E2open Parent Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 9, 2023

There are 10 speakers on the call.

Operator

Good morning. My name is Tanya, and I will be your conference operator today. I would like to welcome everyone to Cronos Group's 2023 First Quarter Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to Shane Laidlaw, Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, Tanya, and thank you for joining us today to review Cronos' 2023 Q1 financial and business performance. Today, I am joined by our Chairman, President and CEO, Mike Gorenstein and our CFO, James Hall. Cronos issued a news release announcing our financial results this morning, which is filed on our EDGAR and SEDAR profiles. This information as well as the prepared remarks will also be posted on our website under Investor Relations. Before I turn the call over to Mike, let me remind you that we may make forward looking statements and refer to non GAAP financial measures during this call.

Speaker 1

These forward looking statements are based on management's current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward looking statements. Factors that could cause actual results to differ materially from expectations are detailed in our earnings materials and our SEC filings that are available on our website, by which any forward looking statements made during this call are qualified in their entirety. Information about non GAAP financial measures, including reconciliations to U. S. GAAP can also be found in the earnings materials

Speaker 2

results that are available

Speaker 1

on our website. Lastly, we'll be making statements regarding market share information throughout this conference call. Unless otherwise stated, all market share data is provided by HiFire. We will now make prepared remarks and then we will move into a question and answer session. With that, I'll pass it over to Cronos' Chairman, President and CEO, Mike Gorenstein.

Speaker 2

Thank you, Shane, and good morning, everyone. Building off our strategic realignment in 2022, our Our 2023 strategy is focused on launching innovative borderless products, improving the gross margin of our overall business and driving costs out of the P and L as we move toward being cash flow positive in 2024. During our last earnings call, we announced an additional $10,000,000 to $20,000,000 in projected operating expense savings 2023. I'm happy to report that we are tracking towards achieving the high end of this range. This follows our overachievement of savings in 2022 of approximately $29,000,000 versus a target of $28,000,000 to $25,000,000 James will go into more detail on the financial results during his remarks, but I want to comment on the improved trajectory of our gross margin.

Speaker 2

2022 was a transformative year for Cronos, which put us on better footing for the future. But given the quarter to quarter volatility of our gross margin performance, driven by the timing of certain activities associated with our intended changes at the Peace Naturals campus, We prefer to look at the year in totality. As a reminder, our gross margin for full year 2022 was 13%, We ended the year in Q4 with a negative 1% gross margin. Turning to Q1, we posted a 12% gross margin on a consolidated basis. Now that we have solidified our decision to stay at the Peace Naturals campus and have reorganized our business to optimize our supply chain, We intend to build on this momentum to have a smoother gross margin that will improve from Q1 performance as the year progresses.

Speaker 2

We are also keenly focused on margin accretive innovation to further diversify our product mix in higher margin derivative products, such as our number one ranking edibles. In Canada, during the Q1, we continued to execute our plan to create a robust portfolio of borderless products, highlighted by several new launches across critical categories such as pre rolls and vapes. Our spinach brand is the only brand that holds a top 10 market share position in all categories to participate in, which are flower, pre rolled, vapes and edibles. Our award winning spinach gummies became the number 1 gummy in Canada Q1. Spinach completed the quarter with a 15.3% market share in the edibles category, growing retail sales by 49% year over year versus category growth of 25%.

Speaker 2

When focusing on just gummies, spinach had a 21.9% market share. We are thrilled that our gummies have become an integral part of so many adult consumers' lives and would like to thank them for showing brand loyalty and enthusiasm for our products. Winning in the Canadian Edibles category against the top U. S. Brands is this additional confidence that this borderless product platform can win in any market.

Speaker 2

Despite our strong performance, the edibles category has been negatively impacted by chewable extracts, which are products that purports to take advantage of a regulatory loophole to sell at a higher potency per pack than compliant edibles. Health Canada has recently notified producers These products are incorrectly classified as cannabis extract and announced steps to remove these products from market. For reference, 4 of the top 10 edibles are non compliant edible extracts. And as a result, we anticipate a more robust back half performance for our edible portfolio. In the vape category, we achieved a 4.4% market share in the Q1, up 2 30 basis points year over year, climbing to number 7.

