Q3 2020 Earnings Call

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Ladies and gentlemen did you see operator today's conference is scheduled to begin momentarily until that time. Your line is called again be placed on music hold thank you for your patience.

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Okay.

Good morning, My name is Diana and I will be your conference operator today I'd like to walk you cannot be close [laughter] third quarter fiscal Twentytwenty financial results Conference call.

At this time, all participants are and I listen only mode.

I'll now turn the call over to Judy Hong Kong, Vice President Investor Relations. Judy you May begin the conference call.

[laughter] and good morning, everyone I, we're glad that you have taken the time to join our third quarter fiscal 2020 financial results conference call on our call today, we have to decline, our CEO and Mike Lee our CFO.

The markets open today, we issued a news release announcing our financial results for third quarter fiscal 2020 ended December 31st 2019.

It's really is available on kind of equally website and had been filed on SEDAR.

Certain matters discussed on today's call or answers that maybe give into question could constitute forward looking statement.

Actual results could differ materially from those anticipated.

[noise] risk factors that could affect results are detailed in the Companys annual information form and other public filings that are available on SEDAR <unk>.

During the call we will refer to some supplemental non-GAAP measures adjusted EBITDA and free cash flow adjusted EBITDA and free cash flow our defined in the press release issued this morning as losses periods management's discussion and analysis documents filed on SEDAR.

No that all financial information is provided in Canadian dollars unless otherwise noted.

Oh I couldn't hear comments by David and Mike, We will conduct a two and a session.

Sure that we get to as many questions as possible, yes, it and hope to limit themselves to one question with that I'll now turn the call over to David David.

Thank you Judy and good morning, everyone.

I'm very excited to be on this my first earnings call as CEO of cannot be growth.

I'll begin my remarks, I'll offer a perspective on why I decided to join canopy.

First I believe the kind of this market is one of the most exciting business growth opportunities of our lifetime.

We are taking part in the creation of a new regulated consumer market the likes of which we've never seen.

Second having been an early advocate of constellation brands investment in cannot be growth and having been on the board. Since October 2018, I firmly believe canopy is well positioned to win in the global kind of its market.

We have a leading market share in the recreational market in Canada, and a strong position in the medical market in both Canada and abroad.

Additionally, I believe canopy has the opportunity to create an unassailable global position in Canada.

Fair enough he possesses excellent know how industry experience intellectual property and talent.

The combination of these assets has the ability to set us apart from the competition.

Another asset of canopies that cannot be overlooked is the strength of our balance sheet.

In a sector, where capital is becoming increasingly costly if it's available at all the value of having $2.3 billion in cash cannot be understated.

Our job is to nurture the strength and ensure that we build a profitable world class company with brands that consumers Trust.

Now I know you'll have many questions about what I'm planning to do especially in light of what's going on in our industry.

Make no mistake, we have a lot of work to do.

I'll detail our path forward during our fourth quarter earnings call. Once that's completed my assessment.

However, you can be assured that I am along with the management team already taking actions that will keep us in the leadership position of the cannabis industry.

We're now let me highlight my key priorities.

My first priority will be improving canopy growth connection with our consumers.

The winter in this market will possess the brands that are most trusted and most loved by our consumers.

We will leverage our consumer insights intellectual property and production capability to consistently deliver consumer preferred products that deliver the best quality at each price point.

My second priority is bringing more focused and disciplined to our organization.

As this new nascent industry developed over the past five years, playing across the board made sense due to uncertainty about industry direction.

The industry. However has evolved and we now need to focus on specific markets and product lines, where we have the legitimate right to win.

This means deciding where we won't play as well as where we will.

My third priority is to define a very visible path to profitability and positive cash flow.

This means we need to align our resources and investments with the size and growth rate of the market as it exists today.

We've begun taking steps designed to bring our inventory in balance with their supply demand forecast. This includes a thorough strategic review of our footprint, which is underway.

Mindful of future market growth, we're prepared to take initial steps to rightsize our business over the next 90 days.

My final priority is building the company and managements credibility with all stakeholders, we will do this by delivering on our commitments in a thoughtful and measured fashion.

Let me now briefly cover some business highlights first the Canadian recreational market.

Overall consumer demand remained strong and cannot be continues to hold a leading market share in recreational cannabis markets across the country.

At retail and using data published by provincial agencies and Statscan canopy is number one in Nova Scotia number one in Prince Edward Island, and number two in Ontario.

In Alberta the countries most developed market canopy continues to hold the number one spot accounting for roughly 30% of the market.

Our same store retail sales increased 11% on a quarter over quarter basis.

Sales of dried flower remains strong across all price ranges.

Notably strong demand continued for our value price T. W de strain as well as for premium strains.

Moving to medical cannabis markets.

We're seeing our sales increase in the Canadian medical market. Thanks in part to a growing customer base.

It's noticed notable that sales of oil and soft gel to account for over 60% of our Canadian medical sales.

We're encouraged by the progress, we're making into European markets with strong sales in Germany.

