Canopy Growth Corp

TSX:WEED

Earnings Call Transcript 2021-Q2

[Operator]

Good morning. My name is Sharon, and I will be your conference operator today. I would like to welcome you to Canopy Group's Second Quarter Fiscal 2021 Financial Results Conference Call. [Operator Instructions] I will now turn the call over to Judy Hong, Vice President, Investor Relations. Judy, you may begin the conference call.

[Judy Eunjoo Hong, Vice President of Investor Relations]

Thank you, Sharon, and good morning, everyone. Thank you all for joining us today. On our call today, we have Canopy Group's CEO, David Klein; and CFO, Mike Lee. Before financial markets open today, Canopy issued a news release announcing our financial results for second quarter ended September 30, 2020. This news release is available on Canopy Growth's website under the Investors tab and will be filed on our EDGAR and SEDAR profiles. Before we begin, I would like to remind you that our discussion during this conference call will include forward-looking statements that are based on management's current views and assumptions and that this discussion is qualified in its entirety by the cautionary note regarding forward-looking statements included at the end of this morning's news release. Please review today's earnings release and Canopy Growth's reports filed with the SEC and SEDAR for various factors that could cause actual results to differ materially from projections. In addition, reconciliations between any non-GAAP measures to their closest reported GAAP measures are included in our earnings press release furnished to the SEC and Canadian Securities regulators. Please note that all financial information is provided in Canadian dollars unless otherwise specified. Following prepared remarks by David and Mike, we will conduct a question-and-answer session with analysts. [Operator Instructions] With that, I will turn the call over to David. David, please go ahead.

[David Eric Klein, CEO & Director]

