Canopy Growth Corp Q4 FY2022 Earnings Call

Good morning. My name is Alan, and I will be your conference operator today. I would like to welcome you to Canopy Growth’s Fourth Quarter and Fiscal Year 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. I will now turn the call over to Tyler Burns, Director of Investor Relations. Tyler, you may begin the conference call.

Thank you, operator. Good morning. Thank you all for joining us today. On our call, we have Canopy Growth’s Chief Executive Officer, David Klein; and Chief Financial Officer, Judy Hong. Before financial markets opened today, Canopy issued a news release announcing our fiscal results for the fourth quarter and full fiscal year ended March 31, 2022. 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 our discussion during this call will include forward-looking statements that are based on management’s current views and assumptions and that this discussion is qualified in its entirety by the cautionary note regarding forward-looking statements included at the end of this morning’s news release. Please review today’s earnings release and Canopy’s reports filed with the SEC and on SEDAR for various factors that could cause actual results to differ 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, where we will first address questions uploaded by verified shareholders using the Safe Technology’s platform, followed by questions from analysts. To ensure that we get to as many analyst questions as possible, we ask that they limit themselves to one question. With that, I will turn the call over to David. David, please go ahead.

Thank you, Tyler, and good morning, everyone. I appreciate you joining our call. Today, I will outline Canopy's strategy and the foundation we've established over the past fiscal year, along with the key achievements in fiscal '22 that support our priorities for fiscal '23. Judy will subsequently discuss Canopy's Q4 and fiscal '22 results and provide more details on our ongoing efforts to accelerate our path to profitability. In fiscal '22, we laid a strong foundation for growth and clearly identified how Canopy will seize the significant opportunities ahead of us as a company and within a developing industry. Canopy Growth is a premium branded North American cannabis company with a straightforward strategy focused on creating beloved brands in markets and categories that will drive industry growth with effective routes to market that meet consumer preferences, all underpinned by operational excellence. In fiscal '22, we achieved three main objectives to build this foundation. First, we enhanced our cannabis-branded portfolio in Canada. Second, we bolstered the distribution of our high-performing CPG brands in the U.S. And third, we took definitive steps to develop a competitive U.S. THC ecosystem. Regarding the enhancement of our Canadian cannabis brand portfolio, we maintained our market leadership in premium flower in Canada and, through improvements to our cultivation processes and facilities, we consistently produced both premium and mainstream flower that meet consumer demands. Our share of mainstream flower nearly doubled, reflecting our focus on premium cultivation extending to our mainstream offerings. We strengthened our premium cannabis portfolio by growing DOJA, the best of the West Coast, into a national brand with new flower, pre-rolled joints, and live resin-based products available throughout Canada. 7Acres continued to innovate and deliver industry-leading premium flower and infused pre-rolled joints, showcased through the Know the Grow series, offering insight into the talent, genetics, and cultivation techniques behind the brand and portfolio. Additionally, we rebranded our iconic Tweed brand, which coincided with new Tweed flower and pre-rolled joints that have received very positive consumer feedback. The updated design improved the identification of formats and strains for consumers, and the new packaging was designed to maintain freshness. We are also ensuring that Canopy has a clear road map for new genetics, supported by exclusive breeding rights with top craft growers. We've adopted best practices from the 7Acres facility and implemented drying capabilities at our Smiths Falls and Mirabel sites, alongside upgrades to feeding systems, air circulation, and humidity control in flower rooms, resulting in consistent high THC and other desirable product attributes. In the competitive Canadian adult-use market, we expanded our beverage portfolio with new flavors of Deep Space Limon Splashdown and Orange Orbit, and launched Tweed Iced Tea and Tweed Fizz self-serve beverage lines. The strong demand for these new beverages lifted Tweed to the number one market share among under 5-milligram THC beverages, while Deep Space became the fastest-growing and number two brand in the over 5-milligram THC category. We also launched new gummies under the Hero banners of Deep Space, Tweed, and Ace Valley, ranging from 2.5 milligrams to 10 milligrams with rapid onset. We are committing significant resources to our commercial initiatives in Canada through our budtender engagement program, as budtenders play a key role in influencing consumer purchase decisions. Our goal is to strengthen our relationships with budtenders through investments in educational resources and dedicated unboxing sessions. So far, we've had nearly 4,000 interactions with budtenders and have gathered invaluable feedback from this essential group. The second area of our work in fiscal '22 focused on enhancing the distribution of our high-performance CPG brands in the U.S. We continue to observe strong demand for Storz & Bickel’s popular vaporizers, including the new VOLCANO ONYX and MIGHTY+, contributing to Storz & Bickel's 22nd consecutive year of revenue growth. Their vaporizers set a standard for quality and performance, achieving recognition among both connoisseurs and mainstream consumers. Notably, the Storz & Bickel MIGHTY