In the U.S. market, we achieved an important milestone with online sales at first and free branded him derive CBD products beginning in December 29 team.

I'm excited about the U.S. market opportunity.

Providing cannot be with the resources to enter the U.S. market was a key driver of constellations most recent investment.

That said, we recognize that we want to and need to move faster and make boulder moves in the U.S.

We're focused on creating brands that resonate with our consumers and making sure. We can get distribution of our products in places where consumers can legally purchase them.

Now before I hand, the call over to Mike I'd like to provide an update on our cannabis 2.0 launch in Canada.

Since the very beginning of our 2.0 product development canopy, it's been committed to bringing the highest quality most differentiated products to market.

We believe this is the best business approach to win over the long term.

Our first edible products premium chocolate products shipped out of our Smis falls facility in December 2019.

Multiple products, Tokyo smoke go Tokyo smoke pause and Tweed Baker Street entered the market in December and have been selling out very quickly.

Our next offering being in Bud is on track to be in market late February with additional skews following in the first quarter fiscal 2021.

For our vapor product offering we focused on delivering products with differentiated levels of safety functionality and design.

All of our products will meet underwriters laboratories, or you well 81 39 safety standards.

Our juju power the sectors only you well 81 39 certified rechargeable battery four or 510 cartridges began shipping in December and entered the market in early January 2020 [noise].

We're seeing strong demand for these devices [noise].

[noise], four or 510 cartridges and proprietary pod based Tokyo smoke luma.

We expect to be in market over the next few months.

Now this is later than we previously communicated but we felt our highest priority is to ensure that we provide our consumers with the highest quality and safe its products possible, even if it means delays to our end market dates.

Lastly, canopy has long believed in the low calorie high quality cannabis beverages that rival alcohol beverages in the taste in social experience. They deliver would create a new consumer segment and expand the overall cannabis category.

Leveraging considerable intellectual property canopy has formulated a range of beverages that I believe we'll delight our consumers.

I know some of you had a chance to taste. The non active version of our products, but let me say this the active versions are a whole new ball game.

Add some color here a few weeks ago myself and other board members tasted lie versions of our cannabis beverages.

After the tasting a fellow board members sent me a text the text red simply game changer.

I shared that opinion.

In our view, we truly have a unique and differentiated beverage, which based on our competitive tasting you can't find anywhere.

We also see our cannabis beverage as truly disruptive and the best vehicle to attract new consumers to the candidates market.

In other words, we believe it will be more to recruit new consumers than any other product format in our industry, creating new consumption occasions, and a whole new industry.

Just thinking about how big heart health or is in the U.S. became in just three years.

So we are going to take the next few months to get it right and ensure that we can induce introduce our consumers of today and of the future to a true game changer.

Lastly, and related Lee I would like to take a brief moment to acknowledge in applaud the Ontario governments recent initiation of public consultation on providing consumers with more choice and convenience on cannabis and business opportunities including consumption venues.

The consultation is the first major milestone that's required to move forward with providing Ontario ends with safe convenient access to regulated cannabis, while providing more support for private sector business opportunities.

[noise]. This concludes my remarks, then I'll now pass the call over to Mike to review, our third quarter fiscal year 2020 financial results in greater detail.

Great. Thanks, David Good morning, everyone.

Let me begin my remarks with a brief review of the progress that we made during our third quarter fiscal 20.

Total net revenue grew 13%, excluding the impact of portfolio restructuring charges last quarter.

Our business generated gross margins of 34% before fear value impacts.

Total asked DNA decreased 14% quarter over quarter.

And adjusted EBITDA came in at a loss of 92 million compared to a loss of 156 million last quarter.

I will now move onto a more detail review of select items.

Our topline performance benefited from a broad base of growth in our core cannabis business as well as our strategic acquisition.

Here a few highlights.

Canada recreational revenue increased 10% benefiting from balanced growth across our b to b and B to C channels and we're pleased with the growth of flower sales, which were driven in part by higher sales of premium strains and a greater than 50% increase and the sales a pretty.

All join.

Our beat a fee revenue increased 16% over prior quarter due in part to 11% increase in same store sales.

Canadian medical sales increased by 5% quarter over quarter, driven in part by an increase the number of customers to over 76700.

International medical increased 3% quarter over quarter as our sales in Germany benefited from opportunistic sales to fill supply gaps created by a regulatory hole on products of another vendor.

Revenue generated by C increased by 5% over the prior quarter driven by continued growth in demand for the cannabinoid based therapies.

And over the past year canopy has made a number of strategic acquisitions that are performing as expected.

Sales of these businesses are captured at our other revenue section of our Pierre now and they saw over 40% growth against the prior quarter.

Sales of stores and vehicle vaporizers increased 46% over the last quarter due to solid organic growth as well as seasonal sales over the Christmas holiday season, and we estimate the seasonal timing benefit added around 5 million of incremental revenue during the quarter.

This works revenue increased 42% on solid organic growth.

And our latest acquisition bio steel also contributed a full quarter of revenue.

We're pleased with the performance of our strategic acquisitions and point out that stores in vehicle. This works and bio steel accounted for nearly 22% of our revenue in the quarter.

