of goods sold. So certainly that impacts our gross margin. And then we also have some accounting-driven amortization of our standard cost revaluation that were still flowing through as part of our flower strategy that we’ve been implementing.

So a lot of noise in the gross margins, but I think our focus is really looking to improve our gross margins and looking for a few areas. Number one, it’s — as we really look at our premium mix, so really focusing on premiumizing our portfolio, we do think that focused premium product portfolio will drive improvement in our mix and drive gross margin — gross margin expansion. The other thing is we’ve identified additional opportunities frankly to really increase our cultivation and productivity, streamline processes as well as additional productivity initiatives, which would be looking at distribution indirect and variable spend bucket. So a lot of work is underway to make sure that we’re tackling all of the areas of opportunities and we do expect over time we’ll see gross margin expansion in the Canadian market.

Operator

Your next question comes from Chris Carey from Wells Fargo. Please go ahead.

Christopher Carey — Wells Fargo Securities — Analyst

Hi, good morning.

Judy Hong — Interim Chief Financial Officer

Good morning Chris. Welcome back.

Christopher Carey — Wells Fargo Securities — Analyst

Thank you very much. Good to be back. I just wanted to follow up on that line of questioning around profitability in Canada, and it sounds like there is some good initiatives around expanded distribution, more focus at retail, speaking with bud tenders, really trying to understand the consumer, and that all makes sense. And I suppose there is a concept here where our sales leverage with some of these initiatives over the next three to six months is expected to help quite a bit. But I guess — the other side of that is what if some of these initiatives take a little bit longer.

Obviously, this is a very challenging and competitive market and David, I’m curious, your thoughts here as well in the context of some pretty significant capacity reductions that you made as you came into the organization, specifically on the West Coast. And I wonder, your appetite for may be making more significant changes to the asset base here in the context of what looks like a pretty successful non-cannabis portfolio and a lot of the things that you’re doing in the U.S. as well. So appreciate any perspective there.

Judy Hong — Interim Chief Financial Officer

Yeah, I would say, Chris, I think as I said in my prepared comments, we recognize that our revenue base is lower than I think what we projected to be to really support the expense structure that we currently have. So really looking at tackling across various buckets, where we can streamline the processes as well as additional G&A savings and SG&A savings that will allow us to be profitable in Canada recognizing that the realities of where we are today is different than what we had anticipated. So I think what you will hear more from us in the next call is just a lot of those initiatives in place to make sure that we’re streamlining processes. We’re looking to optimize expenses to get us to that profitability as quickly as possible.

David Klein — Chief Executive Officer

And Chris, what I would add to that is kind of like set the tone, which is we’re only growing for premium flower in our facilities, right? So we’re creating focus there. We’re streamlining our portfolio of brands so that we’re really focused on DOJA, 7Acres, DNA, Tweed on the flower side to create more of a simplified operating environment. And then when you get through all that you get to, we have three facilities, Kincardine, Smiths Falls and Mirabel. And we think that each of those facilities with this strategy can improve on the performance from a cost perspective that they’ve delivered on in the past.

And I might throw out one caveat and this would apply to some of our advanced manufacturing activities in Smiths Falls, and that is the facilities are built out. And so, they’re admittedly overbuilt and so they create that depreciation and amortization drag that Judy talked about in her last comment. And so we’ve really been focused on as much as possible, getting the right throughput, the right brand set, the right SKU set so that we can actually optimize our margins with a lot of attention on kind of cash margins or EBITDA kind of margins so that we’re really — there are some things that we can’t easily change like again, the size and scale and scope of our drinks facility. And so we’re operating it as efficiently as we can knowing that it’s a long-term drag on our on our margins.

Operator

Your next question comes from Pablo Zuanic from Cantor Fitzgerald. Please go ahead.

Pablo Zuanic — Cantor Fitzgerald & Co. — Analyst

Good morning. Thank you. David, just talking on the export markets, right, I know that we about Canada and a lot of focus on the U.S., Germany could legalize; just talk about how prepared are you there? Does the sale of C3 hurt you in any way there? We see the numbers that you [Indecipherable] really more market share, just remind us of your strength and how ready would you be if market start to liberalize there, thank you, in Europe?