was recently featured by the New York Times for delivering the best tasting vapors among the portable vaporizers they tested. BioSteel experienced growth in distribution and sales velocity of ready-to-drink products, leading to a 50% revenue increase in fiscal '22 compared to fiscal '21. We believe this challenger brand is quickly emerging as a winner, showcased by Team BioSteel’s performance in the playoffs, including stars like Luka Dončić, Connor McDavid, and Andrew Wiggins. Lastly, I am pleased to share the actions taken in fiscal '22 that established a competitive U.S. THC ecosystem, enabling Canopy's swift entry into the U.S. market. Our model stands out from competitors, providing us with a unique position in the U.S. with THC assets such as Acreage, Wana Brands, Jetty Extracts, and a significant ownership stake in TerrAscend. Importantly, we are not waiting for U.S. legalization to begin capitalizing on these assets; we've already secured majority ownership in Wana and Jetty, with Acreage and TerrAscend providing valuable market access. All these entities are currently generating healthy profits. Our U.S. ecosystem has ample growth potential, particularly in significant markets. Acreage is well situated to thrive in key Northeast states like New York, New Jersey, and Pennsylvania, with Acreage and TerrAscend benefiting from the newly opened adult-use cannabis market in New Jersey. Our brand portfolio includes Wana, the leading cannabis edibles brand in North America, and Jetty, a top 10 cannabis brand in California and a top 5 brand in the vape category. Jetty's expertise in solventless vape technology has established its reputation in California's competitive cannabis market, positioning it for rapid national growth through Canopy's U.S. ecosystem. Jetty also provides a vital market access pathway in California, facilitating the introduction of our impactful Canadian brands, such as Deep Space and Tweed, to the market. We are actively working to introduce the Jetty brand and its innovative products to Canada, building on the success Wana has achieved as a respected premium U.S. brand in Canada, and we look forward to bringing Jetty to consumers there. When all these elements are combined, Canopy ranks among the top five cannabis players in North America. If we consider Canopy’s yearly revenue together with the reported revenue from our U.S. THC ecosystem, which includes Acreage, Wana, and Jetty, Canopy could exceed $1 billion in revenue with healthy margins. I firmly believe in the strength and competitive position of the U.S. THC ecosystem we are building. Canopy's unique model is set for rapid growth with a focus on prioritized markets, fast-growing categories, strong brands, and a balanced operational footprint. Now, I would like to discuss our strategic priorities for fiscal '23, which aim to build upon the foundation we established in fiscal '22. Our first priority is to enhance the performance of our Canadian cannabis business and achieve profitability as soon as possible. Judy will detail our margin improvement efforts, which are essential to attaining positive EBITDA, and there are many facets to this initiative. We must continue pursuing success in premium categories that drive higher margins, and we anticipate that our pipeline of new products launching in fiscal '23 will enhance our competitive positioning and, together with our efforts to engage retailers, will help us capture market share. Our second priority is to accelerate the growth of our promising CPG brands. We will strategically invest in marketing and new product development for our high-growth CPG brands, Storz & Bickel and BioSteel. There is significant potential for both brands, and our investments will focus on enhancing brand awareness and visibility among consumers and building a strong distribution channel. I’d like to emphasize that Storz & Bickel is already a $100 million brand with attractive margins, while BioSteel is the fastest-growing sports hydration drink in North America. Our goal is to elevate BioSteel to a top 5 position as we expand distribution through major retail partnerships. In U.S. CBD, we await the regulatory developments needed to fully unlock its potential. In the meantime, we are shifting our approach to emphasize a direct-to-consumer e-commerce retail model alongside key account partners, which is currently yielding success for our Martha Stewart CBD brand. Although this more focused strategy may lead to slower growth for our U.S. CBD business in the medium term, we remain optimistic that once clear regulations are established to support a national CBD market, our leading brands will perform well. Finally, we aim to strengthen our U.S. THC ecosystem. We firmly believe that investing in high-quality U.S. THC assets provides Canopy with the competitive position to succeed in the largest cannabis market and create substantial value over time. We have made these investments proactively for several reasons. We believe that the elements of our ecosystem complement each other. Most importantly, we possess strong heritage brands that are highly scalable for the burgeoning East Coast recreational market. Collaboratively, these companies will generate synergies that will drive substantial business growth for our ecosystem and increase shareholder value for Canopy. Furthermore, we continue to leverage our strategic relationship with Constellation Brands, utilizing their expertise to support the advancement of our U.S. strategy, particularly in commercial sales, marketing, and operations. In summary, over the past year, we have taken decisive steps to align Canopy, tailored our operations to market realities, and successfully refined our brand offerings to meet consumer desires and align with our growth vision. Ultimately, we aspire to maintain and strengthen what we believe is the industry's leading fully North American premium branded company. With that, I will now turn it over to Judy.