Looking forward to the fourth quarter, taking into consideration some timing benefits. We saw during the third quarter, we anticipate our overall revenue to be up modestly versus the third quarter.

I'd now like to take a few moments to provide canopies perspective on a dynamics that we're seeing and the Canadian wrecked channel.

Over the past number of weeks, we've seen examples of aggressive pricing by some competitors, which began in earnest and the back half of the third quarter.

We expect these isolated pricing actions to continue as our market intelligence suggests that these competitors are focused on freeing up cash from their long inventory positions.

At the same time, we see strong consumer demand for premium hi, THC strain products as evidenced by the well over 50% growth, we saw and our Lps sunset premium flour and pre roll joints during the quarter.

We believe our brand architecture is working as we focus on building brand equity, while offering consumers a range of products across premium mainstream and value price points, and we will continue to monitor the market and adjust as needed to remain competitive, but tw de will come.

10 used to serve as our price fighter and the value segment.

Now, let me briefly cover gross margin [noise].

Gross margin in third quarter fiscal 20, before I FRS fair value impacts was $42 million or 34% of net revenue.

Gross margin in the quarter benefited from higher capacity utilization, which is a trend that we've seen over the past few quarters.

Operating costs related to underutilized facilities has continued to decrease from approximately $24 million and the fourth quarter fiscal 19 to under $8 million and the third quarter fiscal 2000.

The growth of our higher margin consumer products businesses, such as SMB and vis works also had a positive impact to gross margin during the quarter, we remain committed to delivering 40% gross margins in the short term as we expect ongoing reductions in various period costs, but we wrap.

Ignite that they're delays in our beverage and based products will serve as a modest headwind in the short land short term and it's also worth while highlighting that the any rightsizing on our supply could introduce some short term headwinds as well.

Speaking briefly about operating expenses.

Total opex declined 14% versus the prior quarter and GSK declined by over $20 million versus last quarter as a couple of the discrete expenses were not repeated and a third quarter, a as well as to focus on continued cost controls and this area.

Share based compensation expenses decreased from $92.9 million in the second quarter to $61.7 million in a third quarter and the decline in stock based compensation was due to certain onetime benefits as well as reductions that resulted from the restructuring of I shared.

Based compensation program that I spoke about last quarter.

Looking forward to fiscal 21.

And with the restructurings that we made we expect share based compensation to be 30% to 40% lower than in fiscal 2000.

Further we expect share based compensation to normalize over time at between 125, and a $150 million per year, depending on head count.

I highlight that we provide a full discussion of our operating expenses in our mdna sodium the interest of brevity, we're eliminating a comprehensive discussion of operating expenses from our press release and from this conference call and you can expect us to be our standard practice in the future.

Moving onto a free cash flow.

Our free cash flow and a third quarter of fiscal 20 was an outflow of $360 million, which is a 16% improvement over the second quarter fiscal 2000.

And as David highlighted in his remarks earlier, a key priority is to reduce cash burn.

And I am confident that the work that we started in January will identify opportunities to reduce operating expenses.

And will moderate our capital expenditures as we seek to focus our efforts and align our organization to our key priorities.

Another key focus area is better managing supply.

And to work towards having a supply and demand balance as quickly as possible.

During the third quarter, our inventory before fair market value adjustments increased $81 million versus the last quarter.

Acquisitions, and our U.S. HAMP harvest contributed around $20 million of this increase but the balance was driven by an increase and our semi finished goods such as resins distillate and isolated.

As David indicated in his prepared remarks, we have indicated initiated a thorough review of our production footprint and we plan to act quickly to rightsize, our supply to align with the current market demand, while ensuring that we can deliver on our margin commitments.

Next I would like to provide a brief update on our transition to U.S. gap, our preliminary view of the change in accounting principles has identified a number of changes to the consolidated statement of operations and I will highlight a few of them now first under U.S. gap there is no biological asset account.

Moving onto a U.S. GAAP agricultural products are accounted for at cost and this change will have no impact on our adjusted EBITDA metric.

Second under Us GAAP <unk> amortization of right abuse assets is no longer considered as a component of depreciation and amortization expense and as such is not excluded from adjusted EBITDA going forward and this will have an impact of reducing our adjusted EBITDA by an estimated $10 million on.

An annualized basis.

The third item to be aware out is in our accounting for other financial assets and financial liabilities, there will be changes and the classification of certain other financial assets and liabilities, which will result, and fair value adjustments impacting net income.

And this is in lieu of reporting against OCI or other comprehensive income and as these fair value adjustments are currently excluded from adjusted EBITDA, There will be no impact as a result of the change the U.S. gap.

Finally, I would like to private <unk> provide just a brief update on some of the priorities I covered during our last call, we are making tremendous progress and reengineering, our financial close and reporting processes and we expect to achieve the accelerated close timelines required at our fiscal year end.

We continue to make progress in improving our control environment and we've begun testing the effectiveness of end user computing controls and we are on track to remediate. The currently reported material weakness by the end up the fiscal year.

