Cronos Group Inc

TSX:CRON

Earnings Call Transcript 2023-Q1

[Operator]

Good morning. My name is Tania, 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 Shayne Laidlaw, Investor Relations. Please go ahead.

[Shayne Laidlaw, IR]

Thank you, Tanya. And thank you for joining us today to review Cronos' 2023 first quarter financial and business performance. Today I'm joined by our Chairman, President and CEO Mike Gorenstein and our CFO James Holm. Cronos issued a news release announcing our financial results this morning, which is filed on our EDGER 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. 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 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 that are available on our website. Lastly, we'll be making statements regarding market share information throughout this conference call. And unless otherwise stated, all market share data is provided by Hifyre.

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.

[Mike Gorenstein, Chairman, President and CEO]

Thank you, Shayne. And good morning, everyone. Building off our strategic realignment in 2022, 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&L, as we move toward being cash flow positive in 2024.

During our last earnings call, we announced an additional $10 million to $20 million in projected operating expense savings for 2023. I'm happy to report that we are tracking towards achieving the high-end of this range. This follows our over achievement of saving in 2022 of approximately $29 million versus a target of $20 million to 25 $million.

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. 2022 was a transformative year for Chronos, 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 activity associated with already pending changes at the peak natural campus, we prefer to look at the year in totality. As a reminder, our gross margin for full year 2022 was 13%, but we ended the year in Q4 with a negative 1% gross marketing.

Turning to Q1, we posted a 12% gross margin on a consolidated basis. Now that we've solidified our decision to stay in the feed natural campus and 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.

We're also keenly focused on margin accretive innovation to further diversify our product mix in the higher margin derivative product, such as our number one ranking edibles. In Canada, during the first quarter, we continue 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 vape. Our Spinach brand is the only brand that holds the top 10 market share position in all categories that participate in which are flour, pre-roll, vapes and edibles. Our award winning Spinach gummies became the number one domain in Canada in Q1. They just completed the quarter with a 15.3% market share in the edibles category, growing retail sales by 49% year-over-year versus category growth 25%.

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 we'd like to thank them for showing brand loyalty and enthusiasm for our products. Winning in the Canadian edibles category against the top U.S. brand is this additional confidence that this borderless product platform can win in any market.

Despite our strong performance, the edibles category has been negatively impacted by chewable extracts, which are products that purport to take advantage of a regulatory loophole to sell at a higher potency per pack and compliant edibles. Health Canada has recently notified producers that these products are incorrectly classified as cannabis extract is announced steps to remove these products from market. For reference four of the top 10 edibles are non-compliant edible extracts, and as a result, we anticipate a more robust back half performance for edible portfolio.

In the vape category, we achieved to 4.4% market share in the first quarter up 230 basis points year-over-year climbing to number seven. We will build on that momentum in '23 with the continued push to include flavor forward profiles 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% CBD. 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'll also introduce our Spinach Field BlackBerry Kush THC CBN vape, which has helped contribute to our outsize 155% growth in retail sales in the category year-over-year in Q1, versus is category growth of 22% for the same period.

Pre-rolls are one of the fastest growing categories in the cannabis market. The category increased 38% year-over-year during the first quarter and reduced pay roll accounted for approximately 24% of the dollar share in pre-rolls during the same period. Using our success and edibles category, as a blueprint for other formats, firm continued to elevate and differentiate the consumer experience by bringing a portfolio infused pre-rolls to market utilizing our best-in-class potent genetics or flavor forward and terpene rich formulations and sought after rare cannabinoids.

In Q1 we launched two new rare cannabinoids focused prerolls, Spinach Field Mango Kiwi Haze THC CBC pre-roll, and Spinach Fields BlackBerry Kush THC CBN pre-roll. Since revamping the portfolio last year, Spinach pre-roll gained market share, moving up to the eighth most popular ran in Q1, up from 16 in Q4. With the right vape pre-roll portfolio in place and the recent launches of four infused pre-roll offerings, three of which utilize their cannabinoids. We aim to build off this momentum to drive continued market share gains in this critical category for us.

We closed the first quarter by maintaining our number three market share in the flour category, equating to a 5.2% share of retail sales. Flour in the Canadian market continues to be heavily weighted to 20-gram bag encompassing nine of the top 10 SKUs. Despite this, we continue to defend market share across pack sizes, leading with our 3.5-gram GMO cookie SKU in our 28-gram wedding cake.