Thank you, Judy, and good morning, everyone. I hope that you and your families are keeping safe as we begin to see COVID infection rates increase in all of our core markets. I'd also like to take this opportunity to thank our veterans across Canada and the U.S. as we prepare to observe Remembrance Day in Canada and Veterans Day in the U.S. I'm pleased with the continued progress we're making as our renewed strategy of winning consumer mind share, along with increased agility and execution, drove record revenue in the second quarter. Before I discuss our performance, I'd like to take a few minutes to talk about how we see the U.S. landscape evolving post last week's election and provide an update on our U.S. strategy. First, we believe the Biden win is an important step on the path to federal permissibility of cannabis in the U.S. market through decriminalization and de-scheduling. Second, and maybe more important, the results of the ballot initiatives clearly showcase that support for adult-use marijuana legalization extends across geographic and party lines and is supported by a majority of Americans. Legal marijuana is becoming the American norm as ballot measures passed in Arizona, Mississippi, Montana, New Jersey and South Dakota. 36 states plus Washington, D.C. have now legalized cannabis for medical or recreational purposes. This will likely increase pressure on Congress to pass major federal marijuana reform in the very near future. By having states like New Jersey legalize adult recreational use, we are de-stigmatizing and normalizing the use of cannabis. In 2021, we expect to see a lot of positive activity at the state level. Governor Cuomo in New York, for example, has made legalization of priority. In addition, there are also significant deficits within state budgets, and cannabis provides a net new industry to combat this with new job creation and new tax revenues. Further, we think that states which border legalized states, for example, New York and Pennsylvania bordering New Jersey, will see increased pressure to legalize. We're excited by the prospects of participating in the U.S. THC market, and we've already developed a U.S. ecosystem that positions us well at hemp and cannabis powerhouse when, not if, U.S. permissibility happens. So let me highlight some of the key components of our U.S. strategy. We're building a portfolio of scalable brands across cannabis and CPG. Our goal is to become a cannabis-focused CPG company. We're bringing our THC brands such as Tweed and Houseplant into the U.S. market through multistate operator relationships or CBD line extensions. We're growing new-to-world CBD brands such as Martha Stewart to meet consumer needs. We're establishing routes to market with our CPG brands such as BioSteel, This Works and Storz & Bickel. These are strong brands in their own right with distinct value propositions. Building these brands today allows us to generate revenues without the headwinds of regulatory challenges. And then we plan to line extend these brands into CBD or even THC as regulations evolve. We will layer in additional brands over time, which will create further scale with our existing distribution networks and further build our relationships with retailers. We're leveraging our insights and innovation capabilities across North America. By gathering consumer insights in recreational states like Colorado or California, we can adjust our product development activities and portfolio mix. We can also develop and test new products in Canada based on those insights from the U.S. market. Our agreement with Acreage gives us a fast start into the U.S. THC market, with Acreage already deploying Canopy's IP to build brand awareness in the U.S. for our brands such as Tweed. In addition, our relationship with TerrAscend, which continues to perform extremely well, provides additional optionality to strengthen our U.S. business. Our retail banners, such as Tokyo Smoke and Tweed retail stores will build brand awareness and serve as a testing ground for innovation. And finally, we have a great strategic partner in Constellation Brands, not only giving us the balance sheet strength and access to capital, but also we're leveraging Constellation's powerful distribution network in their key account relationships. We're sharing best practices across insights, R&D and operations. And both companies' government relations and legal teams are collaborating and engaging with politicians and regulators to help shape legislative policies and regulations in Canada and in the U.S. Now let's discuss the tangible progress we've made against our strategic plan. There are 3 key themes that Mike and I would like to focus on this morning. First, momentum is building across our key businesses as our new strategy is coming to fruition. We achieved record quarterly revenue in Q2, led by our Canadian recreational business and strength across our strategic businesses, including Storz & Bickel, This Works and BioSteel. Second, we're continuing to improve execution and agility. Our fill rates are now consistently exceeding 90%. Our flower quality improvement program is generating positive results, and we've improved our new product development process to allow us to bring better products to market faster. Third, we're accelerating our path to profitability, notably in our largest market, Canada. Let me tie these themes together and give you more details on how our key strategic priorities are driving improved performance in our business. The first point I'd like to make is we're winning consumer mind share driven by insights and innovation. We strengthened our competitive positioning in the recreational market in Canada, gaining market share by 200 basis points