Great. Thank you very much, David, and good morning, everyone. I plan to focus my comments on a quick review of our fourth quarter and fiscal year 2022 results, discuss in detail the actions that we’re taking to advance our cost of profitability, and provide some perspectives on our fiscal ‘23 outlook. Let’s start with a review of our fourth quarter and our fiscal ‘22 financial results. In Q4, healthy performance in our CPG business was offset by softness in our Canadian recreational business and adjusted EBITDA was further impacted by continued gross margin challenges, despite a strong operating expense discipline. In Q4, we generated net revenue of $112 million, representing a 25% decline over the prior year. Excluding the impact from acquired businesses and divestiture of C3, net revenue in Q4 declined 26%. Details and drivers of net revenue in Q4 and fiscal 2022 are provided in the press release that we issued earlier today. Let me briefly touch on our Canadian recreational B2B revenue performance. In fiscal ‘22, we made a deliberate decision to transition our Canadian business to focus on higher margin mainstream and premium products. We deliberately chose not to chase low-margin value flower sales. And for cannabis companies transitioning your product mix can be challenging. As we continue to focus resources on actively pursuing low-margin value flower sales, our Canadian recreational cannabis business would have delivered significantly stronger revenue in fiscal ‘22, but at the expense of doing what was right, which was putting our Canadian cannabis business on a path to sustainable growth and profitability. I’m pleased that efforts to premiumize our business in Canada drove over 25% revenue growth in our premium brand with strong growth from DOJA and Deep Space brands during Q4. We also delivered a positive mix shift with premium and mainstream sales accounting for a combined 56% of Canada recreational B2B sales in Q4 of fiscal ‘22, up from 32% in Q4 of last year. Turning to gross margin. Our reported gross margin in Q4 was negative 142% and our adjusted gross margin was negative 32%, which excludes the impact of $4 million inventory step-up charges from the Supreme acquisition, as well as the $19 million charge, mostly related to inventory write-downs, resulting from strategic changes to our business. Now, similar to prior quarters, gross margin in Q4 was further impacted by lower production output and price compression in the Canadian recreational business, higher supply chain costs as well as inventory write-downs. Excluding inventory write-downs and payroll subsidies received from the Canadian government pursuant to a COVID-19 relief program, Q4 adjusted gross margin would have been negative 18%. Adjusted EBITDA in Q4 amounted to a loss of $122 million. I’d like to now take this opportunity to speak to the efforts underway to improve our profitability. As David mentioned, achieving profitability in our Canadian operation is a key priority for us, and we’ve taken additional steps to improve our gross margins and reduce our SG&A spending. First, on gross margins. Over the past couple of years, we faced three key headwinds for gross margins in Canada. One, lower production output, driven by reduced sales, is a significant burden on our fixed cost structure in our Smith Falls manufacturing facility. Second, a combination of an unfavorable mix and price compression, particularly in our flower business pressured net revenue and gross margin. And third, we incurred significant noncash costs that amounted to nearly $120 million in inventory write-downs in fiscal ‘22, which we did not exclude from our adjusted gross margin as well as adjusted EBITDA and $47 million of depreciation cost, which is included in our cost of goods sold. When adjusted for noncash costs and the benefits from payroll subsidy, our cash gross margins in the global Cannabis segment is estimated to be at 7% in fiscal ‘22. We expect our cash gross margins in fiscal ‘23 to improve significantly versus last year, driven by a few factors. First, our premiumization strategy. We anticipate continued shifts in our Canadian recreational sales to higher margin premium and mainstream flower and pre-rolled joints, edibles, beverages, and vapes. Second, our cost savings program should drive reductions in our cost of goods sold. Our cultivation productivity initiatives, including improvement in facilities, are expected to lower per gram cultivation costs. We’re also reducing indirect fixed costs in our operations as we move to a more flexible manufacturing platform by outsourcing production of certain products, and developing a number of productivity initiatives across manufacturing, supply chain and procurement. In addition, we’ve improved our demand forecasting process to ensure that we’re more agile in adjusting our production to reduce further inventory write-offs. Now, some of these savings are expected to be offset by higher wage inflation and supply chain costs, but we are committed to delivering savings of $30 million to $50 million over the next 12 to 18 months, and we plan to look for additional opportunities to capture more savings throughout this fiscal year. The other key initiative is reducing our SG&A expenses. During fiscal ‘22, we incurred $400 million of selling and marketing, G&A, and R&D expenses. Over the past few months, we took a hard look across all of our areas of our SG&A spending with the realities that our expense structure was too high to support our near-term revenue. This has resulted in several cost savings initiatives, which we expect will reduce our SG&A expenses by $70 million to $100 million over the next 12 to 18 months. Roughly half of the savings is expected to come from reduced headcount across our businesses, as we have further tightened our strategic focus and streamlined our business. The remainder is expected to come from lower professional fees, office costs, insurance fees, and IT costs. Let me now provide some perspectives on our financial outlook. Based on our fiscal ‘22 results, changes to our business mix, due in part to divestiture and continued volatility in the Canadian recreational market, we are removing our medium-term financial targets that were provided in February of ‘21. We also believe that shifting consumer preferences, low barriers to entry in the Canadian recreational market, and slow regulatory progress across Canada and the U.S. make it difficult for us to provide near- to medium-term targets. That said, we expect the execution of our premiumization strategy in Canada, our cost savings initiatives, and growth in BioSteel and Storz & Bickel will, over time, result in strong revenue growth, an attractive margin profile, and free cash flow generation that are in line with premium branded CPG companies. So with that in mind, let me offer some perspectives on our outlook for fiscal ‘23. First, we expect significant revenue growth from BioSteel as the team drives higher distribution and sales velocity, which is supported by sizable marketing investments in fiscal ‘23. We expect another year of solid growth from Storz & Bickel, building on a strong foundation with investments to increase higher awareness. Our Canadian recreational B2B business is expected to show improved performance as the benefits from premiumization strategy and new product launches with the growth weighted towards the second half of the year. Our Europe and Rest of the World business is expected to show strong year-over-year growth in medical sales in Germany, Australia as well as continued opportunistic bulk sales to Israel. Our U.S. CBD business will see a tighter focus against our brand with emphasis on the e-commerce channel and key direct-to-ship accounts as we will wait for further regulatory progress. From a phasing standpoint, we expect revenue growth on a year-over-year basis to be weighted to the back half, reflecting continued mix away from value flower that really began in earnest in the second half of last year, and the timing of our new product shipments in Canada. Second, we expect fiscal ‘23 to show significant improvement in our profitability, with expectations that this year being a transition year as we work towards profitability. We are already profitable in select areas of our business and we intend to further improve our profitability in S&B and This Works in fiscal ‘23. We’re focused on achieving profitability in our Canadian business as soon as possible as we execute against our cost savings program. During fiscal ‘23, we intend to make strategic marketing investments in BioSteel to drive increased velocity and as we’ve secured a significant number of doors over the past several months. We also plan to make investments in our U.S. THC ecosystem strategy. To be clear, our P&L reflects investments we’re making against the development and execution of our THC strategy in the U.S., but none of the revenue and profit in our U.S. THC investments are included in our P&L. We anticipate achieving positive adjusted EBITDA in fiscal ‘24, with the exception of strategic investments in BioSteel and advancement of our U.S. THC strategy. Let me now speak to our cash flow and balance sheet. We anticipate cash interest payments of at least $120 million based on our current debt position in fiscal '23, and our full-year CapEx is expected to be in the range of $50 million to $60 million. Our balance sheet remains strong with $1.37 billion of cash and short-term investments as of our fiscal year-end. We have USD 2 billion of base shelf available to us as well as additional debt capacity of USD 500 million. Regarding our convertible notes that are set to mature in July of '23, we have several options that we're currently reviewing, and we’ll update once we have any news to share. We’re diligently working to reduce our cash burn through OpEx savings, discipline around CapEx, and other initiatives that we are planning to really look into for fiscal '23. And also, we expect cash proceeds from some of the divestitures of the noncore businesses. In conclusion, achieving profitability is critical for us, and we’ve undertaken initiatives to streamline and drive additional efficiencies for our global cannabis business, and we’re focused on executing our path to profitability in Canada, while we continue to invest in high potential opportunities, particularly in our BioSteel business and to further develop our U.S. THC ecosystem. This concludes my prepared comments. We’ll now take questions. To begin your Q&A session, we’ll first address investor questions that were uploaded through the questions-and-answer platform developed by Safe Technology. Tyler, can you take the first question?