GrowCo's performance continue to be strong and Q1. GrowCo reported us preliminary unaudited revenue of approximately $3.2 million to non-Chronos customers. Additionally, the credit facility that Chronos previously provided to GrowCo currently has $73.2 million outstanding following the principal repayment $0.7 million by GrowCo in Q1. In addition, GrowCo made a $5.5 million interest payment in Q1.

The strong financial performance of GrowCo 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 and government appointment disruptions, which has led to multiple changes in the Health Ministry causing a slowdown and patient permit authorization and increased competitive activity. 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 the public health care services from its current model, which issues personal patient licenses and as 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% of the population. This compares to certain mature medical market, such as Florida in the U.S. with 3.7% of the population is approved to purchase medical cannabis. As Israel want to reach 3.7% of their population that would equate to 346,000 patients and they're tripling of the current market size.

This is a realistic scenario, we think is possible over the next couple of years, especially given the changing result in a favorable regulatory environment, such as pharmacy distribution and a federally legal jurisdiction.

We are confident in the long-term potential of our position the Israeli market, as it's still one of the world's largest federally legal medical programs today. We have the top performing brand in the market, Peace Natural, 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 we're moving forward by returning more domes to its roots as an adult use brand featuring high quality cannabinoid products. We are assembling a portfolio of borderless 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 on to James to take you through our financials.

[James Holm, CFO]

Thanks, Mike. And good morning, everyone. I will now review our first quarter 2023 results in relation to the prior year period. The company reported consolidated net revenue in the first quarter of $20.1 million, a 20% decrease from the prior year period. Constant currency consolidated net revenue decreased by 14% to $21.7 million. The revenue change is primarily driven by lower cannabis flour sales in the rest of world segment and a decline in the U.S. 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 and Canada.

Consolidated gross profit in the fourth quarter was $2.4 million, equating to a 12% gross margin, representing a $4.5 million decline from the prior year period. The decline was primarily driven by reduced gross profit in the rest of world segment due to lower cannabis flour sales in Israel and adverse price mix shift and 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.

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 $16.8 million, representing a $2.1 million improvements in 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 million to $20 million and operating expense savings and 2023.

Turning to our reporting segments, in the rest of world segment, we reported net revenue in the first quarter of $19.5 million, a 14% decline from the prior year period. Constant currency net revenue in the rest of world segment decreased 7% to $21 million. Revenue change is primarily driven by a decline in cannabis flour sales in Israel due to increased competitive activity to slow down in patient permit authorizations and political unrest. While sales in Canada were impacted by adverse price mix shift in the flour category driving increased excise tax payment as a percent of revenue and increased returns. These results are partially offset by growth in cannabis extracts in Canada driven by edibles and vapes.

Gross profit for the rest of the world segment for the first quarter was $2.9 million, representing a $3.8 million decline from the prior year period. The decrease is primarily due to lower cannabis flour sales in Israel, adverse price mix shifts in the Canadian flour category driven by the consumer transition to 28-gram bags from 3.5-gram box. These results are partially offset by higher cannabis extract sells in Canada, which carry a higher margin profile than other product categories and lower cannabis biomass costs.

Adjusted EBITDA in the rest of the world segment for the first quarter with negative $10 million, representing a $6.6 million declines in the prior year period. 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 first quarter 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.S. business. Gross profit for the U.S. segment for the first quarter was negative $550,000 representing a $760,000 decline from the prior year period. The decrease year-over-year was primarily due to lower sales volumes and increased inventory reserves.

Adjusted EBITDA in the U.S. segment for the first quarter was negative $2.9 million, representing a $4.2 million 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 million in cash and short term investments. In addition to maximizing the return on our cash, we received an interest payment on our GrowCo senior secured loan of $5.5 million, which combined with regular quarterly principal payments of $0.7 million, for total cash paid by GrowCo to Cronos of $6.2 million in Q1. Having the best balance sheet in the cannabis industry enables us to take calculated strategic fit, while we remain steadfastly focused on reducing cash burn.

Last year, we made significant strides to reduce spending and improve our cash burn rate, and in February we committed to an additional $10 million to $20 million 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 $32.8 million in income taxes payable associated with the one time Altria warrants relinquishment, free cash flow in Q1 2023 would have been negative $15.7 million, representing a 55% improvement year-over-year. We anticipate recouping most of the tax payment associated with the onetime Altria warrant relinquishment over the next three years.

