Canopy Growth Corp Q4 FY2020 Earnings Call

Good morning. My name is Denise, and I will be your conference operator today. I would like to welcome everyone to Canopy Growth Fourth Quarter Fiscal 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. I will now turn the call over to Judy Hong, Vice President, Investor Relations. Judy, you may begin the conference call.

Thank you, Denise, and good morning, everyone. Thank you all for joining us today. So, on our call today, we have Canopy Growth’s CEO, David Klein; and CFO, Mike Lee. Before the financial market opened today, Canopy issued a news release announcing our financial results for the fourth quarter and fiscal year 2020 ended March 31, 2020. This news release is available on Canopy Growth’s website under the Investors tab and has been filed on EDGAR and SEDAR profiles. Please note that our fourth quarter and fiscal year 2020 financial results presented in the press release issued earlier today, and to be discussed during our conference call today has been prepared in accordance with U.S. GAAP. I would like to note that certain matters we discuss in today’s conference call could constitute forward-looking statements that are based on assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements, including as a result of the factors described in the cautionary statements and Risk Factors included in the Company’s earnings release and regulatory filings by which any forward-looking statements made during the call are qualified in their entirety. Risk factors that could affect results are detailed in the Company’s most recent annual information form and other public filings on the Company’s EDGAR and SEDAR profiles, and will be described further in our annual report on Form 10-K for the fiscal year ended March 31, 2020. Further, during this call, we’ll refer to supplemental non-U.S. GAAP measures, which are not recognized under U.S. GAAP that are defined in the press release issued this morning and will be described further in our annual report on Form 10-K for the fiscal year ended March 31, 2020. We believe that these non-GAAP measures assist management in planning, forecasting and evaluating business and financial performance, including allocating resources. Reconciliations of these non-GAAP measures to their closest reported GAAP measures are included in our earnings press release furnished to the SEC. Please note that all financial information is provided in Canadian dollars unless otherwise noted. Following the prepared remarks by David and Mike, we will conduct a question-and-answer session during which questions will be taken from analysts. To ensure that we get to as many questions as possible, we ask analysts to limit themselves to one question. Now, with that, I’ll turn the call over to David.

Thank you, Judy, and good morning, everyone. We have a lot to cover this morning. So, we’ve provided a supplemental earnings presentation to help you follow along with our call. We’re operating in unprecedented circumstances due to COVID-19. On behalf of our entire Company, our thoughts go out to all who’ve been impacted by this global pandemic. We sincerely thank those who’ve been working to keep all of us safe. And we also want to recognize the work of all of our employees, suppliers, customers, and retail partners during this difficult time. From Canopy’s standpoint, from day one, our number one priority has been to keep our employees and customers safe and healthy to ensure business continuity and to support the communities in which we work. A majority of our non-production related staff continue to work remotely. And we had a COVID response team handling daily issues, closely coordinating with myself and my senior management team. In our retail operations, we temporarily closed down our 22 corporate-owned retail stores in mid-March. But, as of today, 20 of those stores have reopened and the final two will reopen this coming Monday. We successfully rolled out click-and-collect to all of our Tokyo Smoke and Tweed stores as well as home delivery for nine of our Tokyo Smoke and Tweed partner stores in Ontario. For our production facilities, we implemented a daily screening process at the beginning of March. And we’ve added additional safety and social distancing measures at all of our facilities. Luckily, we’ve seen only minor disruptions to date, mostly related to staff scheduling. Our supply chain is in good shape, having had ample inventory of consumables on hand pre-COVID and ensuring continuity of production thus far. A key pillar of Canopy’s culture is giving back. We’ve donated over 75,000 pieces of personal protective equipment to be used by frontline workers in various provinces and local organizations across Canada. And I’m proud that BioSteel has pledged up to $2 million worth of its Hydration Mix products to frontline workers, hospitals, and patients, while This Works is providing hand sanitizers to homeless shelters. The U.S. team has also supported nurses in various hospitals by donating First & Free CBD products. Turning to our business, our Q4 performance was mixed. Our top-line performance didn’t meet our expectations and we lost market share in the Canadian recreational market. On the positive side, we finished the full year with 76% year-over-year growth and reduced our cash burn. Mike will walk through our financial results in more detail. Over the past couple of months, we moved our business forward with the launch of a number of new products globally with more to come. First, we have three ready-to-drink cannabis beverages in the market in Canada: Tweed Houndstooth and Soda; Tweed Bakerstreet and Ginger; and Houseplant Grapefruit. As the latest update, we began shipping Deep Space this week. Early response from consumers for all of our beverages has been very positive. In fact, Tweed Houndstooth and Soda was the number one selling cannabis beverage in Ontario in April. And let me share with you some quotes from a recent online review of Tweed Houndstooth and Soda. 'I love the taste, minimalistic but complex, similar in taste to Hendrick’s Gin and Soda. Really nice effervescence and botanicals.' And a second quote: 'It was like drinking one beer, same kind of mild buzz.' In addition, we now have several vape products in the market. In Q4, the JUJU Power 510 battery was our top-selling accessory SKU in our own stores. We also launched 510 vape cartridges under the Tweed in Twd brands. Our Tokyo Smoke Luma pod-based vape devices, Luma Go pods, and Pause pods are also available in the Canadian recreational market. We’ve expanded our chocolate offerings and now have four SKUs in the market, and we doubled chocolate production capacity last quarter. In the U.S., we broadened our First & Free portfolio, introducing a new line of hemp-derived CBD creams. This Works launched a line of CBD Booster skincare which are currently available through direct-to-consumer channels in the UK and the U.S. Just late last month, This Works also launched its stress-free hand sanitizers, which led to the best e-commerce selling day on the This Works site on the day it was launched. Since our last earnings call, we’ve made several changes to our operations aimed at improving our focus and rightsizing our cost structure. We’ve reduced our production capacity in Canada by 40% by closing down our two greenhouses in British Columbia as well as an indoor facility in Saskatchewan. We shuttered a hemp farming operation in New York. We transferred all of our operations in Africa to a local partner and are moving to an asset-light model in Colombia. We’ve significantly reduced our headcount. Finally, our strategic review of the business is 100% on track and our change agenda is already underway. I’m going to stop here and turn it over to Mike to review our financial results. And then, I’ll come back with more details around our revised strategy.