to 15.5% from Q2 -- in Q2 from Q1. We grew share in the flower category by 320 basis points to 17.3%, with further improvement to 19.4% in the latest 4 weeks ended October 25. In Ontario, we grew our flower -- our value flower share by 930 basis points, led by our TWD brand. We established leadership position across total cannabis-infused beverages during Q2, accounting for nearly 54% dollar share with 5 of our beverages under Tweed, Houseplant and Deep Space brands. Within the ready-to-drink category in Ontario, our share was nearly 70% in Q2. We recently launched Quatreau CBD beverages across Canada and have now shipped over 2 million cans of our drinks. Now I know you'll have any questions about our market share methodology. So Mike will provide details on our internal proprietary market share tracking tool during his remarks. The point, however, is that our insights team, which we defined as a key component of our CPG strategy, is already beginning to drive value by providing a near real-time measure of our market performance. Turning to the U.S. We're accelerating growth by bringing our differentiated brands to consumers and quickly expanding distribution. We launched our Martha Stewart-branded health and wellness CBD gummies, oil and softgels in the U.S. in September. This new line brings together the exquisite flavors that you'd expect from Martha with the science and distribution power of Canopy. The launch generated significant earned media, driving record sales on shop canopy.com the day after the New York Times ran a story. The products are now getting listed in brick-and-mortar retail stores, and we expect to see Martha Stewart CBD products in thousands of stores as we launch additional SKUs in the coming weeks. BioSteel continued to accelerate its momentum, signing distribution agreements with leading beer distribution companies such as Reyes Holdings and Manhattan Beers alongside several other partnerships through Constellation Brands' gold network. We expect to cover 100% of the U.S. market via direct store delivery by January of next year. The BioSteel team is currently in discussions with a number of large national accounts and expect to have products on shelf across food, drug, mass, convenience and gas channels over the course of calendar 2021. Storz & Bickel continue to expand its distribution in the U.S., while repeat orders from newly added distributors confirm that Storz & Bickel vaporizers are seeing strong consumer pull. Storz & Bickel will be celebrating its 20th anniversary on December 5 as they continue to expand their leadership in the vaporizer category. Another key milestone we achieved in the U.S. is the implementation of the amended agreement with Acreage, which obtained overwhelming support from Acreage shareholders. As I stated on our previous call, the amended agreement is a win-win for both Acreage and Canopy. For Canopy, the agreement reduced our total purchase obligation, thus conserving 71 million canopy growth shares for Canopy shareholders. There are also additional closing conditions that need to be met by Acreage, which didn't exist in the original agreement. We look forward to Acreage launching THC-infused beverages, which leverages Canopy formulations and brands in the states of California and Illinois next summer. The recently improved focus from the Acreage board and leadership team causes me to be extremely bullish on Acreage as they work to drive profitability and growth in their core states. I'm highly confident that Acreage will emerge as one of the top U.S. multistate operators as the U.S. heads toward permissibility. The next point I'd like to make is that we're improving execution across our organization. In Canada rec, our revamped integrated business planning process is driving much better forecasting, and we continue to see our fill rates improve, resulting in increased market share performance. We're strengthening our retail presence and improving execution. We opened 9 corporate-owned stores in Alberta during Q2 with additional store opening in October, bringing total corporate-owned stores to 33 as of today. The number of partner stores has also increased to 16 in total, up from 14 in the first quarter. And we're executing against our plans to increase our market share at our corporate-owned stores. Our share within own retail improved by 6 points to 54% in Q2 versus Q1 and is approaching 60% in recent weeks. We're making significant progress in our comprehensive flower improvement programs. We completed the first phase of a consumer research project aimed at defining the product attributes that matter most to consumers along with their willingness to pay for those attributes. We're leveraging this work to lay the foundation for our brand and product strategy, ensuring our dried flower products have tangible attributes such as moisture level, harvest methodology, grow location or packaging solutions that directly correlate with consumer expectations at each particular price point. And the last point is that we're accelerating our path to profitability. Mike will provide more details in this area, but just to highlight a few examples. We move quickly to reduce our labor costs in our Canadian operations. We held our SG&A broadly stable versus last quarter despite higher revenue driving improvement in our SG&A ratio. And our end-to-end supply chain review has identified significant savings across our cost structure. We plan to provide our medium-term financial targets when we report our Q3 earnings in February, but I'm confident that we're now firmly on a path to achieve positive adjusted EBITDA at some point next fiscal year. At this point, I'll turn it over to Mike to review our Q2 financial results.