David Klein — Chief Executive Officer

Yes. So thanks for the question, Pablo. So we have a robust organization in Germany that I — we continue to perform well in that market but as called in, in our comments, our sales in that market were down in the quarter. C3 doesn’t really affect. In fact, I think C3, Pablo, is a bit of a simplification strategy for us because it allows us to focus in particular on flower in Germany, which we think ultimately is beneficial for us.

And in terms of when Germany gets to permissibility, our ability to address the market, supply product into the market is super strong. So we think we’re reasonably well positioned. Now, that said most of our activity, most of our attention, most of our mind share is against getting our Canadian business premium and mainstream profitable, focused on premium and mainstream and profitable and building out that U.S. THC ecosystem. And we’re going to continue to focus in those two areas while we wait and see what happens elsewhere in the world.

Operator

Your next question comes from Owen Bennett from Jefferies. Please go ahead.

Owen Bennett — Jefferies Equity Research — Analyst

Good morning guys. Hope all are well. I just wanted to come back on the Canadian market share. So lots to focus on flower trends, what’s gone wrong there and how you’re addressing with premium. But if we go back to an investor meeting you guys had — it was back in June 2020 you called out 2.0 products as a big area of focus where you wanted to be the leader and win. Delivery, obviously not been great. Gross sales down 40% in 2.0 versus a year ago. I just wanted to get your thoughts on what you think has gone wrong in 2.0 and why should we believe the trends there can also improve like you’re hoping to see flower trends improve? Thank you.

David Klein — Chief Executive Officer

Yeah. So if I split out 2.0 products, I’ll chop it into three areas, right? So I’ll start with drinks and I think, look, the thing with drinks and even as I talked about scaling our drinks facility. The key unlock is if we get movement on equivalency in Canada because we just can’t sell the volumes across the market that would be necessary to get the kind of returns that we want. And we’re hopeful that that comes in the not too distant future. I think that would be good for the industry in general and certainly would be really good for Canopy.

Switching to edibles, our edibles portfolio has performed reasonably well with the introduction of Tweed and TWD coming into the market this year. But on top of that, I think when we talk about our U.S. THC ecosystem, our acquisition of Wana makes us ultimately the brand owner of Wana in the Canadian market, which has a 38% share of the gummy trade in Canada. And so we believe that Wana plus Tweed plus TWD plus our Deep Space line of gummies in the market will allow us to be really competitive.

And we think we can have good margins from that segment of business over time. The area that we haven’t performed to the level that we would like to has been in the area of vapes. As a company admittedly we focus a little bit more on flower vaporizers like Storz & Bickel. And so that’s maybe taken a preponderance of our attention. But distillate vapes we’ve lagged the market and we’re continuing to work in that area to see how we can ultimately improve over time.

Judy Hong — Interim Chief Financial Officer

And Owen, I would just add just when again, going back to kind of what we want to really achieve from a product portfolio standpoint, we really want to focus on growing and profitable categories, right? So I think when you kind of identify which categories in the market are profitable and are growing, premium segment of the flower category, pre-roll categories really seeing good growth and good margins there.

In vapes, I think what you’re seeing is the growth in some of the premium side of that category two live resin, concentrates where the margins are much better and then distillate based category. So that’s going to be the area of focus for us. If you look at beverages and edibles, I think that’s really about category expansion. So I think it’s a combination of getting the regulatory unlocks but how can we offer products in beverages and edibles that really provide unique attributes and some excitement that can really expand the category. So I think that is — it’s both market share but certainly focused on category expansion as well.

Operator

Your next question comes from Adam Buckham from Scotiabank. Please go ahead.

Adam Buckham — Scotiabank, Inc. — Analyst

Hi David and Judy. Thanks for taking my question. So more of a strategic queue from me, but I wanted to talk a bit more about the U.S. THC ecosystem and what the team is trying to do there. Now obviously, the regulatory backdrop is what it is and certainly a gray area that becomes hard to comment on. But in a scenario where it remains unchanged for a longer period of time how does the team think about creating value for the investments and carry costs that Canopy has made there?

David Klein — Chief Executive Officer

Yeah. So, great question, because I actually think this is maybe one of the more underappreciated components of our story, right? So, we have this U.S. THC ecosystem, that’s really, right now it’s made up of an investment in tariffs and a 70% stake in Acreage and ownership of Wana. And it’s actually a bit of an interesting, I guess Financial Markets conundrum because take Wana as an example. We’ve paid for Wana. So the cash has left our balance sheet. But you don’t see the consolidated results coming through our earnings and you won’t see them until we have a federal permissibility event.