Thank you very much, David, and good morning, everyone. I will begin my remarks with a brief summary of our financial results for the fiscal year ending 2020. As part of this discussion, I will review the details of our restructuring program that was announced in March. I will then provide a brief overview of the COVID-19 impacts on our business and what this means for Q1 of our new fiscal year. So, with this, let’s jump into the financial results for fiscal 2020. Let me first cover net revenue. With our first full year of recreational cannabis behind us, I’m happy to report that we generated $399 million in revenue or 76% growth versus the prior year. Despite year-over-year growth, we know we missed opportunities along the way as our supply chain grappled with some complex products and production systems and worked to gear itself against a dynamic market with shifting demand and evolving consumer preferences and, quite honestly, volatile ordering patterns. And these challenges continued into Q4 as we generated $108 million in net revenue, which was not only below our internal projections but was well below demonstrated demand. Simply put, we missed opportunities. The good news is that we are making changes to our operations and supply chain, some of which have already been announced and some of which will be discussed later today when we get into the strategy portion of our remarks. But for now, let me reassure you that we are focused on improving our agility and cost structure so that we can improve execution across our supply chain and deliver on the margin commitments to our shareholders. Notwithstanding the above, we are making progress on gross margins, and I’m pleased to announce that our adjusted gross margin in Q4 was 42%, after excluding one-time restructuring costs and inventory step-up costs. We are seeing margin accretion as our diversified portfolio of strategic business units continues to grow, and this is clear demonstrated progress against previous communications around achieving a 40% margin by year-end. Adjusted EBITDA in the fourth quarter was a loss of $102 million versus a loss of $97 million last quarter. Free cash flow in the fourth quarter of fiscal ‘20 was an outflow of $305 million, which is a 15% improvement over the third quarter of fiscal ‘20. Let me briefly cover our main channels of business. Our global medical revenue increased 6% versus Q3, driven by strong international growth of 11%. We’re continuing to see strong growth in both, our international flower business with sequential growth of 14% and C3, with sequential growth of 10%. Our Canadian medical business was flat, even though more consumers are purchasing cannabis in the rec channels. Our other strategic businesses collectively performed in line with expectations, lapping the seasonal benefits of Q3, which included the November and December holidays. Conversely, our rec business experienced sequential decreases in both B2B and B2C channels. Our B2B gross sales decreased 31% as growth in soft gels and oils was more than offset by declines in flower and pre-rolls as we witnessed a number of changes in the marketplace. We estimate that our market share decreased from the low-20s to the high-teens. Given the importance of this category, let me make four points. Number one, the low-end flower category came on strong in Q4, taking greater share of the overall flower category, and we did not move quickly enough to the changes in the market. This will be addressed in the coming weeks, as we expect to be competitive in the value category. Number two, despite our progress in shifting more of our cultivation to high THC strains, we continued to miss purchase orders due to high THC product availability. We’re working to address this but we are simply bound by the lead times of our harvest cycles. Number three, following an exhaustive review of our portfolio, we’ve recently rationalized our SKUs by approximately one-third. This is going to improve our agility as a supply chain, increasing our ability to meet demand while also reducing costs and complexity. Lastly, number four, our phased rollout of 2.0 products hindered our Q4 sales performance as 2.0 items collectively represented less than 2% of our sales. Although we recognize this significant headwind to our performance, we are committed to phasing these products into the market to ensure that we maintain the quality that our consumers demand while being able to produce enough product to fill the pipeline. We are making progress, as illustrated by our quarter-to-date sales in Q1, where 2.0 products are now greater than 9% of our sales. In summary, we are taking actions to improve our B2B performance. Our B2C sales decreased 14% versus Q3, primarily due to COVID-19 store closures in mid-March. We estimate same-store sales would have been up 4% after adjusting for store closures. Before I move to restructuring charges, let me briefly cover our operating expenses. Overall SG&A increased 17% over the prior quarter as we continue to ramp up our U.S. CBD business while also launching our new 2.0 products. We’ve taken actions to right-size our