[Michael Alan Lee, Executive VP & CFO]

Thank you, David, and good morning, everyone. During Q2, Canopy achieved record net revenue. Gross margins came in line with our expectations, and we saw another quarter of improvement in our operating expense ratio. Our free cash flow was an outflow of $190 million, which represents an improvement of 57% over the prior year, and we ended the quarter with over $1.7 billion in cash and short-term investments at quarter end. Let me review Q2 performance in more detail, starting with net revenue. We generated $135 million of net revenue or 24% growth year-over-year after adjusting for a $33 million portfolio restructuring charge incurred in Q2 of last year for returns, return provisions and pricing allowances related to our recreational softgel and oil portfolio. Net revenue increased 23% versus the previous quarter. Canadian recreational net revenue increased 12% versus the prior year, excluding the same portfolio restructuring charge, and 38% over the prior quarter, benefiting from growth in both the B2C and the B2B channels. Recreational B2B sales increased by 21% over the prior quarter, driven by a number of factors. First, the pace of retail store openings accelerated in key provincial markets, especially Ontario, contributing to increased sell-in during the quarter, and total active store count nationwide grew by 185 stores in Q2, with Ontario seeing 46 additional stores open, bringing the total to 147 at quarter end. And looking ahead, we expect more store openings to continue to have a positive impact on industry sales, and we now expect there will be over 1,250 stores in Canada and over 240 stores in Ontario by the end of this calendar year. We continue to improve our customer order fill rate with our supply attainment exceeding 90% during the quarter. And we grew market share in the dry flower category following the repositioning of our value flower offerings as well as flower quality improvements implemented across the range of flower products that we offer. Our 2.0 products drove 8% of our B2B gross revenue in Q1, driven by strong demand for our THC beverages. As David mentioned in his remarks, I'd like to share details on our market share performance based on our own market share tracker. To help the team better understand the performance of our products in Canada, we've developed an internal proprietary market share tracker utilizing point-of-sales data supplied by third-party data providers, data provided by government agencies and then our own retail store operations data across the country. And what we've compiled here is what we believe to be the most comprehensive view of the Canadian rec market, giving us a real competitive advantage that allows for accurate market share reporting and market insights on a near real-time basis. Recognizing that many of you utilize other third-party information such as Headset or BDSA, I'd like to highlight some distinguishing elements for our internal tool. First, our tracker has broad coverage. We cover 9 out of 10 provinces compared to 5 currently offered by Headset. Second, our tracker provides deeper coverage within the provinces we track. In Alberta, British Columbia, Saskatchewan, Manitoba and Newfoundland, we capture, on average, 32% of stores point-of-sale data. In New Brunswick, Nova Scotia and Prince Edward Island, we capture 100% of POS data. In Ontario, because we do not have POS data, we use depletions, which are provincial sales to the retailers, as well as e-commerce data from the OCS, which provides us with full coverage. We do not have visibility to Québec, so it's the 1 province missing from our data set. Now as with any retail sales data such as Nielsen or IRI, there are limitations as this data does not capture 100% of the stores in every province. And the stores we're including in Saskatchewan, Manitoba and Newfoundland skew to our own retail stores as we have a disproportionately higher market share. That being said, we believe our market visibility is broader, deeper, and closer to real time compared to existing third-party research data used by the LPs as well as the investment community. Let me provide some recent market share metrics based on our share tracker. Our Canada recreational market share based on the provinces tracked in the data increased to 15.5% during Q2, up 200 basis points versus Q1. And notably, our market share grew by 190 basis points in Ontario and 140 basis points in British Columbia, while it declined by 40 basis points in Alberta, all Q2 performance versus Q1. Our flower market share increased by 320 basis points quarter-over-quarter to 17.3%. Our market share of the value flower category increased 800 basis points to 16.5%. And in Ontario, our share of value flower more than doubled to 13.7%. More recently, in the 4 weeks ended October 25, our share of the value flower market increased further to 19.5% and improved to 16.9% in Ontario. Our share of the premium flower segment in Ontario decreased 60 basis points to 15.5% in Q2 as strong gains from Houseplant was offset by softer performance in our other premium brands. Our dollar share of the beverage market was 54%, and we remained #1 in Ontario with 51% market share in Q2. And for clarity, this is against all cannabis-infused beverages, not just ready-to-drink beverages. Our beverage market share during the last 4 weeks ending October 25 was 40%, maintaining market leadership position even as new entrants have come into the market. Now turning to volume, price and mix trends in our rec flower business. Our rec flower B2B business saw gross sales increased 50% in Q2 compared to Q1 driven by volume growth of 90%. And during this period, our average selling price in rec B2B flower decreased by 40%, of which 38% was negative mix and 2% was true price. The mix impact within flower this quarter was exceptionally large as we saw a sizable shift toward larger-sized value offerings, and these trends are further exacerbated as value flower accounted for 60% of our flower mix in Q2, up from 40% in Q1 as we further established our value offerings across the market. We do anticipate that average selling price will decline further in coming quarters, though the rate of decline should moderate. Recreational B2C sales increased 43% over Q2 and more than doubled compared to the previous quarter. Same-store sales increased 44% compared to Q2 of last year. Growth versus Q1 was driven by store operations returning to pre-COVID levels as well as increased foot traffic from a broader product assortment across both Cannabis 1.0 and 2.0 products. Additionally, we opened 9 new stores in Q2 with 32 corporate-owned stores operating at the end of the quarter. Turning to medical. Our global medical net revenue increased 1% versus Q2 of last year. Our Canadian medical net revenue increased 7% year-over-year, driven primarily by higher average order sizes. Our international and C3 businesses experienced slight declines compared to last year. Dried flower sales in Germany decreased 5% year-over-year due to slower market growth and intensifying flower competition. Our C3 business declined 3% year-over-year due to a packaging supply issue with 1 distributor, which has since been resolved. To summarize our global cannabis business, Canopy generated total cannabis revenue of $92 million, which represents an increase of 18% over the