And so it’s just, it’s an interesting scenario where we have, if you combine these businesses as a group, our U.S. THC ecosystem is good size, it has really strong growth and it’s all profitable, right? We just don’t get to consolidate that into our numbers. And so it’s hard to see what’s happening in that market. However, using — continuing to use Wana as an example and I could use Acreage and TerrAscend as well, in the quarter Wana opened up the market in Nevada.

So they continue to expand their business, continue to grow their business, continue to drive increased profitability, which will consolidate into our P&L upon permissibility. So and I could again make the same case for Acreage, which has its third consecutive quarter of profitability. They’ve opened up Ohio in a big way and they just continue to do all the right things to position their business well.

And so they can — each of these businesses continue to drive value creation in their businesses, which ultimately accrue to us upon permissibility. And so who knows when we’re going to hit a permissibility event. I think we’re seeing a lot of — continue to see a lot of positive momentum and it’s certainly in my view a question of when, not if, but we’re just not waiting. With this THC — U.S. THC infrastructure that we put in place we’re continuing to create value. Those companies are continuing to create value that accrue to us when we get to the permissibility event.

Operator

Your next question comes from Doug Miehm from RBC Capital Markets. Please go ahead.

Douglas Miehm — RBC Capital Markets — Analyst

Thanks very much. Yeah, I just wanted to follow-on some of the conversation as it relates to the premium market in Canada and maybe what you could delineate for us is, could you talk about the size of that market on a market share basis right now? And where you might think that could go to over the next year or two taking into account more mature markets in the U.S.? And I really like you to spend a little time, if it’s possible just walking through what’s going on in the Craft side of the market because they originally took 20% of the market. And recently they’ve even taken more when most people believe that they would start to reverse at some point and that may still occur. But I just want to get your thoughts on what you see happening in the market over the next year or two? Thank you.

Judy Hong — Interim Chief Financial Officer

Yes. Hey, Doug. Thanks for the question. So I’ll provide some color on market share and I’ll turn it over to David just to give a bit more color on our strategy. But when you look at the flower category, I think certainly as we’ve talked a lot about the value flower segment in the past, premium is a sizable category in the market, right? So when you kind of look at the total flower market, the value store around 50%. But when you look at the premium mainstream, again it’s a 50% of that remaining market and our expectation is that premium flower segment is going to be the growth driver of the flower category growth going forward.

So we’re looking at premium really to drive that growth in the segment of the market. And I think that is going to be a function of a lot of these new genetics and new strains coming into market and and frankly those drive that excitement from the consumers. I think the consumers are still trying to find their footing where a lot of that sort of churn is happening in the marketplace, but I think as we focus really on the premium strains and the new genetics that we’re bringing to market that is going to really allow us to win in that part of the market. Dave, do you want to?

David Klein — Chief Executive Officer

Yeah. And so, just a couple of just maybe concepts that we think about a lot. I believe over time the cannabis market will look a lot like other CPG categories where there is a sizable and growing premium segment and a sizable and potentially shrinking value segment over time, once you get to total market build-out. And we like what we can do at the premium end of the market. We get to be more innovative, we get to create better offerings for our consumers. We get to charge more for them and so it’s just an area that we want to focus instead of chasing things all over the market.

And your Craft comment is fascinating because I probably said in a seat where I think that Craft probably ends up being and you see this in other markets like say, beer, Craft will end up being a sizable share of the market, 15% to 20% of the market over time. But what I love about what’s going on with Craft right now is some of the genetics activity that’s happening in the marketplace and we’re looking to partner with Craft players through our 7Acres Craft Collective and a couple of other initiatives that we have going on. We just think it’s — I think it’s good for the market and I think it’s ultimately going to be good for Canopy and so again, it’s going to be fascinating to watch this unfold. But I think premiumization is a trend that we clearly want to participate in, in a big way.

Operator

Your next question comes from Andrew Carter from Stifel. Please go ahead.

W. Andrew Carter — Stifel Financial Corp. — Analyst

Hey, thanks, good morning. So I was a little confused about the kind of this quarter, showing kind of improving revenue growth. You were down 3%. I think you mentioned an acceleration last quarter. You were down 8% this quarter. So kind of confused on that. And then second point, could you give us any guard rails around where the fourth quarter is going to shake out on an absolute basis? I know the C3 headwind — will they decline/accelerate before improving, will improve? Just anything to help us out. Thanks.