cost structure to match the expected market opportunity over the next 12 to 24 months, and you’ll start to see the benefits of these actions in our Q1 results. Next, let me provide some details around our restructuring charge. In total, we recorded a $743 million charge, which is in line with the range of $700 million to $800 million that we announced in March. Of this total, $715 million was non-cash. This charge was primarily driven by fixed asset impairments of $563 million, of which $335 million was for property, plant, and equipment, mostly tied to the cultivation assets, and $193 million was for impairment of intangible assets, mostly tied to our exit from various international markets. We also recorded $132 million for inventory write-offs related to obsolete packaging, flower, and biomass inventory across our North American market. Finally, we recorded share-based compensation expenses related to acquisition milestones of $33 million. As David mentioned in his first month, it’s critically important that we align supply and demand, and this restructuring program addresses that. I should also highlight that we have many options to increase our supply, including outdoor growth, offtake agreements, and continuous improvement initiatives within our own facilities to further optimize supply. We are adequately positioned to take advantage of forecast growth in demand over the next several years. Next, I’d like to share how COVID-19 is impacting our Q1 performance, starting with Canada. Our Canadian B2B recreational business has been impacted by reduced traffic to physical retail stores due to social distancing. In the case of Ontario, cannabis was temporarily moved from essential services to non-essential services, which resulted in physical store closures from the beginning of April through May 19th. Key provinces, including BC, Alberta, and Ontario, have undertaken rebalancing actions of their inventory levels, looking to hold only six weeks of supply instead of 12 to 15 weeks prior to COVID-19. This has resulted in lower purchase orders and replenishment to their warehouses. Quarter-to-date, our B2B business is seeing a 15% reduction versus a rolling 13-week average during the six months ended March 2020. Our Canada B2C business has been more heavily impacted, as the majority of our corporate-owned retail stores are now open but currently operate on a click-and-collect model and with reduced hours. Through the first eight weeks of Q1, our B2C business is seeing approximately a 50% reduction versus the same 13-week rolling average relative to the six months ending March 2020. Conversely, our Canadian business benefits from a proven e-commerce channel, and sales have reverted to pre-COVID levels and have been quite stable in recent weeks. Furthermore, our international medical business also operates on a pharmacy model, and thus far, the negative impact of COVID-19 has been modest. Our other strategic businesses are seeing a 20% to 40% reduction versus their average sales during the six months ended March 2020. Looking broadly, given the challenges we’re facing to our top line, we are taking measures to limit our spending, flex down our staffing, and defer or cancel non-binding commitments where possible. Considering that around 50% of our production costs are fixed, we do expect margin pressure in the coming quarters as we lose some of our economies of scale. In stress-testing our business, let me remind investors that we have a strong balance sheet with nearly $2 billion in cash at the end of the fourth quarter, plus an additional $245 million of cash inflow from Constellation Brands’ exercise of its November 2017 warrants. With these actions, we believe our Company will weather COVID-19 and emerge stronger on the other side. Before I close, I’d like to provide a brief update on a few priorities that I previously highlighted during our quarterly earnings call. On SAP, I’m happy to report that we launched SAP in the U.S. under budget and ahead of schedule. In fact, this was the first go-live our third-party implementer ever completed in a virtual setting as a result of COVID-19. Our experience with SAP was so positive that we’ve elected to re-sequence our global rollout, focusing on Canada next. This will provide Canopy with a single North American ERP solution that will allow us to drive down costs and increase agility. On our control environment, we have made tremendous progress in our internal controls over financial reporting. We recently remediated our longstanding material weakness on end-user computing while also reducing the number of significant deficiencies in our financial reporting processes. Our control environment continues to improve. On financial reporting, we recently completed our conversion to U.S. GAAP and will meet our timelines as a large accelerated filer with our first-ever 10-K filing on Monday. We have provided adjusted EBITDA under U.S. GAAP for prior quarters in our press release. This concludes my remarks. I’d now like to turn the call back to David for a review of our recently completed organizational and strategic review of the business.