Speaker 2

We will build on that momentum in 2023 with the continued push to include flavor forward profile and rare cannabinoids in our base, driving innovation while leading on our winning formulations that consumers love across the portfolio. We launched a new Mango Kiwi Haze CBC vape under the Spinach Field brand with 32% THC and 5% CBC. Our CBC gummies performed well in the early innings of their launch in the Canadian market, and we're excited for consumers to try CBC in the vape format. We also introduced our Spinach Field Blackberry Cush THC CBN vape, which has helped contribute to our outsized 155 percent growth in retail sales in the category year over year in Q1 versus category growth of 22% for the same period. Pre rolls are one of the fastest growing categories in the cannabis market.

Speaker 2

The category increased 38% year over year during the Q1 and infused pre rolls accounted for approximately 24% of the dollar share in pre rolls during the same period. Using our success in edibles category as a blueprint for other formats, Cronos continues to elevate and differentiate the consumer experience by bringing a portfolio of infused pre rolls to market, utilizing our best in class potent genetics, our flavor forward and terpene rich formulations and sought after rare cannabinoids. In Q1, we launched 2 new rare cannabinoids focused pre rolls, Spinach Field Mango Kiwi Haze THC CBC pre roll and Spinach Field Blackberry Kush THC CBN pre roll. Since revamping the portfolio last year, Spinach pre rolls have gained market share, moving up to the 8th most popular brand in Q1, up from 16th in Q4. With the right base pre roll portfolio in place and the recent launches of 4 infused pre roll offerings, 3 of which utilize rare cannabinoids, We aim to build off this momentum to drive continued market share gains in this critical category for us.

Speaker 2

We closed the Q1 by maintaining our number 3 market share in the flower category, equating to a 5.2% share of retail sales. Flower in the Canadian market continues to be heavily weighted to 28 gram bags, encompassing 9 of the top 10 SKUs. Despite this, we continue to defend market share across pack sizes, leading with our 3.5 gram GMO cookies cube and our 28 gram wedding cake. Groco's performance continued to be strong in Q1. Groco reported us preliminary unaudited revenue of approximately $3,200,000 to non Cronos quarters.

Speaker 2

Additionally, the credit facility that Cronos previously provided to GroCo currently had $73,200,000 outstanding following the principal repayment $700,000 by GroCo in Q1. In addition, GroCo made a $5,500,000 interest payment in Q1. The strong financial performance of GroCo yielding equity pickup, interest payments and loan payback to Cronos is a vital component of our overall financial picture. Turning to Israel. The growth of the medical cannabis industry slowed in Q1, driven by geopolitical factors government appointment disruptions, which has led to multiple changes in the health ministry, causing a slowdown in patient permit authorization and increased competitive activity.

Speaker 2

Following recent news from the Israeli Health Ministry, we have renewed optimism about the prospect of regulatory change impacting how medical patients can access cannabis. A government committee recommended that Israel transition to issuing prescription via public health care services from its current model, which issues personal patient licenses and is a more complex process. The new proposal would enable a more streamlined approach to obtaining a cannabis prescription, potentially increasing patient counts by multiples. As a reminder, the current number of medical patients in Israel is approximately 125,000 or just 1.3 percent of the population. This compares to certain mature medical markets Such as Florida in the U.

Speaker 2

S. Where 3.7% of the population is approved to purchase medical cannabis. If Israel were to reach 3.7 percent of the population, that would equate to 346,000 patients, a near tripling of the current market size. This is a realistic scenario we think is possible over the next couple of years, especially given the change would result in a favorable regulatory environment such as pharmacy distribution in a federally legal jurisdiction. We are confident in the long term potential of our position in the Israeli market as it's still one of the world's largest federally legal medical programs today.

Speaker 2

We have the top performing brand in the market, PEACE Naturals, and we continue to invest for growth in this market. In the U. S, we have nearly completed the transition away from the beauty category and are moving forward by returning Lord Jones to its roots as an adult use brand featuring high quality cannabinoid products. We are assembling a portfolio of Boardless products with strategic infrastructure and global partnerships combined with an industry leading balance sheet allowing us to execute effectively in any market. With that, I'd like to pass it over to James to take you through our financials.

Speaker 3

Thanks, Mike, and good morning, everyone. I will now review our Q1 2023 results in relation to the prior year period. The company reported consolidated net revenue in the Q1 of 20,100,000 20% decrease from the prior year period. Constant currency consolidated net revenue decreased by 14% to 21,700,000 The revenue change was primarily driven by lower cannabis flower sales in the Rest of World segment and a decline in the U. S.