We've also made solid progress and the design of our S&P ERP solution, which will eventually roll out across the entire enterprise and we are on track to roll out the S&P solution and the United States beginning in the first quarter of fiscal 21.

This now concludes my review of cannot be gross financials for the third quarter fiscal 20 ended December 30, Onest 2019, and we're happy to take questions from analysts at this time.

[noise] [noise] at this time, if he would like to ask a question. Please press Star then the number one on your telephone keypad.

To ensure I need you fishing calls that gets to questions on this many analysts as possible ambleside requested to limit themselves to one question. Once again press star one on your telephone keypad ask a question.

Yeah first question comes from the line of Chris Kerry Bank of America.

Hi, good morning.

Good morning.

First of all David.

Graduations on your new role.

And I guess, you know like clearly a number of line items were quite a bit ahead of expectations on on revenue and profit right, but I.

I think as you implied in the prepared remarks, the one area, which still underwhelmed was free cash flow, which is really where I think the debate around the can it be stories, it's focused now.

And it sounds like we're going to get more details around that in fiscal Q4. So you know, perhaps all all approaches question a little differently.

You mentioned that managing inventory relative to demand was a key focus and you're viewing your footprint.

Clearly that could imply shutting down some production capacity and I just wonder.

From a practical standpoint.

You know, how how difficult is that kind of endeavor.

And what could that mean to near term margins, even if positive for the long term and I guess connected to that it might you had mentioned that you expect to get the 40% gross margin overtime.

Essentially that's a mixed comment on the fiscal Q4, but does that imply that the 40% is more kind of assess what 21 reality.

Anyway, so it's a thanks for all those.

Yes, sure. So yeah, Chris So first of all or we are not going to run out of cash.

And we have a lot of levers to pull in that regard and as I indicated we'll talk about that more on them on the next call.

Clearly, we have to do a better job managing inventory and overall working capital.

We have to slow our capex spend we will pull back on the M&A activity. That's a business has been doing and you know we need to do a better job with our piano. So so literally we need to work across every line item.

We're we're going through a review process I've I've been in the role actually a it's one month today.

And I will say that the team is a fairly.

Very strong team at the leadership level at canopy and the team is very committed to the objectives that I talked about my priorities that I talked about in my script.

So I'll, let Mike comment on the timing of margin achievement, but we will do the right thing for our stake holders, which means our shareholders our consumers in our employees and we'll communicate that as soon as we can and then when we do there will be an obvious float.

Through that we'll have to be taken into account.

Yeah, I, just I would just add to that that whatever we do we want to do it with an eye toward not just what works for today, but what works for the long term as well and as you guys have heard me talk about over the last year starting off in shutting down facilities is really arc.

So we need to be very thoughtful about it very mindful about it and we're taking a strategic approach to say look we want to make sure that we're designing our supply chain and our footprint for not just the realities that today, but the realities of the next year two years three years as the size of the market develops.

But also as the various categories of the market develops and we know that these value category is here to stay we're quite happy with how tw D. is performing in the market and we want to make sure that regardless of what consumers are buying that we've got line of sight to deliver our target margin profile.

File across the entire range of products that we offered to our consumer. So that's the work that is underway and really to engineer the ideal supply chain that allows us to achieve those financial objectives. So in the short line are we going to face some headwinds with some of the cannabis delayed yes are we gonna face some headwinds from some potential de leveraging.

Facilities in the short run as we make some fine tuning adjustments, yes is that going to move us materially off of our 40% gross margin goal I do not think it well.

Your next question comes from the line of Glenn Mattson Latin burnt Solomon.

Hi, Thanks for taking the question.

David you made very specific comments about the U.S. market opportunity I believe you said.

They do you see a need to move faster and in the U.S., creating brands.

Specifically in getting and getting distribution to.

Customers, who can buy them so I'm curious.

What you meant by that a little bit the number one is.

Do you see yourselves, having to make a significant further investment in the U.S. and then number two when you mentioned customers, who can buy them you're talking about.

THC based products to customers in the U.S. and maybe just flesh out those comments a little further. Thank you yeah. So we know where we sit today, it's really focused on hence derives CBD ER and there are states, where where we're we're free to or you know to sell our products and other.

Her states, where we're not so that was really to the point of that comment.

And I don't see significant in investments clearly no incremental capital required in the U.S., it's really more about getting our brands on the shelf at retail.

As much as we possibly can across the U.S.

We launched first in free in December it was mostly.

And in E Commerce launch, we now need to get on the shelf with first in free and with some of our other products such as bio steel.

With CBD in the U.S. So it really is more about execution and you know quite frankly, Glenn I think that's the point that I can make about canopy in general I think.

We're well positioned in terms of.

Product development and production capacity, we now need to begin to really connect with that consumer and execute a from a sales standpoint, and a brand building standpoint, so that we can create a.

Those trusted brands in the mine to the consumer that's the next stage of our evolution and clearly we'll be focused on that in the U.S.

Your next question comes from the line of CVN Oh, sorry.