I’d like to spend some time talking about our refocused strategic plan. I know we won’t be able to cover it all here today, so we’ve also scheduled a virtual investor meeting for June 22nd to provide more details. Last quarter, I announced my intention to rapidly complete a strategic review of our business. Since that announcement, the Canopy team has worked hard to clearly define a path forward that enables us to deliver on our objective of being the world’s best cannabis company. I’m pleased to report the analysis is largely complete and has the full support of our Board of Directors and our largest investor, Constellation Brands. We are building the best cannabis company in the world, where we will use world-class consumer insights to inform our already existing best-in-class R&D and science capabilities to produce high-quality products for each need state and each price point, and to deliver them to consumers as efficiently as possible. Over the past four months, I’ve done a deep dive into Canopy’s operations and organization. As we all know, Canopy grew quickly to achieve a leading position in a rapidly expanding industry. During that time period, being first was clearly rewarded. However, being first isn’t a sustainable strategy or a point of differentiation, nor is it necessarily tied to creating value. This is especially true in a sector where markets have taken longer to develop than was originally and perhaps optimistically expected. The strategy of being first in all areas is no longer relevant. Second, in line with the former strategy, the organization’s size and scope increased dramatically. Canopy went from 400 employees in Canada to more than 4,000 employees in 15 global markets in just a few years. While this was a great talking point that came with great consequences, the Company became less agile, siloed, and was burning too much cash. We’ve already taken decisive actions to bring some much-needed focus. We designed a new operating model that will focus on the consumer and will increase our speed and agility as an organization. We’ve adjusted our organization structure to deliver that strategy and are ensuring we have the best talent in the industry. We’ll focus on three core markets and are taking meaningful steps to redeploy our resources to these geographies: Canada, the U.S., and Germany. We’ve made substantive reductions to headcount, divested redundant production assets, and exited some markets to reduce our cash burn and increase our focus. This is not a quick transition but the beginning of a journey that will put us firmly in the ranks with the top consumer product companies in the world. The cannabis industry is still in its infancy, and we intend to lead the growth in the evolution of this industry. I believe we need to continue to invest in R&D, consumer insights, and route-to-market capability while we become as efficient as we can in all other areas of the business. These changes can’t be implemented overnight. Coupled with a five-month grow and production cycle, it will take time for our results to become apparent. Over the past few quarters, we’ve been slow to react to changing market dynamics and consumer preference shifts in the developing markets in which we participate. It’s my intent to ensure that we don’t repeat those mistakes going forward. We think there’s a huge demand from existing legal customers. We intend to know what we need to do to win their business away from our competitors. We are also aware there are many consumers who prefer to purchase from the illicit market. We intend to learn what we need to do to win their business. We believe there’s a significant set of consumers who don’t currently use hemp for cannabis products, and we intend to know what we need to do to win their business as a substitute for alcohol or as a replacement for over-the-counter medicines that address pain, anxiety, and sleep. To do all of this, we’re building world-class consumer insights and analytics capabilities. To lead this function, we’ve created the role of Chief Insights Officer, a new C-suite position that will report directly to me, ensuring we leverage data as a core differentiator. Chris Edwards, a proven executive from Constellation Brands, who led the analysis that drove Constellation into the cannabis space, has accepted the role and will start next week. Today, we have what I believe is the best science and R&D capability in the industry. This talent has been diffused across too many initiatives. We want to focus that capability using the insights I just described, to develop solutions that inspire our consumers. To lead this newly combined science, innovation, and R&D function, we’ve created the C-suite role of Chief Innovation Officer. I’m pleased to announce that we brought on Julian Cohen in this role. Although Julian is in his first week at Canopy, he’s not a stranger to us, as he worked closely with the team that developed our Deep Space and Quatreau beverages. Turning to our focus markets. The three markets that have the largest and most tangible profit opportunities in the near term are Canada, the U.S., and