Lastly, we anticipate the cash flow defined as the net change in cash and cash equivalents excluding the impact of the purchase of proceeds of short term investment for the remainder of fiscal year 2023 was declined by less than $25 million. The company also expects that cash flow will be positive in 2024. The improved cash flow trajectory will be driven by among other items, net revenue of $100 million to $110 million for full year 2023, continued gross margin improvement, operating expense reduction efforts and anticipated interest income of $30 million for the remainder of fiscal year 2023.

With that, I'll turn it back to Mike.

[Mike Gorenstein, Chairman, President and CEO]

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 a top 10 market share position in all categories to participate in, which are flour, pre-roll vapes and edibles. We are confident that as regulations change, we will be among the best position 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. We closed Q1 with $836 million in cash equivalents and zero debt. And we generated $11.2 million in interest income with an anticipation to generate additional $30 million interest income for the remainder of 2023. Our Spinach brand has the following market share rate for Q1. Overall Spinach is the number three cannabis brand and is number one in edibles number three in flour, number eight and pre-rolls and number seven in vapes. We have a leading medical brand, Peace Natural in Israel, with close to $5 million in net revenue in Q1 with a 6.3% stake in PharmaCann, one of the largest private us MSOs currently on our books for $49 million. We have an approximate 10% stake in Vitura, a leading publicly-traded Australian Medical Cannabis provider worth approximately $13.8 million as of the end of Q1. We own 50% of the equity in Toronto's GrowCo, which is profitable and pay the $6.2 million in principal and interest payments in Q1. We ended the quarter with the remaining balance of approximately $87 million on our combined loans to GrowCo and as partners. We own real estate and multiple licensed facilities free from any conferences. And last but certainly not least, we have an exclusive partnership with Altria on a global basis.

At the close of the market yesterday, Chronos traded at a market cap of approximately $780 million and enterprise value of approximately negative $56 million.

With that I'll open the line for questions.

[Operator]

Certainly. [Operator Instructions] And our first question will come from John Zamparo of CIBC. Your line is open.

[John Zamparo, CIBC Capital Markets]

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

[Mike Gorenstein, Chairman, President and CEO]

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 are issued, in which pharmacies are able to carry cannabis. So this would essentially move from the kind of special process they have now where you have to get, all these different steps that are barriers for patient entering the system to opening it up to being treated like another controlled substance.

And when we talked about in the prepared remarks, we can 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's 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 can happen this year. So we're looking at that over the next couple of months, seeking more Q4, and I think that would really just open up the entire market and return to what we saw the beginning of last year in terms of growth.

[John Zamparo, CIBC Capital Markets]

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 the gross margin in rest of world somewhat stabilized. I assume there's some moving parts with the switch back to Steiner. Obviously, there's a decent amount of fixed costs in that line, so you're not able to completely predict it. But are we at the point now, where gross margin should somewhat stabilized or is that like the back half of the year development?

[James Holm, CFO]

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 Steiner and so some of those are in process. And so we would expect further improvements as we see some of those flow through COGS and so we would expect, potential margin pickups 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 we're seeing in the prior year.

[John Zamparo, CIBC Capital Markets]

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.

[Andrew Carter, Stifel]

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

[Mike Gorenstein, Chairman, President and CEO]

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?

[Andrew Carter, Stifel]

A little bit. I mean, I'm just so to back up $100 million $110 million in revenue for the year to start there, means the back nine has to grow 19% to 34%. And that means constant currency as 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 -- if I heard Jon's question right, Israel doesn't improve till the fourth quarter?

[Mike Gorenstein, Chairman, President and CEO]

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

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

[James Holm, CFO]

And just to layer on that. I think when I'm -- when we're talking about Israel that Q4, that's really for you to see a huge step change and what I think would be meteoric growth. When we're -- when we're talking about that we're not relying and guidance on the regulatory change. But we do think it's something that's more likely to not and that we're very optimistic about.

[Mike Gorenstein, Chairman, President and CEO]

Yeah, it would be additional upside.

[Andrew Carter, Stifel]

And then the second, kind of to clarify number one, in 2024 I think you said positive free cash flow, is that based on current interest rates? And I guess, going back to 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 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&A? Thanks.