prior quarter. Revenues generated by our strategic businesses increased by 82% year-over-year and 60% on an organic basis, adjusting for the timing of the BioSteel acquisition. Storz & Bickel vaporizer revenue increased 100% year-over-year, benefiting from expanded distribution in the U.S. and a broader product portfolio and increased consumer pool. This Works revenue increased 34% compared to last year due to strengthened e-commerce sales, sell-ins to U.K. brick-and-mortar stores ahead of the holiday season and the launch of a new Stress Check hand sanitizer in the U.S.. BioSteel sales benefited from reopening of big-box retailers after the pandemic as well as expanded retail networks in Canada and increased contributions from the U.S. With this, let's move on to an analysis of gross margin for the quarter. Gross margin of 19% was up 1,400 basis points versus Q2 of 2020. Gross margin was broadly in line with our expectations and was impacted by the following factors: first, our gross margin continues to be negatively impacted by under absorption of fixed costs with an estimated 21 percentage points or $28 million of impact in Q2. Second, we saw adverse business mix impacts of 12 percentage points relative to Q1, driven primarily by lower sales contribution from our high-margin C3 medical business. Third, gross margin benefited from headcount reductions completed during the quarter that saw operations staff headcount lowered by approximately 14%. And finally, we saw lower inventory adjustments compared to Q1. We remain committed to delivering at least 40% gross margin over time. And in support of achieving this target, we are nearing completion of the operations and supply chain review that we began in Q1, and we are now moving quickly to implement these initiatives and expect potential savings of $150 million to $200 million across cost of goods sold and operating expenses over the next 24 months. And these initiatives include further optimizing our footprint, organizational design that includes further rightsizing of our labor; procurement savings, some of which is tied to our design-to-value program; and finally, supply chain optimization, which includes improved inventory management. Now let me briefly cover our operating expenses. Overall SG&A, including acquisition costs, decreased by 19% versus Q2 of last year driven by year-over-year reductions in sales and marketing and general and administrative expenses, partially offset by higher research and development expenses. Sales and marketing expenses declined by 30% year-over-year driven by a number of factors.First, marketing and promo expenses decreased by over $17 million versus prior year due to the switching of trade marketing from print to lower-cost digital programs and from small store displays to lower-cost national programs as well as overlapping elevated spending from last year to capture retail space and build brands ahead of the 2.0 launch. Second, compensation expenses decreased year-over-year due to headcount reductions, partially offset by higher investments in the U.S. Lastly, marketing and promo expenses also declined versus prior year due to lower travel expenses as a result of the restricted business travel in response to the COVID-19 pandemic. General and administrative expenses decreased 26% year-over-year due in part to lower compensation expenses resulting from corporate restructuring costs taken earlier in the year as well as reduced insurance costs, and lower travel costs. R&D expenses rose by 19%, mainly driven by ongoing research studies that commenced after Q2 of last year. Stock-based compensation expense in Q2 of '21 decreased 76% year-over-year to $20 million. And this is lower than the forecast of $45 million that I communicated during our last conference call, and the decline from the Q2 forecast was primarily related to higher forfeitures of options resulting from staff reductions that occurred during the quarter. Stock-based compensation is expected to be in the range of $25 million to $35 million per quarter for the remainder of this fiscal year. Now moving on to free cash flow. Our free cash flow in the second quarter of fiscal '21 was an outflow of $190 million, which represents an improvement of 57% versus the prior year. The cash outflow during the quarter includes biannual interest payments of our outstanding convertible debt of $13 million. And excluding these interest payments, our free cash flow was flat to the previous quarter. Our working capital decreased year-over-year due to lower inventory levels but increased versus previous quarter due to the timing of accounts receivable as well as modest increases in inventory. CapEx declined to $29 million, down 87% from Q2 of last year and down 50% from the previous quarter. And we now expect our full year CapEx to be in the range of $200 million to $245 million. As you can see from our results in Q2, we continue to make progress against the key financial metrics that we laid out during our June investor meeting. On our profitability metrics, we have delivered a reduction in the SG&A as a percentage of sales, and we are working to get back to our 40% gross margin target. On our cash flow metrics, both working capital and CapEx have declined on a year-over-year basis. Before I close, I would like to offer a few key factors to consider as it relates to our Q3 outlook. First, from a net revenue perspective, we expect our Canadian rec business to continue to improve with additional store openings in Ontario, and our improved flower market share continuing to provide momentum. In addition, we expect continued contribution from our 2.0 products as we refocus our vape portfolio and our beverages benefit from the launch of Quatreau. Second, we expect strategic business units to continue to benefit from expanded distribution in the United States. BioSteel is expected to see growth accelerate as its ready-to-drink sports hydration beverages gain access to thousands of retailers through our new direct store delivery network. This Works has a number of new product launches planned across the U.K. and the U.S. and should benefit from holiday selling season. Third, we're continuing to monitor the global COVID-19 pandemic. In response to rising case numbers over the past couple of months, various jurisdictions, including Germany, have reentered some form of lockdown. And the adoption of new and prolonged lockdown measures within our core markets is worth monitoring. Lastly, we expect gross margins to continue to improve in coming quarters, resuming a path to achieving our 40% gross margin target over time. And as we improve execution and address our supply chain efficiencies and return to positive operating leverage, we expect gross margins to be in the low 20s as savings from our initiatives won't start to kick in until Q4. In conclusion, momentum is building across our key businesses as our new strategy is coming to life and we are seeing strong growth in our Canadian rec cannabis business with our improved market share. And our U.S. business is evolving as we build a diversified ecosystem that has multiple routes to market and many ways to win in the U.S. And finally, we are doing this while also maintaining our financial discipline. This now concludes my prepared remarks. And operator, David and I would be happy to take questions from the analysts.