Hi, one and company.

Hi, good morning, and congrats David on the new role on thank you very much for intercept prepared remarks, I was hoping to get some perspective strategically David from you on kind of balance it priorities between topline growth and profitability. It seems from from your commentary that clearly there's.

Laser focus on Rightsizing the business from that to you and Mike, which I think it's encouraging but you did.

Just a point as you know reinforcing your market share leadership in the category and so I'm just trying to understand.

Committed argue to market share leadership <unk> are you willing to sacrifice that.

And your profit aspiration is because given your background you certainly I think we'd be comfortable not being a market leader, but you know operating from the fishing market share gain is once you've achieved a REIT profitability framework. So any commentary on that would be helpful. Thanks, Yeah, Yeah. Vincent So look that's why we.

Havens race to put out you know cut numbers or you know for for staff, what you're seeing across the industry. Because I think it's important to understand where we need to win in where we want to when and where we can profitably play in the in the business and then we'll continue to invest in those areas and we'll pull back.

Next spend from the areas that that don't.

Fit into that category I think the thing that we do have to keep in mind, though is that we are in a growth industry and I know, there's a bit of a paul over the industry of late but but we need to keep in mind that this is a growth industry, we're still attracting new consumers to the space.

We see ways for us to be profitable across the spectrum as ER of consumer preference as Mike talked about our ability to be profitable at the value end as well as our ability to be profitable at the at the premium end and.

We just need to get our business focused on executing in those in those areas I think I think there is.

A school of thought though that we can continue to drive.

The industry share leadership and improve profitability at the same time by simply creating a tighter focus on a on the consumer proposition.

Your next question comes from the line.

But some of Scotiabank.

Hey, good morning, Thanks for taking my question. So I was just hoping we could get a little more color on the b to B segment.

So just want to get an idea whether there's any bulk sales in the quarter and if there was what the magnitude of those where versus previous quarters. Thanks.

Yeah. Thanks, Adam I'm, we did have some bulk sales in the prior quarter. This quarter was nonexistent to my knowledge.

Continues to be an area of consideration as we think about rightsizing, our inventories cross dirt and certain segments of the value tier bought at this point, we're focused on getting or product to market not not necessarily pursuing wholesale but that's an option that continues to exist.

Okay, great. Thanks.

Your next question comes from Andrew Hotter, Oh my phone.

Hi, Good morning, I, just want to return to kind of the comment around the modest revenue growth quarter over quarter, and just kind of help kind of help us understand what that means for the RAC business you called out the 5 million seasonality.

Shifting a 119 base, but how should we be thinking about Canadian recreational business I would assume that the businesses now kind of aligned where shipments will better match kind of the consumption growth of the market should we be factoring in a lot of price compression you. Obviously, we'll have some secondly shipments just help us understand how you're thinking about that line item.

Sure Andrew we we're not modeling in anything for price compression at this point, we are modeling in that that can the mix in the category continues to evolve as TWC establishes itself in the marketplace than that that brand is performing.

Quite well, but the high end is also performing quite well the pre rolls are performing quite well.

My comments around a modest growth in the quarter are really driven by just you know as I mentioned that some of the seasonality benefits from SMB and even our retail stores.

In Canada benefited from a very strong December so there's a bit about headwind going into next quarter as a result of that.

And you know store count continues to increase and you're correct. We are seeing tremendous benefits of supply chain stability. All the provinces are now are getting their inventories in order and we're starting to establish that cadence of.

Not quite a mature industry, but there is minus site to getting to a mature industry and then near term and quite honestly, our biggest opportunity today to grow and whats relatively a static sort of store count environment is continuing to get the right product at the right time as the purchase.

Orders come in from the funds from the province is.

Driving our fill rates up by better forecasting a better fulfillment. So that's where our growth is going to come from in the near term and then is the stores continue to increase will continue to deliver.

Your next question comes from the line of Chinese Genpower else F.C.I.B.C.

Thanks, Good morning, I wanted to ask what the retail functioning at canopy subsequent to the quarter, you announced a meaningfully increasing the total footprint in terms of the Ontario license lottery winners I'm, sorry, I assume it's fair to say that you've seen something about retail. It's made you want to get more involved. So I'm wondering is it simply unit level economics really attractive.

Or is it more the ability to sell your own brands.

But just we'd like to get a sense of how you view retail and maybe how much capital you might allocate it out over the next couple of years. Thanks.

Yeah, Great. So you have store count continues to increase I think we added 15 stores and of course 12 stores in the quarter from 15 to 27.

Between owned stores and partner stores.

But we were very happy with our store performance and the economics become very attractive in our stores when or can it be share of store sales reach that 60% plus range, which.

Yeah, we're starting to see across our network, but that gives us the best opportunity to build brands to educate consumers.

It allows us to do pop up activities to help educate consumers on different formats and things like that and then as as cannabis 2.0 rolls out it's going to be an incredibly valuable format for introducing new consumers to these new products as well. So we expect to continue to add stores.