How do you plan to incentivize shareholders as well as bring in new investors in this volatile market?

Thank you for the question. So, I think the share price decline is really not unique to Canopy. When you look at the share price performance of the U.S. and Canadian LPs, many of those names are down pretty substantially from a share price standpoint. Now, from Canopy’s standpoint, we are focused on really controlling what we can control, which is really laying the foundation for long-term sustainable growth and really building a premium branded cannabis company as the market goes through these types of cycles. For investors with a long-term focus, we believe that Canopy really represents a compelling value as we do have a unique and compelling strategy to win in the North American cannabis market, and we’re really excited to engage and educate many of the current shareholders as well as new investors going forward.

Okay. Thank you, Judy. The second question. How is Canopy planning to make a name for itself in the U.S. market?

Yes. So, as I called out in my script, we’re not waiting, because we’re already doing this with brands like Wana edibles, with Jetty Extracts, and along with our MSO partners in Acreage and TerrAscend. We already have a sizable and profitable and growing U.S. presence, which focuses on brands as well as premium positioning. So, we think that surely, like everyone else, we would benefit from the opening of the U.S. market from a federal permissibility standpoint, but we don’t have to wait for that in order to have our businesses work together to create value in that marketplace. As Judy pointed out, the difficult component of this strategy is communicating it, because we don’t consolidate their results into our results. But for many of these assets, we’ve paid for them. And so while the cash has left our balance sheet, you’re not seeing the P&L and cash flows from those businesses accrue to us, but rest assured that they’re continuing to grow while the market grows in the U.S. And the other thing I just want to point out there as well is that, we as well as people in the industry and experts around the industry, continue to believe that the North American cannabis market is in that $60 billion to $80 billion range at revenue. And that’s not the hope that you sometimes see in a nascent industry that consumers are going to adapt the products that you offer in that industry. This is an industry where we’re looking at how to shift consumers from the illicit market to the legal market. So, I think the size of the prize in the industry and in the U.S. in particular remains dramatic, and we think we’re well positioned to perform there. Operator, Judy and I are now happy to take questions from the analysts.