[Operator]

[Operator Instructions] First question comes from Bryan Spillane with Bank of America.

[Bryan Douglass Spillane, Managing Director of Equity Research]

David, I guess, I wanted to step back and just ask about the cost savings that you announced this morning or described this morning. And I guess, 2 questions related to that. One is what does that contemplate in terms of, I guess, the evolution of the U.S. market? So -- and I guess what's underneath my question is, is that subject to change if the market opens faster if we get like a full federal legalization? And then second, I guess, related to it also is in terms of pacing, can you give us any sense of just how quickly you think you can achieve those goals?

[David Eric Klein, CEO & Director]

Yes. So Bryan, so in terms of the cost reductions, they're mostly focused on the Canadian market. We continue -- one of the reasons -- one of our drivers of our loss is that we continue to invest ahead of revenue in the U.S., although we see that swinging around as we begin to grow revenue in the U.S. as we discussed throughout our prepared remarks. So the U.S. activity wouldn't necessarily affect it. Now that said, I think we should be really clear that if we get a permissibility triggering event in the U.S., it's probably a 60-day window to -- until we would be able to take over full control of acreage, at which point we might want to bring our balance sheet, our know-how and our brands to bear on the U.S. market. So I would hold that a bit off to the side, but that will not affect this $150 million to $200 million savings initiative that we outlined. And then in terms of speed, we're really talking about implementation. And so we've begun the implementation process already. The real timing of when it comes through our P&L will mostly be affected by the length of time in that execution, which won't be that long and then flow-through from inventory.

[Bryan Douglass Spillane, Managing Director of Equity Research]

All right. And I guess that was -- what really underneath my question is as we're thinking about flowing through the savings -- I just want to make sure I'm hearing you correctly. It's possible that it would be impacted by the triggering event, right? So if there's a decision or an opportunity to invest, that might affect how much of the savings you decide to flow through versus invest, at least in the medium term?