Speaker 3

Segment due to its strategic repositioning. Consolidated results were additionally impacted by the weakened Canadian dollar and Israeli shekel against the U. S. Dollar during the current period. These results were partially offset by growth in cannabis extract sales in Canada.

Speaker 3

Consolidated gross profit in the 4th quarter was $2,400,000 equating to a 12% gross margin, representing a $4,500,000 decline from the prior year period. The decline was primarily driven by a reduced gross profit in the Rest World segment due to lower cannabis flower sales in Israel and adverse price mix shift in cannabis flower sales in Canada, increased returns and a reduction in gross profit in the U. S. Segment. These results were partially offset by higher cannabis extract sales in Canada with a higher margin profile than other product category and lower cannabis biomass costs.

Speaker 3

As Mike mentioned, our results in 2022 were volatile quarter to quarter driven by the realignment of our business, which makes the comparison on a gross margin line in Q1 difficult. With that in mind, looking at both the full year 2022 where we had positive 13% gross margin and the sequential progression from Q4, which had a negative 1% gross margin to Q1 2023 where we had a positive 12% gross margin, You can see encouraging signs of improvement and stability and we intend to build off this momentum throughout 2023. Consolidated adjusted EBITDA in the first quarter was negative $16,800,000 representing a $2,100,000 improvement from the prior year. The improvement was primarily driven by a decline in general and administrative and research and development expenses. As Mike mentioned, we're tracking toward the high end of our previously announced $10,000,000 to $20,000,000 in operating expense savings in 2023.

Speaker 3

Quarter. Turning to our reporting segments. In the Rest of World segment, we reported net revenue in the Q1 of 19,500,000 14% decline from the prior year period. Constant currency net revenue in the Rest of World segment decreased 7% to 21,000,000 revenue change was primarily driven by a decline in cannabis flower sales in Israel due to increased competitive activity, the slowdown in patient permit authorizations and political unrest. While sales in Canada were impacted by adverse price mix shift in the flower category driving increased excise tax payments as a percent of revenue and increased returns.

Speaker 3

These results were partially offset by growth in cannabis extracts in Canada, driven by edibles and vapes. Gross profit for the Rest of World segment for the Q1 was $2,900,000 representing a $3,800,000 decline from the prior year period. The decrease is primarily due to lower cannabis flower sales in Israel, adverse price mix shift in the Canadian flower category driven by the consumer transition to 28 gram bags 3.5 gram bottles. These results were partially offset by higher cannabis extract sales in Canada, which carry a higher margin profile than other Product Categories and Lower Cannabis Biomass Call. Adjusted EBITDA in the Rest of World segment for the Q1 was negative $10,000,000 representing a $6,600,000 decline from the prior year period.

Speaker 3

The decrease versus the prior year was primarily driven by a decline in gross profit. Turning to the U. S. Segment, we reported net revenue in the Q1 of $650,000 a 72% decrease from the prior year period. The decline year over year was driven by a reduction in promotional spending and SKU rationalization due to the strategic realignment of our U.

Speaker 3

S. Business. Gross profit for the U. S. Segment for the Q1 was negative $550,000 representing a $760,000 decline from the prior year period.

Speaker 3

Q1 was negative $2,900,000 representing a $4,200,000 improvement from the prior year period. The improvement versus the prior year was primarily driven by a decrease in sales and marketing and general and administrative expenses. Turning to the balance sheet, The company ended the quarter with approximately $836,000,000 in cash and short term investments. In addition to maximizing the return on our cash, We received an interest payment on our GroCo senior secured loan of $5,500,000 which combined with regular quarterly principal payments of $700,000 For total cash paid by growth go to Cronos of $6,200,000 in Q1. Having the best balance sheet in the cannabis industry enables us to take calculated strategic bets, while we remain steadfastly focused on reducing cash burn.