In a very strategic way Ontarios, our biggest opportunity in front of us and we had a press release about that a few weeks ago that I'm sure you saw I. So it continues to be a priority for us.

Your next question comes from the line of Michael slavery Aside from Sandler.

Thank you good morning.

You touched on a couple of the drivers of the inventory build and and I will see some of the 2.0 launch and building into that is a part of it as well can you just give a sense of how it's likely to evolve from here and and was this last quarter. The peak inventory levels or is there any reason it might actually still go higher.

We see how do you see that working down and then what kind of speed.

So I like maybe my comment on some of the details, but you know my early observations Michael our that.

You know were ER as a company we've built inventory.

But we need to get better at connecting the consumer demand signal to the inventory that we're building. So that we can deliver that high end consumer experience that is expected of you know leaders in this space and I think we're in the early innings of brand building in cannabis and so.

We need to be on the shelf with the high T.H.C. bugs that the consumer is demanding at the right price points.

And so for US we're going to continue to make sure that were not stocking out at retail which is.

Not good for us it's not good for brand building, it's not good for our retail partners at the same time, we need to be able to bring down our total inventory balance and that as I said is the work that's going on as we look at our footprint because.

We need to be able to.

Both decrease our inventory and make sure we stay on the shelf at retail and deliver the quality experience that stuff that we feel should be expected of our brands.

I would just I think that's very comprehensive I'd, just add Michael that I would not model that this is our peak quarter I think as we do the strategic review, there's a lead time to any decisions that we make that being said I would not say that you know that they increase is going to beat me period in Q4, I, just don't think or we can call. It a peak at this point until we finish these.

Procedure for review of our footprint, but Directionally, we know that we could do a better job of managing inventory relative to overall sales and everyone knows the story of anticipated market growth and wherever you are so we're we're working through that as we speak.

Okay. That's helpful. Thank you.

You're welcome.

Your next question comes from the line as Aaron Great of Alliance Global partners.

Hi, Thanks to the question I, just wanted to dive back a little bit into the market share trends. So I believe you said, 22% for the rack mark in the quarter I think last quarter was just north of 25. So could you talk a little bit about the market share trends you saw it during the quarter would it be fair to think that you know as a quarter one on you.

So on the market share as far as you saw that aggressive pricing from competitors and then as we see this aggressive pricing of competitors and potential shake out. It's a fair to think that we could you do see some at least near term share being being lost with the aim of long term share gains as youve kind of made it clear that you're not going to current plan. Those you know super low priced categories with payments come out.

More you know premium of products and just haven't cheated we de so I just think about near term shares and kind of that long term share aspirations. Thank you.

I'll take this one so yes, we did see some modest share declines as you referenced but I would also point out that there's been some variability in that is the industry's developed what I commented on earlier around.

Some of the isolated pricing actions, we've made a decision to not chip chase those price points in some instances. So there has been some share impact as a result for that however, our goal continues to be achieving between a 25 and 30% in market share. There is gonna be a little bit of noise with some of these isolated price.

The actions that we think will go away over the next several months.

But 25% to 30% is really our goal and we think we're well positioned to achieve that but yeah, you might see some noise in the numbers.

Between now and call it the longer term.

And what I'm what am I.

Do Aaron is also almost come back to a video games question and say you know were we liked the split in the market with maybe 40% is more premium of the total market I'm, saying, 30% is that value, we won't chase market share at at any cost but.

I think the best thing, we can do to continue to drive market share for us is to make sure that for a our premium products that we are on the shelf consistently at retail.

I think that that more than anything else can move the needle for us in terms of a ship holding share or growing share in the near term.

Your next question comes from the line of Rupesh Parikh of Oppenheimer.

Good morning, Thanks for taking my questions. So I wanted to go back to your other businesses in the the acceleration that you saw there so outside of I know there was a seasonal benefit that you saw but if you look at the stores and impactful vaporizer business. In this works just wanted to get a sense in terms of what's driving the strength of both businesses and just how to think about them going forward outside about seasonal benefit.

<unk>.

Yeah, we have that it's a few things there's been a number of new items that Weve up you know previously press released so innovation is driving a good portion of the growth we have a new distribution agreement with Greenland and the U.S. So we're seeing some good growth there as well and we've built a good business as you guys know this is a fantastic.

Brand and as we talk about the brand building and being more consumer aware I think David and I are about the opinion is many of our management team is SMB is an amazing brand that we could leverage for so much more than what we are today. So we're working on future plans to further or.

Boy that brand globally, but lot of innovation coming up next year as well. So yeah. We did have some seasonal benefits, but that being said, we still see that as a growth business over the next year too.

[noise] any anything there.

Your next question comes from.

Grain Kreindler <unk> capital.

Yeah, Hi, good morning. Thank you for taking my question I wanted to follow up Michael in the prepared remarks, you mentioned that there was higher capacity utilization in the quarter when I look at the kilograms harvested figure if my numbers you're correct. It was around 29000 kilograms this quarter and in the previous.

Whether it was 40000 kilogram, so that number coming down just want to square that away with the higher capacity utilization and also tying that back to you are talking about rightsizing the footprint, whether we're already seeing some evidence of that given where the harvested number is going quarter over quarter. Thank you.