Your first question comes from Vivien Azer with Cowen.

So, Judy, I just wanted to follow up on your commentary around the outlook for ‘23. I appreciate that clearly, it will be back half weighted given the accelerating year-over-year declines that you guys are seeing for the total enterprise, in particular, for B2B. But, as I look at the B2B segment specifically, it sounds like you guys are making some very specific, painful, but strategic decisions in terms of portfolio mix. But, is it reasonable to think that that segment can grow next year on a full-year basis?

Yes. So, Vivien, I’ll make a couple of comments, and David, you can also chime in as needed. So, first, I think you have to think about the shift that we’ve made throughout fiscal ‘22 from a premiumization strategy, where when you look at the first half of the last fiscal year, we still have sizable value flower sales that were flowing through our revenue base. So, on a year-over-year basis, I would expect that that impact would continue to show up on a year-over-year basis with the value flower sales really being deemphasized within our portfolio. I think the good news is, on a sequential basis, we’re starting to see stabilization even in our overall sales. And I think the other good news is when you look at the market share performance of our premium brands and markets, we really do think the evidence shows that those brands are starting to gain traction in the marketplace and show good momentum with consumers. When you look at all of the premium segments, including flower, pre-rolled joints and other categories, we are number one in all of the premium segments collectively. So, I think we’ve made really good strides. The premium segment itself is also growing on a year-over-year basis. So, we feel pretty confident that as we execute on our premiumization strategy, that the growth of the category as well as our market share momentum will mean in the back half that we’ll see much improved performance from a Canada led B2B perspective.

And the only thing I would add to that, Judy, is I think the key component of being able to win in mainstream and premium is the ability to consistently grow high THC, good terpene profile flower, and we made some decisions during the course of the year to change the way we grow our plants in terms of feeding schedules and irrigation and lighting. We’ve made adaptations around our post-harvest process, in particular, in areas like hang dry. We’ve started to add to our final packaging, packets that allow us to retain moisture levels in our finished goods when they’re going out to consumers. So, we’ve done all these things so that we can continue to consistently deliver flower in particular, for the premium and mainstream segments. And to me, that’s been the biggest issue, not just for us, but for many of the LPs over the last couple of years is the ability to consistently remain on the shelf with the right value proposition. And we think given all the changes we’ve made, we’re there. With the caveat, as Judy called out, that, because it’s an ag business, it takes a while for us to be fully producing at the attribute level that we want to be producing at, but we’re getting really close.

Your next question comes from Tamy Chen with BMO Capital Markets.

I wanted to revisit the adjusted gross margin for the cannabis segment. First, could you clarify the numbers you mentioned, like the 18% gross margin, excluding any COVID subsidies or write-downs? Secondly, I’d like to ask why the cannabis segment's gross margin was particularly low this quarter. Was it primarily due to the significant changes you've been making, resulting in a unique instance of lower production that couldn’t cover the fixed costs? Or was there something else that significantly impacted the margin? How should we view this situation moving forward in the next few quarters?

Sure, Tamy. Regarding your question about the adjusted gross margin percentages, the adjusted gross margin was negative 18%. The negative 32% we reported includes noncash inventory write-downs that were not related to any strategic decisions made in Q4, which significantly affected our adjusted gross margin. We had a slight benefit from the payroll subsidy payment, and if we consider these factors, we estimate our global cannabis business would have been around negative 18% from a gross margin perspective. The 7% gross margin figure relates to the full year and excludes some noncash costs, as we experienced inventory write-downs earlier in the year too. On a full-year basis, if we exclude noncash inventory write-downs, depreciation costs, and the payroll subsidy we don’t expect to continue in FY23, our cash gross margin would be around 7% for the cannabis business. In Q4, the cannabis gross margin performance was affected by inventory write-downs, which have shown volatility throughout the year due to changing consumer preferences and our strategic shift away from value flower, leading us to take some write-downs. We also experienced price and margin compression across the cannabis market. Looking ahead, as we transition out of this premiumization phase, we anticipate our gross margins will improve as we benefit from a better product mix. Furthermore, by enhancing our demand forecasting and reducing inventory write-downs while achieving the outlined cost savings, we expect significant improvement in our cash gross margin performance in Canada.

Your next question comes from Chris Carey with Wells Fargo Securities.

I wanted to follow up on the question about gross margins. You mentioned that there is a 7% underlying gross margin rate, which is certainly better than the adjusted figure for the quarter, but may not be sufficient for sustained profitability in the future. This could pose a challenge, even with the SG&A reductions you’ve announced. Considering all the mix, adjustments, and product right-sizing for the market, how do you see the long-term trend for gross margins in this business? Do you have an estimate? Additionally, regarding the non-cannabis gross margins, could you elaborate on the factors that led to the sequential decline? It's clear that inflation is impacting various non-cannabis categories, so can you detail those factors and what steps you are taking to alleviate some of that pressure as we enter fiscal ‘23?