Speaker 3

Last year, we made significant strides to reduce spending and improve our cash burn rate. And in February, we committed to an additional $10,000,000 to $20,000,000 in savings across operating expense categories in 2023 and we are currently tracking towards the high end of that range. Moving to cash flow, adjusting for the cash outflow of approximately $32,800,000 in income taxes payable associated with the Onetime Altria warrants relinquishment, free cash flow in Q1 2023 would have been negative $15,700,000 representing a 55% improvement year over year. We anticipate recouping most of the tax payment associated with the one time Altria warrant relinquishment over the next 3 years. Lastly, we anticipate that cash flow defined as the net change in cash and cash equivalents excluding the impact of the purchase or proceeds of short term investments for the remainder of fiscal year 2023 will decline by less than 25,000,000 The company also expects that cash flow will be positive in 2024.

Speaker 3

The improved cash flow trajectory will be driven by among other items, net revenue of $100,000,000 to $110,000,000 for full year 2023, continued gross margin improvement, operating expense reduction efforts and anticipated interest income of $30,000,000 for the remainder of fiscal year 2023. With that, I'll turn it back to Mike.

Speaker 2

Thank you, James. We are winning in Canada and Israel due to all the hard work our employees do to bring best in class borderless products to market. Our Spinach brand is the only brand that holds the top 10 market share position in all categories to participate in, which are flower, pre rolled, vapes and edible. We are confident that as regulations change, we will be among the best positioned cannabis companies to capture additional market share in any market. Before getting into questions, I want to level set what is under the Cronos umbrella and where things stand today.

Speaker 2

We closed Q1 with $836,000,000 in cash and equivalents and 0 debt, and we generated $11,200,000 in interest income with an anticipation to generate additional $30,000,000 in interest income through the remainder of 2023. Our spinach brand has the following market share rates for Q1. Overall, spinach is the number 3 cannabis brand and is number 1 in edibles, number 3 in flower, number 8 in pre year old and number 7 in base. We have a leading medical brand, Peace Naturals in Israel, which posted $5,000,000 in net revenue in Q1, with a 6.3% stake in PharmaCann, 1 of the largest private U. S.

Speaker 2

MSOs currently on our books for 49,000,000 We have an approximate 10% stake in Vittura, a leading publicly traded Australian medical cannabis provider, worth approximately 13,800,000 as of the end of Q1. We owned 50 percent of the equity in Cronos Provo, which is profitable and paid a $6,200,000 in principal and interest payments in Q1. We ended the quarter with a remaining balance of approximately $87,000,000 on our combined loans to GroCo and its partners. We own real estate and multiple licensed facilities free from any encumbrances. And last but certainly not least, we have an exclusive partnership with Altria on a global basis.

Speaker 2

At the close of the market yesterday, Cronos traded at a market cap of approximately $780,000,000 and an enterprise value of approximately negative 56,000,000

Operator

and wait for your name to be announced. Please stand by while we compile the Q and A roster. One moment for our first question. And our first question will come from John Zamparo of CIBC. Your line is open.

Speaker 4

Thank you. Good morning. I wanted to start on Israel and would like some additional color there and apologies if I missed it. But I'm curious What it is you think that market needs to do to get back to growth? What is it you're seeing on competition?

Speaker 4

And Historically, you've been somewhat protected versus your peers on the Israeli market because of your brand. I wonder exactly What needs to change to get you maybe more optimistic for the back half of the year in Israel?

Speaker 2

Sure. Thanks, John. I think the biggest thing that we're seeing in Israel related to competition, it has to do with patient growth. There's been some unrest politically and that's really stalled a lot of the regulatory process. But there have been announcements, especially recently on progress for announcements sorry, for regulations to actually change the way that the prescriptions issued in which pharmacies are able to carry cannabis.

Speaker 2

So this would essentially move from a kind of special process they have now where you have to get All these different steps that are barriers for a patient entering the system to opening it up to being treated like another controlled substance. And what we talked about in the prepared remarks, we could see that really increasing the patient count by multiples. And if you think about look at Q1 last year, we've seen that when there is a favorable regulatory change in Israel, You can see really, really rapid growth. And given the announcements, all indications are that that is something that that can happen this year. So we're looking at that over the next couple of months, thinking more Q4.

Speaker 2

And I think that would really just open up the entire market and return to what we saw at the beginning of last year in terms of growth.

Speaker 4

Okay, understood. And then my second question is on gross margins, in particular on Rest of World. You saw a nice uptick in Q1 versus Q4. But I wonder at what point and maybe we're at the point now, but will gross margin rest of world somewhat stabilized. I assume there's some moving parts with the switch back to Stainer.