[David Eric Klein, CEO & Director]

Yes. So I would -- now I understand your question, Bryan. So maybe just around semantics. So would we -- we're going to continue to execute on these initiatives however, as I said, if the U.S. were to open, I think we would want to make sure that we took control of Acreage as soon as possible, and then we would begin to try to build out that market. But we're also seeing that Acreage has a pretty clean path to profitability. And so it's quite possible that we could -- we wouldn't slow down our time line to profitability even as we invest in the U.S.

[Operator]

Next question comes from Michael Lavery with Piper Sandler.

[Michael Scott Lavery, Director & Senior Research Analyst]

You've talked a lot about the 2.0 opportunities. And now we're lapping a year ago, the write-down on oils and softgels. But it's interesting that the product splits you give for Canadian rec show those sales to be pretty similar. How should we think about -- and softgels and oil are actually up pretty significantly. How should we think about the opportunity for 2.0 relative to your expectations and what's ahead? Is it tracking where you expect it to? Should we see a step-up from some things like the Quatreau launch? Or what -- how does it look against where you expected us to be at this point?

[David Eric Klein, CEO & Director]

So I'll start out, and Michael -- and then I'll let Mike fill in. But I think the write-down last year was really more about misestimating how quickly the market demand would arrive. But we are seeing good demand in the market for softgels and oils. And the same kind of issue maybe as we launch drinks, as you're going through channel fill and trying to understand the consumer demand, you have to build -- in the drinks instance, we had to build our production to meet that demand. In the oil and softgel instance, we had a slow production down. So I think it's just the nuances of launching products in -- new products in a new industry that have maybe created some of the fits and starts because I would say, in general, we're happy about how we're growing across all of the categories in 2.0.

[Michael Alan Lee, Executive VP & CFO]

Yes. And it's a very broad question, Michael. So just on the softgels and oils, the softgels and oils are a lion's share of the medical channel and continue to perform well. As you know, the medical channel, patients have decreased month-on-month since the rec channel was created 2 years ago. But within that medical channel, patients, the retention rate's been high. The spend per patient continues to grow. And it's been quite a stable business for us from a price and volume perspective. Looking more broadly at 2.0 in terms of what's coming and what the learnings have been and what you can look from Canopy to -- over the next several months, look, we've looked hard at our vape portfolio and recognize that price continues to compress within the vape category. We will be introducing cartridges later this year that increased the fill rate from 0.42 to 0.5 mls, which will get us more competitive in the market. We're -- we've done some price resets on the chocolate category, and we're continuing to plan for new product introductions there as well. And then it really is about leaning into beverages in every way, shape or form. We're excited about our results, but we're also excited in some ways that competitors are also validating the space and bringing new offerings into the category because we believe that's going to further build the category, and that's going to further open up points of distribution over time, putting pressure on the provinces to provide for on-premise consumption and things like that. So we welcome the competition. We think our beverages will stack up against any competitor out there and more coming from Canopy over time in the beverages category as well.

[Operator]

Next question comes from Vivien Azer with Cowen.

[Vivien Nicole Azer, MD & Senior Research Analyst]

Just recognizing your desire to consummate the Acreage deal but also acknowledging the Republican control, the Senate is probably a pretty meaningful limiting factor there. It seems like your focus needs to continue to be market share for the adult-use market in Canada. And in that vein then, David and Mike, I'm curious to understand how you guys are thinking about navigating kind of the tension in your operating model relative to retail operators. You guys kind of uniquely have a big retail presence. Some of your retail competitors have not taken kindly to that. So how do you think about managing your access and shelf space in terms of driving overall market share?