Germany. Our resources will be focused against these three markets, while we operate with asset-light models in places like APAC and Latin America. This means we will not be seeking geographic expansion. In the medical segment of our business, our focus will be on meeting the needs of our existing medical patients, generally addressing the wellness category and creating substitutes for medications for pain, anxiety, and sleep. This means we will not focus on developing pharmaceutical products. Given the relative maturity of the medical markets around the world, we believe Canopy is already well-positioned to lead in this segment and we generate significant growth in the near-term in the medical segment. We need to build highly effective routes to market in each of our core markets. We, therefore, initiated a search for a Chief Commercial Officer who will work with me in driving sales across the Canopy portfolio and ensuring we have the right products in the right place at the right time. We’re transforming our supply chain to be more agile and responsive to changing consumer preferences. I believe there’s an opportunity to unlock significant cost savings in our supply chain. We also recognize the need to consistently deliver higher quality experiences for our consumers. Quality, in this context, means quality as measured by the consumer. This includes attributes such as the right amount of THC in a product, optimal moisture levels in our flower products, the burn of our pre-rolls, the taste of our edibles, and how our consumers experience our drinks in terms of onset time and effect. The work is well underway, and we’ve initiated the search for a new Chief Operations Officer who will lead us to greater agility and expanded margins. To drive this product-led approach to the market, I’ve asked Rade Kovacevic to assume the role of Chief Product Officer. Rade has held several important roles at Canopy over the past five years. He is a well-known proven leader in the industry, with an unmatched understanding of all aspects of the cannabis industry. I’m looking forward to seeing the results of his leadership in this function. Those of you who attend our virtual investor meeting will have access to the talented executive team, so that you can hear from them how we plan to bring the strategy to life. These are ambitious goals, and our work has just begun. For that reason, expect fiscal ‘21 to be a transition year as we rapidly evolve. Additionally, given the COVID-19-related uncertainties, we’re withdrawing our previously communicated milestones for achieving positive EBITDA and net income. It’s our intention to provide new financial targets during the second half of fiscal ‘21. We also plan to report on our progress against our key strategic priorities in upcoming quarters. In the interim, let me offer a perspective on how our strategy will connect with our financial aspirations. Our objective is to be number one or number two in value share within our core markets: Canada, the U.S., and Germany; and in our focus product categories of flower, vapes, edibles, beverages, and topicals. Canada and the U.S. are already massive markets. Canada’s legal recreational market is already at about $2.1 billion and growing month over month, and this was with just 60 stores in Ontario, which is Canada’s largest province. Behind Tweed and Tokyo Smoke retail banners, our production scale, and our best-in-class 2.0 products, Canopy’s Canadian revenue will grow substantially. The U.S. CBD market is already a large industry, and leading projections see it becoming a $10 billion industry over the next few years. We plan to win in this space. With our collaboration with Martha Stewart or with brands like This Works and BioSteel, we expect to deliver on the promise of advanced CBD products in this lucrative U.S. market. So, between the U.S. and Canada, there’s tremendous revenue opportunity for Canopy over the next two to three years. When added to the continued growth in the German medical market, we see immense near-term opportunity for Canopy. This opportunity will be supplemented upon federal permissibility in the U.S. through our acreage arrangement. I’m pleased with our gross margin progress. Getting to 40% was the stated objective, and we made good on it. We know we can do even better as we optimize our supply chain. We are going to do a deep dive, end-to-end review of our operations, and we believe there’ll be significant opportunities to unlock efficiencies across that supply chain. Finally, we have the balance sheet strength to responsibly invest in the right opportunities while maintaining our financial cushion. We remain resolute in our effort to reduce our cash burn and will emerge from this transformation period with a significant amount of cash that can be deployed to further enhance shareholder value. We expect these actions to enable us to deliver significant profits over the medium term. We’re well-positioned to unleash the power of cannabis to the benefit of our consumers and our shareholders. This concludes our prepared remarks, and now Mike and I are happy to take your questions.