Speaker 4

Obviously, there's a decent amount of fixed cost in that line, so you're not able to completely predict it. But are we at the point now where gross margin should somewhat stabilize or is that likely back half of the year development?

Speaker 3

Hey, John. Thanks for the question. So, I guess to answer, I would say, yes, we're somewhat stable, but we do expect further improvements from here. So we're continually optimizing our supply chain as you highlighted, right. We are evaluating moving certain activities back to Stayner and so some of those are in process.

Speaker 3

And so we would expect further improvements as we see some of those flow through COGS. And so we would expect a potential margin pickup right throughout the remainder of the year, But we're coming kind of coming back to more of a normalized state versus a lot of the volatility you were seeing in the prior year.

Speaker 4

Okay. That's helpful. I'll pass it on. Thank you.

Operator

One moment for our next question. And our next question will come from Andrew Carter of Stifel. Your line is open.

Speaker 5

Hey, thanks. Good morning. Just wanted to ask first off on the revenue guidance for the year, the 100% to 110%. I'm getting 19% to 34 percent for the remainder of the year, which looks like its spot rate is 24% to 39% constant currency. Could you give us the cadence phasing and if I heard your answer to John's question right, you don't really expect an improvement in Israel until the Q4.

Speaker 5

Just help me square all that. Thanks.

Speaker 3

So Andrew, can you maybe reframe the question? So are you talking about when we're Expecting the revenue for each period, for each quarter?

Speaker 5

A little bit. I mean, I'm just so to back up $100,000,000 to $110,000,000 in revenue for the year, let's start there, means the back 9 have to grow 19% to 34%. And that means cost of currency, this is my math just on spot, 24% to 39%. So I'm asking kind of what's the phasing of that revenue growth acceleration? And within that, what about if I heard John's question right, Israel doesn't improve till the Q4?

Speaker 3

Got it. Okay. Fair. So, yes, we're confident in the revenue guidance of $100,000,000 to $110,000,000 for the full year 2023, right, driving some of that back half improvement you've highlighted. We've introduced a meaningful number of new innovations over the last 6 months, but we have also the strong pipeline of innovation launches planned for the remainder of the year to help fuel that additional growth, right?

Speaker 3

Now we also have announced today that we're on track to achieve the top end of our OpEx savings targets, right, for $10,000,000 to $20,000,000 All of that will work together to drive the overall cash flow improvement, but we do expect kind of continued revenue improvement right throughout the duration of the year.

Speaker 2

Hey. And just to layer on that, I think when I'm when we're talking about Israel and that Q4, that's really For you to see a huge step change in what I think would be New York growth, when we're talking about that, We're not relying in guidance on the regulatory change, but we do think it's something that's more likely than not and that we're very optimistic about.

Speaker 3

Yes, it would be additional upside.

Speaker 5

And then the second kind of to clarify, number 1, in 2024, I think you said positive free cash flow. Is that based on current interest rates?

Speaker 2

And I guess going back to

Speaker 5

your kind of your comments at the end of the script, Mike, You talked about kind of where the enterprise value is right now. Does that become a hindrance in terms of what you're trying to do here and overall in terms of having an equity value that's a negative enterprise value or is it just, hey, you have enough capital to allocate, You're going to continue to allocate or do you feel some kind of impetus to get the shares moving to your direction, obviously helpful for M and A? Thanks.

Speaker 2

Sure, James. I'll let you go first on guidance and then I can jump to the balance sheet and Where we're positioned.

Speaker 3

Yes. And I apologize, Andrew. I'm having a little bit of issues on my line. If you could reframe or restate the guidance question?

Speaker 5

Yes. Just the cash flow guidance for next year, is that based on current interest rates and kind of your cash flow projections?

Speaker 3

Got it. So interest rates, we definitely are assuming right some stability there, right, but there's a little bit of flexibility, let me put it that way. We're also assuming same qualifying. We're assuming no significant degradation right in general economic or regulatory environment, Right. So, but I'll say we've got some flexibility on all of those.

Speaker 3

So, we're very comfortable with the interest rate. The guidance we've given It's reasonably conservative as well, right? So, I would say if there's material changes, right, then obviously that could impact the guidance.

Speaker 5

Let me try one more time to be absolutely clear. So the positive free cash flow in 2024, is that based on core operations or does that include an assumption for interest income, kind of similar to how interest income is providing, I guess, $40,000,000 of cash this year.