Sure, Chris. So, yes, I mean, look, we are focused and committed to gross margin improvement across all areas of our business, including cannabis and the CPG businesses. Now if I just go through each of our businesses, note that we are already profitable and carry a healthy gross margin in Storz & Bickel, This Works, and our international medical business. With the Canadian business and then I talked about this in our prior question, but it’s really some of the price compression and the noncash costs that we’ve been incurring that’s been really pressuring the gross margin. So, as we execute our premiumization strategy and see the benefit of that mix improvement, as we achieve our cost savings that we’ve outlined, we do believe that we can achieve 35% to 40% cash gross margin in our Canadian business over time. And I think that that is a margin structure that we think looks reasonably attractive. For BioSteel, our gross margin in the near term and frankly, in Q4, was hampered by higher co-packing costs as well as increased distribution and warehousing costs, and this is in part a function of us scaling up in terms of revenue as well as just the higher supply chain costs that everyone in the industry is incurring, including fuel costs. We do have a number of initiatives in sight to reduce our co-packing cost, distribution, and warehousing expenses, and we do expect improvement in the gross margins in the BioSteel business in fiscal ‘23 and beyond. Globally, as you mentioned, we are dealing with some of the current inflationary pressure, wage inflation, the supply chain costs that are going up, but we do believe that our cost savings program should drive overall improvement in gross margins in fiscal ‘23 as well as on a go-forward basis. So again, if we can think about our cash gross margin in the Canadian business in that 35% to 40% range, and then the rest of the other businesses actually carrying a higher gross margin, we do think that over time, we can be in that 40% plus gross margin as a total company.

Your next question comes from John Zamparo with CIBC.

I wanted to ask about the EBITDA guide maybe from the revenue side and the cost cuts you announced that get you to around one-third of the delta on the current run-rate EBITDA versus your target. So, presumably, you’re planning for some significant sales growth. But the changes that you’re referencing, especially in the Canadian market, are also on competitors are undergoing. And this is a market that’s now growing 20% to 30% a year. So, to get to your EBITDA, you need to grow significantly above that rate. So, I’m wondering what gives you the confidence that you’d be able to get there given the pace of the market growth and the level of competition you’re seeing, and presumably no end of price compression in sight.

Yes. I think we will continue to experience strong competition in the Canadian market. I believe we have some brands that are starting to connect with consumers, although Canada is not fully realizing its brand potential yet. Our ability to execute at retail is exceptionally strong, and I discussed our efforts with budtenders and our overall strategy to enhance retail presence. We are currently facing a challenging retail environment, with many retailers struggling, but we are effectively collaborating with them to improve their performance. We believe that our strengths, along with our ability to consistently produce premium quality flower at scale in Canada, will set us apart. I would like to highlight that we have maintained our number one position in the premium segment again this quarter, and we have doubled our share, particularly due to the success of our Tweed brand in the mainstream market. The areas we are concentrating on are showing positive signs, though the wider market shifts that Judy mentioned are placing a significant burden on our revenue.

I would like to add that we believe making strategic investments in growth areas of the business, such as BioSteel and our U.S. THC strategy, remains a vital part of our approach. From our perspective, we can enhance profitability even if we decide not to invest in those areas, yet we are optimistic about BioSteel's potential as a challenger brand in the rapidly growing premium hydration market in the U.S. Additionally, we have a strong U.S. THC strategy that we are prepared to invest in. Ultimately, our focus is on these investments while ensuring we maintain profitability across all other facets of our business.

Your next question comes from Andrew Carter with Stifel.

My first question is related to the overall ecosystem. First, you’ve completed agreements with Jetty and Wana. If I’m correct, Acreage has the first right of refusal for those brands. I assume they will launch those brands soon in New Jersey and New York. Additionally, there's an MSA fee that I believe will benefit them and, in turn, help you. The second part of my question concerns your commitments regarding the cost structure and extending breakeven EBITDA to 2024. How does this position Constellation to either benefit from your potential success or end up in a situation where they can extract value or simply walk away?

Yes. Constellation is dedicated to our business. Judy mentioned some supply chain challenges, particularly with BioSteel distribution. We have a Constellation representative fully focused on helping us optimize operations. Additionally, there are team members engaged in field and trade marketing as well as distribution and sales, and we are collaborating effectively. Constellation remains committed, holding a controlling stake in our company, which they plan to maintain. Everything we do, especially in the U.S., is done in partnership with them. I believe our relationship continues to be very productive. Their expectation is that by achieving profitability with our premium Canadian strategy and continuing to develop our already profitable and rapidly expanding U.S. THC ecosystem, we can unlock significant value together at the appropriate time in the future.

Your next question comes from Michael Lavery with Piper Sandler.