[Operator Instructions] Your first question comes from Doug Miehm with RBC Capital Markets. Your line is open.

Yes. Good morning. What I was hoping to do is just go over your thoughts on the U.S. market. I know you’re very familiar with the opportunity there, indicating that it could grow to $10 billion over the next little while. Relative to your share in Canada, how would you expect your share in the U.S. to change over the next several years, and why?

So, we launched an expanding line of products under our First & Free CBD brands in the U.S. We have more SKUs and brands coming to market over the next several months. I would say we expect to take meaningful share in the U.S. CBD market in the categories in which we participate. You have to think about CBD as playing across a number of areas. So, there are ingestibles, which First & Free is quite likely the best product in the market as it uses a very specific formulation that outperforms the competitive set. That’s a growing segment in the U.S. CBD market. The second area we participate in CBD is through BioSteel, our sports nutrition company, where we’ve added CBD to help recovery in athletes. We expect to do extremely well in that area. The largest category, however, in the U.S. market is in skincare and topicals. We have First & Free topicals and This Works skincare and topicals in the marketplace, but that’s an area that will be more challenging for us and take us longer to establish a toehold due to some sizable and well-recognized competitors in that space. But I expect us to grow meaningful share in the U.S. We’ve been investing in the U.S. to position ourselves for that work. That investment puts a little drag on our operating margins and increases our SG&A load, but that’s the benefit of having a $2 billion war chest. Some assume that should cover M&A activity, but I believe it should also be used to position us in the markets where we can see significant growth over time.

Your next question comes from Bryan Spillane with Bank of America.

I guess, the question I had, David, stepping back, looking at ‘21 where there’s a lot of internal work you’re doing now to sort of rewire the organization and make it more efficient. At the same time, I think you talk about the aspirations for market share in the three priority markets? And I guess, my question is, considering that when companies go through massive internal changes, it sometimes has an effect on the external. So, is it reasonable to expect that you’d be able to meet those market share aspirations in ‘21, given all the work you’re doing internally, or are you looking more at accomplishing that as we get past this transition year?

So, Bryan, that’s partly why we’ve elected to withdraw our guidance, because between COVID-19 and the work we’re doing, we need more time to provide well-thought-out guidance on our financial outcomes. You used the term 'rewire' accurately, because that’s what we’re doing in the organization. It’s not simple to come in and cut costs everywhere and feel good about it. I’m optimistic that we can continue at the 76% top-line growth rate. What I don’t want is to cut the organization at the expense of our top line, so we’re seeking balance. You’ll see volatility, but we’ll make progress against market share and profitability objectives amidst some volatility as we navigate the significant changes.

Your next question comes from Vivien Azer with Cowen.

I appreciated the detailed rundown on the specific drivers of some of the market share weakness in the quarter. What caught my attention was your commentary around addressing the explosive growth in value that happened sooner than you expected. It sounds like you might have a value offering coming. What we see as a competitive step is the wide array of outcomes. Arguably, there’s now a value segment and a deep value segment, clearly which has different margin implications. So, a two-part question, please. Number one, can you expand on your commentary around your intentions regarding value? And then number two, how are you thinking about margin?

Yes. That’s great. Thanks, Vivian. So, just taking a step back. We shouldn’t be surprised as an industry that value is taking off. Value was 6% of the category not more than four or five months ago, and it’s now over 20% of the category. When you think about how we got here from a surplus perspective, the root cause is that the number of stores in Ontario and broadly in Canada did not open quickly enough, leading to various LPs working to balance their inventories. The rise in value, although it happened quickly, is replicable. We focus on the four Ps of marketing: getting good quality products at a great price, ensuring national distribution, and keeping the product in stock. Our job now is to ensure we can be competitive in the value market. The Twd brand has been our value offering, and while we’ve been at the top end of the value price range, we believe we can compete in the lower end as well. We’re investing in becoming competitive in value and anticipate making strides soon. However, delivering higher margins in value will be more challenging. We want to engineer outdoor growth in our supply chain to achieve those targets for the low-end segment, but we also recognize the importance of this category.

If I could just add a tenant strategy overlay, Vivian. The move toward value is and was predictable in terms of using it to generate cash. We have excess inventory as virtually all LPs do. Our aim is to create offerings that have the right quality, appropriate THC content, and the right price and margin so we can sustainably compete for the illicit market. That’s a key part of our strategy moving forward.

Your next question comes from John Zamparo with CIBC. Your line is open.