Speaker 3

Yes. So yes, Maybe dig in a little bit more, right. So we're talking net cash flow, right. So it does include interest income. So we're saying this is combination of improved COGS, improved OpEx savings, right, in that $10,000,000 to $20,000,000 range we're tracking toward the high end, right, improved top line that we're projecting throughout the year, which we highlighted that the guidance of $100,000,000 to $110,000,000 right.

Speaker 3

And then obviously the interest would be a significant component of that as well.

Speaker 2

Thanks. To jump in on the second part of your question, Andrew, Okay. I don't think that there's a hindrance. I think that we feel like we have a lot of flexibility, but also I think it's important and And it's time for us to make sure that we're self sustaining. So that's really the importance of being cash flow positive for us.

Speaker 2

That doesn't preclude us. If we see something that's accretive, we will continue to be opportunistic. Of course, my preference will always be way towards anything that is accretive to cash flow, but ultimately, We'll keep turning over every stone and looking for something that's value creative and not just relying on interest income. So, I still think we have plenty of flexibility.

Speaker 6

Thanks. I'll pass it on.

Operator

One moment for our next question. And our next question comes from Michael Freeman of Raymond James. Your line is open.

Speaker 7

Hey, good morning, Mike, It's Shane. Thanks for taking our questions. I wonder given interest payments are becoming or have become an increasingly important part of your Cronos' revenue picture. I wonder if you could just describe your strategy for investing cash and yielding returns from it.

Speaker 3

Sure. Thanks, Michael. So we're constantly looking for how to maximize our return on our available cash. And so we work with, I'll say large, stable, top rated financial institutions, right, especially in the current environment, right, we're extremely focused on ensuring safety and security for those funds, but then obviously making sure we maximize the return on those. So we're looking at vehicles that are typically a year or less, right?

Speaker 3

So we a laddering strategy, 3, 6, 9, 12 month vehicle, but again with the intent that it's large stable financial institutions with top rates of return there.

Speaker 7

All right. Great. That's helpful. As a second question, We've seen your rare and cultured cannabinoid portfolio proliferate through your product sets. I wonder Looking ahead a couple of years, what are some underpenetrated products or markets you can see rare cannabinoids playing an important role in?

Speaker 2

Sure. It's a great question. I think as you see consumer preferences shift From flower towards derivatives, I think you're also going to see more awareness of what those derivative products are and that's where rare starts to come I would keep pointing to pre rolls. You've seen just the general rise in popularity of infused pre rolls. And you'll also notice a lot of our launches include infused pre rolls.

Speaker 2

We still think that that is one of the biggest growth categories over the next few years, one of the best opportunities to differentiate. And similar to what you see in edibles, the further that you get from flower, the more We believe there's an opportunity to differentiate. So I think that's going to be huge. We still have a lot of opportunity across the rest of our portfolio that's In the formats that are in market today in terms of edibles, vapes, pre rolls. And then looking at a few years, I think that there are some interesting things that we'll be able to do with concentrates, which you haven't seen us launch to date, but we're we do think there's opportunity there.

Speaker 7

All right. That's great. If you could if I can just throw in one more. On the given pre rolls and infused pre rolls specifically seem to be a area of focus for Cronos. I wonder how you just how you've seen the price action in that market?

Speaker 7

We've been hearing some talk of price compression and wondering how Cronos is able to how Cronos is going to manage that

Speaker 2

conference. Yes. Look, I think pre rolls is a very big category and I think that you're going to see real segmentation in how the products develop. I think that on one end of the spectrum, there is an opportunity to actually Have pre rolls that you can sell cheaper than flower. You aren't going to be as worried about making sure The flower is well managed because it's going and being processed into a pre roll.

Speaker 2

So you will have a segment that's more value oriented, That's more about automation. And then I think on the other end of the spectrum, you get into something that's almost more cigar like that is much more premium, that I think will be at a significant premium of flower. So I think it's really about innovation. It's about understanding exactly what consumer needs you're targeting. And that's one of the reasons that I keep talking about why it's such a big opportunity there.

Speaker 2

But I think you have to make sure that you know exactly where your product fits and have a very narrowly tailored product for that segment in order to win.

Speaker 7

Okay. Thank you very much. I'll jump back in the queue.