I just want to come back to the EBITDA guidance and just sort of unpack it a little bit and try to understand the magnitude of the profitability headwinds that you anticipate from BioSteel and U.S. THC even by fiscal ‘24. And I guess, partly, I would love to understand if the M&A activity you’re doing in the U.S. doesn’t flow through the P&L and those deals obviously are conditional on U.S. federal laws changing. What operating costs do come through that are related to U.S. THC and how significant are those? And on the BioSteel side, it was growing quickly, but obviously, just a little under 10% of revenues last year. What does it take for that to be profitable? And is it so unprofitable that it overshadows obviously, the entire rest of the business? I just would love to put all that together.

I’ll start, and David can add any additional details. Michael, as I mentioned earlier, we consider our investments in BioSteel and the U.S. THC strategy to be critical. I won't disclose specific dollar amounts for these investments, but we have secured sponsorships with sports teams and athletes. We're also very pleased with the distribution we've achieved over the past few months, with commitments from 53,000 retail locations for FY23. We see FY23 as a pivotal year for BioSteel to leverage these distribution points to enhance sales in those stores, utilizing our investments in field marketing, brand activation, and other areas to maximize the potential of our sponsorships and partnerships. We are enthusiastic about the brand, although it involves a significant investment for FY23. Concerning U.S. THC strategy-related expenses, as you've seen, we've made acquisitions, which involve costs from our M&A team. We have worked hard to establish a solid strategy for developing the U.S. THC initiatives, which are integral to our investments in this area. However, while we are making these investments today, the profits generated from our U.S. THC initiatives don’t yet reflect in our P&L, making that figure appear worse than if we could incorporate the revenue and profits from these investments. It's important to note that while the expenses are visible, the benefits are not yet apparent.

I would just like to add, Judy, that regarding BioSteel distribution, we know the brand performs well with its clean, healthy hydration differentiator when it reaches consumers. Last year, we focused on expanding our points of distribution as Judy mentioned. We increased from about 1,500 points of distribution last year to over 50,000 once everything is operational this year. Our investment in BioSteel is aimed at ensuring consumers are aware of the product now that it is available, leading them to try it. We understand that once we achieve consumer trials, we gain loyal fans. This investment is what we're discussing, and we believe it will yield significant returns in the near future.

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

On the U.S. THC investments that Canopy has made, I’m just curious to what stipulations are in the deal, in the event clarity on legalization doesn’t come from a federal level anytime soon. I guess, what I’m asking is, how do you realize the financial upside of these assets in the event cannabis only ever becomes regulated at the state level?

There is quite a bit of flexibility because our agreements allow us to exercise full control. When we mention not consolidating, it’s because we don’t technically control the businesses, despite owning them. However, our ability to take full control depends on federal permission or Canopy’s discretion. We need to feel secure from a legal and Controlled Substances Act perspective, but we still have some ability to assume control over these businesses even without full federal approval, depending on the additional legislation passed. Currently, it seems that federal approval may not be imminent, but we do see potential for incremental change as discussions around issues like SAFE Banking continue.

Your next question comes from Pablo Zuanic with Cantor.

So actually, it’s precisely related to your last comment on SAFE. So, it’s a two-part question, right? When I think of the Wana and Jetty, does that mean that you think the triggering event may be sooner than expected, right? I mean one from outside within that you wouldn’t be making these investments if you think that that’s being delayed and now it’s much further out. The second question in terms of defining the triggering event, is SAFE enough for you as a triggering event or would SAFE need to have to be followed by uplisting in U.S. exchanges for plant-touching assets for you to define the triggering event? If you can expand on that, please? Thank you.

Yes, sure. So, good question. As it relates to the triggering events definition, I think that it has a lot to do with what gets included in any of the incremental legislation and what sort of safe harbors get created and how agencies, such as exchanges and banks, and so forth, react to that. And so, I think it’s hard to say, Pablo, whether SAFE Banking is enough, but there could be some scenarios where SAFE Banking is at least very helpful. In terms of timing, when we think about a brand like Wana, Wana is doing quite well in Canada. It’s the number one edibles brand in Canada. I’ll also point out that Wana Canada is not in our financial statements. But Wana is the number one edibles brand in Canada. And so, for us, we do have the ability to do some different things with the U.S. brands when they’re operating in our home market in Canada, and we’ll look on that. We’ll continue to work on that. And then, just as importantly, our ability to bring a brand like Jetty, which doesn’t exist in Canada, but has really strong IP, really good brand credibility and heritage in maybe the most difficult cannabis market in the world in California. To be able to bring that to Canada is pretty exciting for us. So, we do have ways to unlock some value prior to permissibility, and we’re going to keep looking for ways to unlock value and ultimately, cash flows as soon as we possibly can.

Your next question comes from Matt Bottomley with Canaccord Genuity.

I just wanted to go back on the strategy of the new goal of inflection for adjusted EBITDA. And maybe just if you could speak a little bit more on the potential disposition side. I know you chatted a lot on the BioSteel and Storz & Bickel prospects. But what are the prospects for Canopy’s longer term views and participation in things like Canadian retail, international infrastructure, and cultivation outside of Canada? Things like that, I’m just wondering, is there an expectation that maybe that will start coming off the books through disposition within this upcoming fiscal year?