Thanks. Good morning. I appreciate all the commentary on value and the pivot in strategy there, but can you talk about your mainstream and particularly your premium products? What do you see in terms of share in that regard? If the value segment is as crowded as we all think, do you plan to rely on premium flower or pre-rolls or prioritize 2.0 products to drive share further?

I’ll start and then, Mike, you can fill in. Our business is organized by verticals: flower-based edibles, which includes beverages and topicals and skincare. We intend to ensure strong performance across all those verticals, including flower. Part of the necessity is to ensure we remain on the shelf consistently, as many LPs have challenged stock presence. We’re prioritizing supply chain work to allow for this. Our focus is shifting to consumer quality and ensuring that we provide differentiated high-end products. I expect the cannabis market will bifurcate similarly to many other CPG categories over the past few years, with participation at both high and low ends!

David, I’d just build on that and say we’re very happy with our portfolio in the high end. The high end continues to grow. I know that value is taking share overall, but the high-end part continues to grow. Our biggest opportunity from a share perspective is supply stability, which is our top focus.

Your next question comes from Andrew Carter with Stifel. Your line is now open.

Good morning. I appreciate you outlining the business challenges, but it’s clear you missed purchase orders on THC and haven’t remained competitive on pricing. One key to near-term improvement would be getting your 2.0 products on shelves, especially with some disruptive initiatives like proprietary pod-based systems and beverages. Can you help us understand how receptive retailers will be to giving you shelf space for this and the extent you’re willing to go to demonstrate this platform innovation?

Yes. There are about 100 SKUs in the marketplace for Cannabis 2.0 based on all of our competitive intel. We launched several SKUs year-to-date: four chocolate SKUs with Tokyo Smoke and Tweed; five vape SKUs with JUJU 510 battery in Q3; and our Tokyo Luma vape pens. We’ve launched three beverages so far with five more vape launches and four more beverages coming in Q1, Q2, and Q3. We’re getting distribution with minimal challenges, which is why we’re focused on the phased rollout strategy to ensure we maintain stock levels. It’s essential to avoid out-of-stocks that hurt brand affinity.

The key to gaining shelf space is to create consumer-generated demand rather than supplier-generated demand. This is why we’re enhancing our insights function to produce best-in-class products that meet consumer preferences. The goal is to motivate consumers to specifically request our products at retail, which we believe will enhance product uptake.

Your next question comes from Adam Buckham with Scotiabank.

I guess I have a high-level question regarding the Canadian market. One of the expected catalysts for the sector in 2020 was the planned storefront expansion in Ontario. Obviously, the timeline has changed, but do you think we will see the same number of stores open post-COVID as anticipated? There’s been a significant increase in approvals, but I'm curious if the current economic environment affects the plans of retailers to open stores soon?

We’re not hearing any concerns from our retail partners. In fact, some are pushing to accelerate openings. We’re seeing over 20 stores opening monthly in Ontario, and last month, about 18 stores opened. As a result, we’re forecasting store counts to rise from 950 to 1,200 for the year. I’m cautiously optimistic; we’ve been surprised before, but note that with only 60 stores in Ontario, it is now the biggest buyer of cannabis in the industry.

Indeed, we are forecasting growth from 950 to 1,200. Given that Ontario stores are crucial to the overall industry, the acceleration of openings should benefit adjacent businesses.

There are innovations that we might not fully understand yet, but I believe will be positive; examples include direct delivery, click-and-collect, and increased customer engagement in stores. Changes brought about by the crisis may help create better consumer pathways to cannabis products over the medium term.

Your next question comes from Rupesh Parikh with Oppenheimer. Your line is open.

Good morning, and thanks for taking my questions. I want to drill down a little more on your operating expenses. As we look forward, given some of the actions you’ve already taken to rationalize your business, what’s the right way to think about the benefits on the operating expense line? What other initiatives are underway that could help reduce the run-rate we saw in Q4?

Yes, I’m happy to take that one. It starts with strategy. We’ve thought about how to improve our speed and agility and align our cost structure to position for growth, particularly with the expectation of achieving 76% growth year-on-year over the next several years. Sales and marketing had been a significant investment that was overextended given the slower store count than we expected. We’re focusing on SG&A load targeting through FY23 and making necessary adjustments to achieve that. G&A also provides a challenge with fixed costs, and we are cautious about reducing G&A while we implement efficiency-enabling measures like SAP. We’ll keep targets in mind, but balancing them against growth remains crucial.

I’d like to emphasize that we’re continuing investments in the U.S. due to the market size, while ensuring we maintain necessary innovation and insights capabilities. Although we’re focused on being lean in other areas, our organizational redesign work is still in progress.