Operator

One moment for our next question. And our next question will come from Nadine Sarwat of Bernstein. Your line is open.

Speaker 8

Hi, good morning everybody. Two questions from me. Can you comment on what you're seeing in terms of pricing in Canada? Any signs of reaching bottom yet? Or are those oversupply in the market still being the overriding factor?

Speaker 8

And then my second question, you called out the strong market share position that spinach has developed, especially within edibles. And if I look back a couple of years, People were saying that developing strong brands in cannabis could prove challenging on risks of it being a commoditized category. So With the experience you've had in the sector, I'm curious to hear what factors would you say are behind the success of building a brand with strong market share in cannabis? Thank you.

Speaker 2

Sure. Thanks. So I think on the first, what we're seeing and maybe one of the bigger factors in the price compression It isn't solely about supply, but it actually has to do with excise taxes and how they're being paid. And what trend you've noticed is that Really big portion of the LPs in Canada are actually not paying the excise taxes. And I think given capital positions.

Speaker 2

They're really leveraging that cost avoidance to really further compress prices. So I do think one of the things that is needed and that I expect will happen will be some enforcement on how excise taxes are collected. And generally, excise tax reform, I think, is something that's very important and very needed for the industry. But we still see especially on flower there is compression. And on the second part of your question, Building a brand, I think it's understanding that it is a product based focus that you need to have a different product.

Speaker 2

We have in cannabis consumers that are very, very focused on what are the features the actual product has. It's less about telling a story. At this stage in the industry, it's less about trying to bring people into a lifestyle community given the regulations That we have in brand building and marketing. So for us, the key things there, certainly, the effect really, really matters. What's the combination of cannabinoids?

Speaker 2

And I think one of the reasons you see we have strength in edibles, it has to do with that. I think that what we can do, giving different experiences leading with either CBN or with CBC or CBG is part of that cocktail, if you will, the big differentiator, but also flavor. Flavor is extremely important. I think that that initial experience you want to be something that is enjoyable for consumers. And I think most of the brands are really just focused on cost.

Speaker 2

So like any other product, flavor matters, experience matters.

Speaker 8

Got it. Thank you very much.

Operator

And one moment for our next question. And our next question will come from Matt Bottomley of Canaccord. Matt, your line is open.

Speaker 6

Good morning, everyone. Thanks for the color so far. Maybe just continuing on, Mike, the comments you're just giving on some of the characteristics there. If you take Maybe a further step back and just look at the overall Canadian landscape. It still seems like it's hard to say, but maybe only 60% of the overall market opportunity legalized has been converted over to legal channels, but markets like Ontario and others already have a saturation of retail stores.

Speaker 6

And it just seems like a lot of the regulatory challenges of what you guys are able to do are keeping some potential future customers continuing to purchase through illicit channels. But is there anything outside of regulatory changes that you think will get the overall market TAM in Canada, which seems to be stuck in the $4,000,000 to $5,000,000 range for some time now.

Speaker 2

Yes. Look, I think there is. I think that When you think about those regulatory challenges, a lot of those are really holding consumers back on pricing and on value. I think on the more premium side, there are things that you can continue doing. You've seen what we're able to do with sours and with the edible platform.

Speaker 2

I think if you're able to come out with a Consistent product, something that's higher end, something that has a transparent supply chain. There are consumers that are willing to pay a premium Over the illicit market that will come in and so I think that's still a big opportunity. There is a different view as far as the sort of highest volume consumer, which is probably a bigger part of TAM. You can See what the regulatory change will do. I talked a bit about the chewable extracts during the remarks.

Speaker 2

And I think what that kind of shows is if you can provide something that's higher potency that a larger pack size that's more similar to purchasing habits that a legacy consumer in the legacy market has. Consumers will shift really quickly into the market. And so I think that making sure that you can combine that when you have a better product and you have Something that's transparent and deemed to be a much safer alternative. That's really important for that conversion. So I think that continues to progress.

Speaker 2

I think they're continuing to make sure that as an industry and as a company specifically, we're improving our supply chain and we're able to be More competitive, that is going to help. But I think those are the 2 main things that will drive it, is innovation on the premium end and potentially with pre rolls being able to drive more value and then it will be the big regulatory change.

Speaker 6

Okay, got it. Thanks. And then just another question for me is just on Your level of interest in some of these U. S. Federal headlines.