[Mike Gorenstein, Chairman, President and CEO]

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

[James Holm, CFO]

Yeah, so and I apologize. Andrew, I'm having a little bit of issues on my line, if you can reframe or restate the guidance question.

[Andrew Carter, Stifel]

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

[James Holm, CFO]

Got it. So -- no, 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 in general economic or regulatory environment. So -- but I'll say we've got some flexibility in all of those. So we're very comfortable with the interest rates. The guidance we've given is reasonably conservative as well. So I would say if there's material changes, right, then obviously, that could impact the guidance.

[Andrew Carter, Stifel]

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 our interest incomes, providing I guess, $40 million in cash this year?

[James Holm, CFO]

Yeah. So I'll maybe dig in a little bit more. So we're talking net cash flow. So it does include interest income. So we're saying this is a combination of improved COGS, improved OpEx savings right in that $10 million to $20 million range, we're tracking toward the high-end, improved top-line that we're projecting throughout the year, which we highlighted with the guidance of 100 to 110. And then obviously, the interest would be a significant component of that as well.

[Mike Gorenstein, Chairman, President and CEO]

Thanks. To jump in on the second part of your question, Andrew, 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 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. 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 weighted towards anything that is accretive to cash flow, but ultimately will keep turning over every stone and looking for something that's value accretive and not just relying on the interest income. So, I still think we have plenty of flexibility.

[Andrew Carter, Stifel]

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.

[Michael Freeman, Raymond James]

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

[Mike Gorenstein, Chairman, President and CEO]

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. We're extremely focused on ensuring safety and security for those fund, 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. So we implement a laddering strategy three, six, nine, 12-month vehicle. But again, with the intent that it's large, stable financial institutions with top rates of return there.

[Michael Freeman, Raymond James]

All right. Great, that's helpful. As a second question, we've seen your rare and cultured cannabinoid portfolio proliferates 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?

[Mike Gorenstein, Chairman, President and CEO]

Sure, it's a great question. I think as you see consumer preferences shift from flour towards derivatives, I think you're also going to see more awareness of what those derivative products are. And that's where rare start to come in. 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, we still think that that is one of the biggest growth categories are the next few years. One of the best opportunities to differentiate.

And similar to what you see in edibles, the further that you get in flour, the more we believe there's an opportunity to differentiate. So I think that's going to be huge. And we still have a lot of opportunity across the rest of our portfolio that in the format that are in market today in terms of edibles, vapes, pre-rolls. And then looking at a few years, I think that there's some interesting things that we'll be able to do with concentrates, which you haven't seen us launch today. But we're --- we do think there's opportunity there.

[Michael Freeman, Raymond James]

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 seemed to be area of focus for Cronos. I wonder how you -- how you've seen the price action in that market? We've been hearing some talk of price compression and wondering how Cronos is able to -- how Cronus is going to manage that going forward?

[Mike Gorenstein, Chairman, President and CEO]

Yeah, look, I think pre-rolls is a very big category. And I think that you're going to see real, real segmentation in -- how the products developed. I think that on one end of the spectrum, there is an opportunity to actually have pre-rolls that you can sell cheaper than flour. You weren't going to be worried about making sure that the flours is well manicured because it's going and being processed into a pre-roll. 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 we'll be at a significant premium of flour. So I think it's really about innovation. It's about understanding, exactly what consumer needs are targeting. And that's one of the reasons that I keep talking about why it's such a big opportunity there. 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.

[Michael Freeman, Raymond James]

Okay, thank you very much. I'll jump back into queue.

[Operator]

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

[Nadine Sarwat, AllianceBernstein]

Hi, good morning, everybody. Two questions for 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 and the market still being the overriding factor?

And then my second question, you called out the strong market share position, finishes 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.

[Mike Gorenstein, Chairman, President and CEO]

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

So I do think one of the things that 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 it's something that's very important, very nice for the industry. But we still see especially on flour there is there is compression.

On the second part of your question, building a brand, I think it's understanding that is a product based focus that you need to have a different product. 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 that the key things there, certainly the effect really, really matters. What are -- what's the combination of cannabinoids? And I think one of the reasons you see we have strength in edibles 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 it to be something that is enjoyable for consumers. And like most of the brands are really just focused on cost. So, like any other product, flavor matters, experience matters.