Judy Hong — Interim Chief Financial Officer

Yeah, I’ll start with my comment, Andrew. So I’d say the comment around improvement is — obviously, when you take a step back and kind of where we’ve been in our business and a lot of actions that we’ve taken in Q3 to really drive distribution gains in our U.S. CBD and CPG businesses, really premiumizing our portfolio in the flower side in Canada and getting new products to market from a Canadian recreational market standpoint. All of those actions, we feel, are starting to stabilize our revenue performance for the overall company. Admittedly, I think the Canada market is still trying to find its footing.

And we do expect more improvement as we get more supply into the market, but I think a lot of the actions that we were taking certainly showing up in the record quarterly performance for BioSteel, record quarterly performance for S&B. So I do think that the actions we’re taking are driving the intended performance on an overall basis. As it relates to Q4, I think I gave a lot of the colors in my prepared comments. I think for Canada, it’s a combination of when can we get the supply of our premium flower in market and as we said earlier, that’s going to be phased over the next couple of quarters.

I think you have to just recognize that some of the headwinds in the marketplace as it relates to COVID, right? You’ve got retail stores and this is not the restrictions from the government, it’s really around staffing shortages because of the Omicron issues and so forth. So you’re seeing some of that intermittent closures. You also have some of the restrictions on consumers entering some of the stores in certain provinces. So we just want to make sure that there is a recognition for some of the headwinds.

For C3, as I called out earlier they generated about CAD16 million in Q4 of last year. Over the course of this year C3 contribution has become less and less as we faced some of that competition in the marketplace. But again, we have to lap that sale from that perspective. And then I think for the bright spots in the quarter will continue to be scaling up BioSteel and getting distribution and then obviously Storz & Bickel continuing to see good momentum with the new products that they rolled out.

Operator

Your next question comes from Michael Lavery from Piper Sandler. Please go ahead.

Michael Lavery — Piper Sandler — Analyst

Good morning. Thank you.

Judy Hong — Interim Chief Financial Officer

Hey, Michael.

Michael Lavery — Piper Sandler — Analyst

It sounds like it’s the right move to reset some of the thinking around your revenue targets and at least walk before you run and adjust the cost accordingly. It sounds like a lot of that planning to that reset to have a new plan is still in the works. But can you give us a sense of either when profitability might be in sight? You talk about it for the Canadian business. Would that also translate to the total company or is it really just focused on Canada in isolation? And if you’re not ready to give timing for that yet should we at least expect to hear that, like, next quarter or maybe timing for the timing?

Judy Hong — Interim Chief Financial Officer

Yeah, Michael. Look, as I said earlier, we are currently going through our annual planning cycle, right? So we got this planning cycle that’s underway. As we complete the annual planning cycle, we will share more details likely in our next quarterly earnings call around some of the key milestones that we’re really focused on and in providing some of the details. If you just take a step back as we said earlier, we do really focus on Canada becoming profitable but there are strategic growth areas that we really are excited about, and you see that in the performance of BioSteel.

So we do want to continue to invest behind BioSteel and then obviously U.S. THC strategy where to David’s point, we don’t get credit for any revenue or profit contribution, but we think this is really the — potentially the great long-term opportunity for Canopy shareholders. So investing in that THC strategy right now we think is the appropriate course of action. So all of those are kind of how we think about from a high-level standpoint, but we will share more details in the next quarterly call.

Operator

There are no further questions at this time. You may please proceed Mr. Klein for final remarks.

David Klein — Chief Executive Officer

Yeah. So thanks again for joining us today and appreciate the thoughtful questions. So in summary, we’ve developed a clear strategy that will deliver a path to profitability for Canada by focusing on areas where we have a right to win with premium brands backed by operational excellence and scale through unparalleled distribution. There’s never been a better opportunity to invest in Canopy. We’re building something unique in the cannabis industry and our true value has yet to be realized. I look forward to updating you at the end of Q4 on our progress against these ambitious plans and our path ahead for FY ’23. Our Investor Relations team will be available to answer any additional questions. Thanks again and have a great day.

Operator

This concludes Canopy Growth’s Third Quarter Fiscal 2022 financial results conference call. A replay of this conference call will be available until May 10, 2022 and can be asset accessed following the instructions provided in the company’s press release issued earlier today. Thank you very much for attending today’s call and enjoy the rest of your day. Good bye.

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