Speaker 6

I know state banking was just reintroduced and there's been dozens and dozens of head fakes in the past. So I think people are looking at it cautiously, but how important are those types of headlines to you in decisions to potentially deploy some of your capital? Or do you think it will have to be something a more meaningful reform maybe like what Joe Biden White House is trying to do with the scheduling altogether?

Speaker 2

Look, I think that state banking is really probably the biggest thing there has to do with Getting progress. I think it's important and it's sort of a bellwether for sentiment capital markets wise. But as far as What it means big picture. I think it's just showing that we have some type of regulatory catalyst in the U. S.

Speaker 2

But If you think of the big things you need, right, like in one of the biggest would be 280 year form, right, what you can do as far as getting Capital Markets, getting some of the larger base involved. All that would be solved with the appropriate rescheduling. And I think it's an underappreciated and the most significant piece of regulatory news that we have in the pipeline. So that's really what I look towards. I think it's something that's moving.

Speaker 2

Safe Banking, I know everyone's focused on it. I'm not going to make a prediction on whether or not it happens, but I think as currently drafted, it's really more just incremental progress. Okay. Thanks for all that.

Operator

One moment for our next question. And our next question will come from Victor Ma of TD Cohen. Your line is open, Victor.

Speaker 9

Hi, good morning. Victor Ma on for Vivien Azerin. Thank you for the questions. So first, based on Hi Fi data ex Quebec, There were some sequential share losses in Vapes and Edibles. Can you offer any more color on what is driving these trends?

Speaker 9

And also comment on the defensibility in Spinach's product differentiation? Thank you.

Speaker 2

Sure. So and sorry, I missed the last part of the question.

Speaker 9

Just comment on the defensibility in Spinach's product differentiation?

Speaker 2

Sure. Look, I think the biggest thing that we've seen here It has to do with chewable extract. So we were, I think, doing very well in defending and winning against it. And once this announcement was made by Health Canada that essentially anyone with chewable extract with 4 out of the top 10 SKUs right now would not be able to sell at the end of May. You did see a fair amount of pantry loading, so that might continue for a few more weeks.

Speaker 2

But given that there has been demand that sort of ramped up for a few weeks. I would expect though that not only to be able to gain that share back in the back half of the year as that inventory depleted, but also anything that we might have given up, I think there's more opportunity to gain Just with that shift and looking longer term as far as defensibility and I think of it more offensively is I really do hope that the government takes this opportunity to look and see The world didn't fall apart with higher potency edibles. It's something that is certainly in demand with consumers and We will be very ready if there is any change there to put a compliant offering on the same quality that we have out today. And I think, absent regulatory shifts, we always do take the approach of making sure our innovation budget goes into things that are long term, making sure we do things the right way, but we do believe that that is a big moat that product differentiation will be there. I think we've been relatively Ultimately, the circumstances around the true black swag flip is more bullish for us than otherwise.

Speaker 9

Great. And then can you just add some color on the share losses for Vapes? I think share was down sequentially as well in that category.

Speaker 2

Yes, I think, vapes is probably a little bit more nuanced, have to do with the size of the actual vape cards in update that we made. And when you make those updates, you can see relatively small fluctuations and that has to do a bit with what the ordering patterns are like and especially when you are doing changeovers. But I don't think that there is any trend that I'm concerned about there and I think you'll see that pickup. Great.

Speaker 9

Thank you. And then just on my second question. So on Israel, can you comment on the increased competitive activity over the quarter? Are you seeing more discounting or promo and how enduring do you think are these competitive activities? Thank you.

Speaker 2

Sure. Yes. I think there's been more discounting, there's consolidation similar to what we've seen in Canada with some of the market participants. You've seen and you're starting to see more consolidation. You'll see more companies exiting the market.

Speaker 2

I think that there's a lot less investment capital in Israel than there was in Canada. And you're seeing more companies in Canada look to try to enter Israel. But ultimately, this is something that I think we're used to, something that I think we can certainly defend against. I do think the biggest relief and the biggest opportunity is related to a regulatory change. But like we've seen in Canada, As there's access, I think there's opportunity and we've been able to with our flower products and other innovations separate And take share and we will continue focusing on Israel.

Speaker 9

Great. Thank you for the color. I'll jump in the queue.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.

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Earnings Conference Call
E2open Parent Q1 2023
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