[Nadine Sarwat, AllianceBernstein]

Got it. Thank you very much.

[Operator]

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

[Matt Bottomley, Canaccord Genuity]

Good morning, everyone. Thanks for the color so far. Maybe just continuing on, Mike, the comments 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 legalizes has been converted over to legal channels.

But markets like Ontario, and others already have a saturation of retail stores. 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 the realistic 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 million to $5 million range for some time now?

[Mike Gorenstein, Chairman, President and CEO]

Yeah, 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.

So you've seen what we're able to do with flower and with the edibles platform. I think if you're able to come out with a consistent -- consistent product, something that's higher end than that as a transparent, 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 a still a big opportunity. There is a different view as far as the sort of highest volume consumer, it's probably a bigger part of TAM.

You can see what the regulatory change will do, I talked a bit about chewable extracts doing the marks. And I think what that kind of shows is, if you can provide something that's higher potency, that a larger pack size, it's more similar to purchasing habits at a legacy consumer in legacy market has.

Consumers will shift really quickly in 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. I think that 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 two main things will drive it is innovation on the premium end and potentially with pre-rolls being able to drive more value. And then it'll be the big regulatory change.

[Matt Bottomley, Canaccord Genuity]

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, and Safe Banking, which is reintroduced. And there's been dozens and dozens of [indiscernible] 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'll have to be something more meaningful reform maybe like what Joe Biden, White House is trying to do with the scheduling altogether?

[Mike Gorenstein, Chairman, President and CEO]

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

But if you think of the big things you need, right, like and one of the biggest the [indiscernible], what you can do as far as getting capital markets, getting some of the larger banks involved. All of 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 that's moving.

Safe banking, I know everyone's focused on it. And 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.

[Matt Bottomley, Canaccord Genuity]

Okay, thanks for all that.

[Operator]

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

[Victor Ma, TD Cowen]

Hi, good morning. Victor Ma on for Vivien Azer and thank you for the questions. So first, based on Hifyre data, just go back. There were some sequential share losses in vapes and edibles. Can you offer any more color and what is driving these trends? And also comment on the defensibility in Spinach's product differentiation. Thank you.

[Mike Gorenstein, Chairman, President and CEO]

Sorry, I missed the last part of the question.

[Victor Ma, TD Cowen]

Just comment on the differentiability in Spinach's product differentiation.

[Mike Gorenstein, Chairman, President and CEO]

Sure. So I think I think the biggest thing that we've seen here has to do with chewable extracts. So we were I think, doing very well in defending in winning against it. And once this announcement was made by Health Canada that essentially anyone with chewable extracts with four out of the top 10 SKUs right now, would not be able to sell at the end of May. And you did see a fair amount of pantry loading. So that might continue for a few more weeks. But given that there has been demand that sort of ramped up for a few weeks.

I would expect though that not only be able to gain that share back the back half of the year as that inventory is depleted, but also anything that we might have given up, I think there's more opportunity to gain just with that shift and looking in a longer term as far as defensibility, and I think of it more offensively is, I really do hope that 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's any change there to do a put up compliant offering on the same quality that we have out today.

And I think, at some regulatory shifts, and 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 differentiated product differentiation will be there, I think we've been relatively consistent in defending on the product side and being able to take share. So I think it's a temporary blip. And ultimately, that the circumstances around the chewable extract flip is more bullish for us than otherwise.

[Victor Ma, TD Cowen]

Great, and then can you just add some color on the on the share losses per vapes? I think, share was down sequentially as well in that category.

[Mike Gorenstein, Chairman, President and CEO]

Yeah, I think, vapes is probably a bit more nuanced has to do with the size of the actual vape carts and potency, which was 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're doing change overs. But I don't think that there's any trends concern about there? And I think you'll see that impact us.

[Victor Ma, TD Cowen]

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

[Mike Gorenstein, Chairman, President and CEO]

Sure. I think there's been more discount, and there's consolidation, similar to what we've seen in Canada with the market participants. And you're starting to see more consolidation, you'll see more companies exiting the market. 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 you know, 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 flour products and other innovations, separate and take share and they will continue focusing on Israel.

[Victor Ma, TD Cowen]

Great, thanks for the color. I'll jump back in the queue.

[Operator]

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