Oh.

Sure two things I would point out number wine given our large greenhouse footprint yields vary throughout the year based on the season.

And yields certainly are lower in the October November December timeframe, which we model in and take that into account and all of our standard cost him.

During December we did take down some capacity at our Delta facility and British Columbia is one of our first steps to help bring supply and demand into balance there are some.

Fixed cost.

The leveraging impacts of that to the tune of around $850000 a quarter, but we also believe that and concentrating our efforts at delta, we actually get benefits with the remaining facility and helping to improve yields there as well the very balanced.

Approach, but when we think about brought utilization across our network are over all network. Despite the fact that yields app and flow throughout the year. The actual number of square feet in our facilities, our operating more in line with their goal with the retrofit activity being largely.

We complete.

Your next question comes from the line of Olin Bennett from Jefferies.

Morning, guys and more of them modeling question for me and obviously case you live at a new line and excel at 18 quite strongly which you expect to continue I was just wondering could you give any insights into gross margins and any other revenue and businesses and then even potentially kind of international.

School business and see kind of help with how we should also coach margin.

Crashing funny you almost support people that thank you.

[noise] yeah. So so all in my recommendation would be that we talked the offline about that versus going into a lot of details plot. The SMB first and free I see three businesses have all been perform.

Being.

At that 40% plus margin and in some cases see threes materially above that is our pharma grade cannabinoid based business.

In terms of guidance on that from a modeling perspective, I think modeling SMB in person free in that 45% range is a good estimate and to see threes band and the you know 65% to 75% range.

And we expect those to the whole over the short time.

Your next question comes from the line of Snap Bottomley Canaccord.

Yeah. Thanks, just wondering if you could provide any color on a the assumptions going into I think it was about a 5 million dollar price provision or sales allows provision this quarter for related to his particular skews or any other assumptions and then also if I could just sneak in there if there's any color on the proportion of your inventory balance or excuse me.

Period, and how much of that relates to things like dry Budd versus a product a in the pipeline to be launched in Canada is 2.0. Thanks [noise].

Yeah.

Sure. So yeah, we we booked about $5 million in the quarter as a revenue provision and I I think just you know just you know going forward as we think about revenue provision. It's a cost of doing business. In every CPG company I've ever worked that has always had an online.

Selling provision and it's really a function of whatever your customer agreements and this industry our customer agreements in Canada are very favorable to the customer meeting. They can return anything at any point in time, which is a more I'd say liberal approach than what I've seen elsewhere, and hence we take a.

Slightly more cautious approach in booking revenue provisions.

As I think about modeling going forward, you know, 3% to 4% of revenue is a very reasonable number given the risk profile the amount of inventory that we see at the province level and and I would expect that to be kind of the normal range going forward, but we true it up every quarter we look.

Yeah, what's actually come back and it's meant to cover not just returns.

But also any provisions for any potential mark downs or we call them by down at the at the province level just for the inventory that's within their four wall. This is not meant to be a provision for what exists and retail it's meant to be just a provision for what exists at the wholesale level. So as a wholesale inventories come down to.

That $4 million to $6 million range, there's just not much risk out there. So the 5 million is in terms of unpacking that for you a million of that million five I think it was for potential returns on just random products across the supply chain, where provinces are long on certain skews.

Very immaterial and the balance was.

Hey provision for potential pricing impacts on certain skews in certain markets, where we're not quite aligned to our national pricing architecture, and we wanted to provide that allowance. So that we could get things lined up properly, but as you all the grand scheme of things, it's 4% of revenue and that's just going to be our normal course.

Going forward, so I would build that in.

Thank you turns up inventory on I think your parts of the question was on inventories I apologize, but on inventory yeah. So our inventory, we think about our inventory really in in a few buckets number one is how much of our inventory is distillate and isolated and whatnot.

And.

A lot of inventory that we're showing there is the anticipation of cannabis to point out and you know jury's still out on how big each of these categories are going to be but we are well positioned on the distillate and isolated to fuel whichever category of cannabis 2.0, skews really take off.

And the shelf life on.

The isolate is very high so we don't have any concerns around quality, oh that inventory relative to the shelf life. The balance of the inventory is really our body inventory and we feel very good that were balanced on high THC Bod, we feel very good that were balanced on a low.

He AC high CBD by the mainstream but which is the balance is what we call it where we're a little longer than what we'd like to be today and that's the piece that we're continuing to work through.

[noise]. Your next question comes from the line of Jason Berg, That's P.I. financial.

Hi, Thanks for taking my question.

Just first of all one or two [noise] applaud the the reduction in operating expenses this quarter, especially in the DNA.

One line item there that I think is.

Those are the just increasing is the is the R&D line, but I wonder is sort of to dig into that just for sort of future modeling for purposes.

He described.

The increase in where we're kind of in the mid teens in terms of a percentage of revenue.

Talk about some clinical trials the CBD based studies as well as.

Some.