Your next question comes from Graeme Kreindler with Eight Capital. Your line is open.

Hi. Good morning, and thank you for taking my questions. I want to follow up on the discussion about the strategic plan and what’s been done in Canada, Africa, and Latin America to-date, moving to a more asset-light model. You also mentioned that Canopy’s reached about 15 countries internationally. With the ongoing PP&E, intangibles, and goodwill balances, do you expect further restructuring decisions looking forward? If possible, could you quantify the timing and magnitude of those possible decisions?

Hi, Graeme. We’re very comfortable with our goodwill position, having completed our year-end annual goodwill assessment. Our market cap provides us with a cushion, but if our market cap decreases, that would trigger another review. As it stands, we feel our restructuring charges are behind us. We’ve successfully balanced our cultivation capacity to meet demand. The facilities we have are positioned to handle expected demand moving forward.

I believe our current investment in PP&E aligns with projected demand. While our facilities might be a bit overbuilt, they are state-of-the-art, and this structural overcapacity will help us efficiently fulfill future demand.

Your next question comes from Aaron Grey with Alliance Global Partners.

I want to get back to gross margins quickly. So, I know they improved Q-over-Q, helped by a mix partially due to flower and gross sales being down. What’s the best way to think about that in the near term, especially if flower and pre-rolls rebound? Even considering you stated 2.0 products have increased quarter-to-date? What are your expectations for pricing and margins within the 2.0 category as you see competitors increase their offerings?

Let me unpack that. In our overall Canadian infrastructure, our fixed costs are around 50% of our total costs. Looking ahead, I would not expect to see 40% margins over the next couple of quarters due to COVID impacts and fixed cost challenges. However, we aim to achieve more progressive growth on margins while maintaining tighter cost and operational control. Canada currently operates at a gross margin of roughly 28% to 30%, but we’re aiming for higher margins as we’ve launched an end-to-end review of operations. We recognize the opportunity to enhance efficiencies and shift to a higher-margin product portfolio.

In terms of pursuing growth in the 2.0 products, we expect them to gradually become margin accretive as we build volume with our offerings. The key is to unlock efficiencies in our supply chain while we target gross margin improvements.

Your next question comes from Michael Lavery with Piper Sandler. Your line is open.

Thanks. Good morning. I want to delve deeper into the market bifurcation you referenced earlier and tie it to the 76% growth you expect to repeat. Specifically, how do you see the middle market evolving? How does consumer behavior differentiate the demand there and what could exacerbate erosion or hinder stability?

Yes. I appreciate your inquiry. However, trends such as a consumer's trading down should be expected. To sustain demand in the mainstream space, it’s vital to maintain a solid value proposition. This aligns with our ongoing commitment to improve our margins. Looking at the growing consumer base, we aim to strengthen our standing in the mainstream segment with compelling value and quality propositions to be competitive.

We are still seeing the premium segment hold steady at about a third of consumer dollars being spent, and the mainstream remains a significant piece at 45%. While value has emerged robustly, the high-end and mainstream segments are similarly witnessing positive growth.

Your next question comes from Glenn Mattson with Ladenburg Thalmann. Your line is open.

Hi. Most questions have been touched on already. I'm curious about the international medical market, which has performed well. Can you give a bit of detail around pricing, the competitive landscape, and if anything has changed in the last three months?

The main point in Germany is we now have supply continuity. That’s been a challenge for us over the past 16 months since all product was being sourced from Canada, where regulatory steps created bottlenecks. We recently commissioned our Denmark grow facility and now have shipments feeding into the German market. Demand has been there; it simply has not been served. This year, we expect to prove our position in Germany, and our C3 business continues to expand both monthly and quarterly.

This concludes the Q&A portion of the call. I’d now turn the call back over to Mr. David Klein.

So, thanks everyone once again for joining us. As I’ve met investors and discussed Canopy since joining as CEO, I’m struck that often people view our industry and product offerings abstractly. I encourage all investors in Canada to test our new drink products. In the U.S., I invite you to explore our First & Free CBD offerings. Everyone should be experiencing our BioSteel sports nutrition products and This Works products. I look forward to your feedback. Our Investor Relations team will be available to address any additional questions. We also hope many of you will participate in our virtual investor meeting on June 22nd. Have a great day.

This concludes Canopy Growth's fourth quarter and fiscal year 2020 financial results conference call. A replay of this conference call will be available until August 27, 2020, 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.