Thanks, Matt. So, I’ll start. So, first of all, I’d say, we’ve already made significant strides in simplifying our businesses and exiting several noncore categories and businesses that we just didn’t feel fit our strategy, and you know that we divested C3 last year. So, I’d say we’ve made significant progress. Now, I think for us, really, we continue to look for ways of sharpening our focus. And I think there are areas where we will continue to really invest in, because we believe in the prospects and the growth aspirations of those businesses. And then, I think there are other areas where there the market dynamics are shifting or we need to further simplify our businesses, we will consistently and constantly review those businesses. Some of the proceeds that I mentioned that we expect to come in FY23 are already the businesses that we either closed down or have made decisions to walk away from. So, it doesn’t include additional activities that we could potentially look into, but I think we do have a pretty compelling strategy, and we’ll continue to look for opportunities to simplify and sharpen our focus.

Your next question comes from Ty Collin with Eight Capital.

I just wanted to follow up on the cost reduction announcement that you made last month. Could you provide some more color on the plans to leverage third-party manufacturing? What’s the rationale behind that particular action and which product formats would that relate to?

Yes, we aim to deliver the highest quality products to the market. By "highest quality," I mean incorporating the right attributes that our consumers love, particularly in relation to flower. We are actively looking to collaborate with craft growers, not only for their ability to cultivate through our 7Acres Craft Collective but also for their involvement in strain development and market evolution. This approach helps us maintain fresh offerings that meet the highest consumer demands. Beyond flower, there are producers capable of taking our formulations and producing them more efficiently, which ultimately leads to better returns and margins for us. We will continue to seek ways to deliver the best product possible, whether that means we produce it ourselves or engage others to do so on our behalf.

I would like to emphasize that this aligns perfectly with our goal of building a premium branded company. We are committed to pursuing our brand-led strategy. Additionally, we are focusing on flexibility. As we've mentioned, we've been facing significant indirect fixed costs in our Canadian operations. If we can convert some of these costs into variable expenses and reduce our indirect labor costs, we believe this will provide us with a flexible strategy that allows us to adjust based on demand as necessary.

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

So, I just want to talk about the U.S. acquisition, you obviously had a ship now of Jetty and Wana brands more so than MSOs previously. I just want to kind of get your overarching view. Number one, why you believe now is the appropriate time to really focus more on the brands? Obviously, very early days, many people believe in terms of brand equity within the space. And then number two, because you don’t have ownership, how are you able to leverage core competencies, Jetty, strong presence in California, Wana, obviously, is stronger in terms of licensing in other markets, and you also have Acreage and TerrAscend as well? And then just last is just overarching brand versus MSOs. How do you look at building the brands, considering TerrAscend and have their own brands, and then you’re also bringing on your brands through these purchases of the Jetty and Wana?

Yes. So, I’ll come at this from a couple of different ways and Judy, fill in the holes here. So, again, we start from the point where we believe that sustainable value was created by being that North American brand-driven, premium-focused company. And so, we see brands like Wana and Jetty really almost in their emerging phase, where they have strong credibility with their consumer bases. They’re well regarded in the markets that they exist in today. And quite honestly, Wana has shown that they do really well when they come to new markets as well. We think the same thing is true with Jetty, where we look forward to the day where New Yorkers can consume a Jetty vape product relying on that California experience in heritage and recognition from a consumer standpoint. So, we think that the brands are important to build a base for consumers. But the brands have to have a reason for being, and that’s why we like brands like Wana and Jetty because they already have the providence that you like to see in a brand over time. In terms of why now, we think that the timing is right to begin to work together or to have the brands work together to find ways to grow. So, for example, you talked about, Wana’s success running their licensing model, Jetty hasn’t really begun to expand outside of California. It would be great for those businesses to work together to take the learnings that Wana has, apply them to Jetty, and be able to bring Jetty into the legal markets across the U.S. In terms of control, I guess, is what you’re really talking about around, without us being able to be in there on a day-in and day-out basis. The way the agreements work is that we have guardrails in place in terms of what the companies can do and cannot do. But most importantly, and maybe almost as important as the brands, we chose to invest in these companies, because they have very strong management teams. And so, we have a lot of confidence in the ability of the individuals running Acreage and TerrAscend and Jetty and Wana, to be able to find the best path forward and create a lot of value before permissibility.

There are no further questions at this time. Mr. Klein, you may proceed.

So, thanks again for joining us today. If you’re in Canada, I really encourage you to try one of our new 7Acres Jack Haze infused pre-roll joint innovations or one of our new great-tasting cannabis beverages such as Tweed Iced Tea Guava. These are superior experiences, and I would really love for you to give them a try. If you’re in the U.S., I encourage you to try a BioSteel ready-to-drink beverage to hydrate over the Memorial Day weekend. Investor Relations will be available to answer additional questions throughout the day. Have a great day, everyone.

This concludes Canopy Growth’s Fourth Quarter and Fiscal Year 2022 Financial Results Conference Call. A replay of this conference call will be available until August 25, 2022, 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.