Product testing for kind of was 2.0. So is this a sort of onetime bulge in.

Not onetime sort of who you know over next couple of quarters, a bold in R&D or should we expect.

Yes, let him to increase sort of what's the what's your long term goal as a percentage of revenue.

So so Jason when when Ah R&D is an area that are already spent some time on since I've been a in the role.

I think as we look at focusing the business would you have to decide.

Where we're going to invest from an R&D and innovation standpoint, and by the way there's a bunch of stuff in that line item, it's not pure R&D some of its or some of its a engineering activities. Some of it is even manufacturing engineering right. So there's a lot of there's a lot of noise in that line.

When we get on the on the call a in the fourth quarter and we're providing more clarity on specificity of a that focus that I want to bring to the business. We will make sure that we address the R&D line in detail.

Your next question comes from the line [laughter] Pablo Zuanic of Cantor Fitzgerald.

Thank you and congratulations or David on your deployment and on the quarter look I just don't just one question it's been running distribution.

You said that.

For you was 31 cents over for you I'm shooting from other people, it's supposed to 50 puts into the industry <unk>.

If that's what we've seen the flow woodmark it doesn't say something about the Canadian consumer in kind of is being bodies 50, and does that bode badly for the two we're not gonna do what do you hold you know given that the price points are much higher if you can comment on that and then just up if it ends thinking that we follow up a it'd be nice you can tell you feel the odds ever line.

Since each of those revenues outside North America. Thanks.

So let Mike handles the revenue.

The revenue, but yeah, Pablo so I think the thing that's a interesting to me is we haven't existing consumer today, that's been pulled largely from the elicit market or and if that consumer today is if say 40% of this spend is happening in the premium segment.

In the markets I'm kinda flipping your question around a little bit.

You know, we feel pretty good about that because I think that looks like a lot of other CPG categories. It's my belief that as we bring 2.0 consumers and they're likely to come in.

At the higher end of the category, because they're going to won a as well as a premium but they're going to want experiences in other other.

Product categories like like like Bates and edibles drinks gel caps, we just see them coming in differently not what I'll say, though is that I believe that that's probably a longer build a total take awhile for that market to evolve I keep talking about.

So there are a lot of consumers that we in the market today, and we need to delight those consumers, but they're also a lot more consumers that don't even know that they love cannabis Ah, but they will learn that overtime and I think those folks will come in at at higher at higher price points and at the premium under the category.

Thanks.

The other revenue.

Your next question comes from a line of injury Leno I'm from National Bank.

Hi, good morning, and Ah. Thanks for taking my questions. Just just trying to go back quickly on the cannabis 2.0, and particularly on the beverages are first but just if you are able to clarify what caused the initial delayed.

And where are you know resolving the cause of that delayed and then more or the overall 2.0 <unk> portfolio like how do you see developing a these have eat a the dry but only that you have right now and.

<unk>, how much could you contribute toward so say your previous guidance of 250 million or revenue per quarter. Thanks.

So so Chris if you don't mind I I want to take a poppel. His question because he got cut off there, but we will follow up Tyler can follow up Judy can follow up with you, but international revenue today Rep defined as revenue outside Canada is around 35% of total revenue and Judy or Tyler will follow up with you after that.

Make sure you get your questions answered and with that I'll turn it over to David to answer that that it's good to look on beverages. Whenever you lost about launch a beverage whether its a.

You know alcoholic drinks or non alcoholic drinks and clearly Canada strengths. It takes a while to get your formulations exactly as you want them you need to ensure that you're having appropriate stability. The we want the product to look a appropriate when it's on the shelf.

And you know we had time to do this work at lab scale, leading up to its obtaining licenses on from health, Canada on 2.0, but kind of post a attaining those licenses. We've only had a very short window of opportunity to go from.

Lab scale production to commercial scale production and you know we've had some issues as we've made that jump and also understand that it's a very involved a quality process that we're putting ourselves through because we believe these are spectacular products, we want to make sure that when.

Consumer tries to them that they decide that this is this is their thing right. So.

We want to get it right, we're taking maybe more precautions a than would otherwise happen in terms of.

The of working our way through that quality process, we have some outstanding.

Scientific and engineering and innovation talent are working on our 2.0 launches and as I said, it's just taking longer than we would like but we think it's worth getting oh getting the products right as opposed to just rushing them out there to make it in market date.

Your next question comes from the line of Chris Lee I flourishing in Spain.

My questions have been answered thanks very much.

Okay.

Your final question comes from the line of chosen to stage Armenia capital markets.

Hi, just quickly.

Aggressive U.S. expansion on the product launches.

Edible launches coming up now and then it looks like you're going to be potentially adding quite a few more new retail stores, especially Ontario.

Lets say with a marketing perspective is should we see that jump up.

The next several quarters on these well you're trying to position the products in the launches accordingly.

No I again, we're still doing the work John in preparing for kind of the next phase actually even working on next year's plan. So.

I don't have a definitive answer but you will you won't see the number jumped up.

That was all no questions at this time.

This concludes today's conference you may disconnect at this time.