[David Eric Klein, CEO & Director]

Yes. So look, Vivien, this is an issue that a lot of companies, as you well know, wrestle with. I think that there's an opportunity for us to bring the learnings that we take from our company-owned stores and pass them on to our retail partners in the marketplace. So I think there's a way that we can really make sure that we're a value added partner. We're not looking to build retail locations across Canada. I think we're fairly comfortable with the footprint that we have today. And so yes, I understand that there's the risk of channel conflict, but we believe that we're going to be open and helpful to our retail partners in such a way that make it a positive experience.

[Michael Alan Lee, Executive VP & CFO]

I would just add to that, that channel conflicts' not new to Canopy. We've experienced that over the times in the medical channel. Even with some of our CraftGrow partners, this is something that Canopy has had experience with over a number of years. And at the end of the day, we have very strong relationships with many of the key accounts across Canada, and they want our brands. Our brands are growing in terms of popularity as demonstrated by a market share, and these retailers want our brands. So clearly, it's a fine line to walk, but we rest on the strength of our brands.

[Operator]

Next question comes from Tamy Chen with BMO Capital Markets.

[Tamy Chen, Analyst]

I just wanted to ask a little bit more on the cost savings initiative that you've announced. I guess, just 2 quick parts. First is can you help us understand, in your Canadian business, what you envision sort of the final footprint or asset base to look like coming out of this? And then just secondly on this, you've described this as accelerating the profitability in Canada. I think if we kind of take a step back in some of your previous comments, it sounded as though you were looking to take a bit more of a gradual tackling to cost because you didn't want to affect your ability to grow. So I'm just wondering, just with the language of accelerating, has something changed in your outlook of growth in Canada that's prompted the sort of acceleration?

[David Eric Klein, CEO & Director]

No. Not at all, Tamy. I think what's actually changed is we -- it was important to me that we didn't come in -- and when I came into the company anyway and just start cutting things, that would be detrimental to building brands, connecting with our consumers and growing our top line. I feel that we now have -- we've gone through many, many months of reorganization on the commercial side of our business. And so we now feel we have the right commercial organization, the right product and marketing organization. We're beginning to build that insights muscle, and we've really focused the innovation muscle in the business. And so now that those things are in place and they're beginning -- it's very early, but they're beginning to produce some results. Now we can really look at the areas of our business that are -- we just haven't been running efficiently because we grew so quickly. And so we worked through an outside-in process where we looked at the entirety of our cost infrastructure. And now we have a very clear view as to where we need to go. And Mike can provide more details on what that might look like.

[Michael Alan Lee, Executive VP & CFO]

Yes, it's a great question, Tamy. When you go back to the March announcement, when we announced the closure of our facilities in Vancouver, in many ways, that was a no-regrets move that was easy to make based on how the facilities were performing and, call it, the near to medium-term requirements from a supply and demand perspective, we just weren't remotely balanced at that time. And a lot of this -- again, just to remind everybody, this comes back to how quickly this industry has evolved. Everyone can agree it's evolved slower than what everyone expected. And hence, a lot of LPs have had a bit of an overhang. That being said, for the last several months, we've been in deep, deep analytics on our entire operations and supply chain and have now built a fact based, data-driven approach on all the elements that we need to go after in order to achieve what's really -- we talk about 40%, but our aspiration is to have a real CPG P&L with margins even in the excess of that. So we're pushing ourselves really hard on this. And what we've learned is across our operations and supply chain in Canada, there's really 4 broad themes of opportunity. Number one, we've bid off too much complexity across the business. We have too many finished goods SKUs in the market, which is a natural outcome of a brand-new market where Canopy, like many other licensed producers, were aggressively introducing as many products to the market as possible without having real consumer insights or history on what consumer needs were. And now that we're 2 years in, we've got a very honed view on what SKUs matter and which ones don't. So SKU rationalization is going to be key. Cultivar rationalization is also going to be key. When you think of the economics of a greenhouse, cultivars drive complexity, and complexity is a drag on productivity. So we are going to rationalize cultivars. And again, based on consumer insights and based on design-to-value to make sure that we are just as competitive, if not more competitive, on the other side of this program to make sure that we're not burning furniture, if you will. So that's one, managing complexity. Number two, optimizing our network so we've continued to challenge ourselves on our site infrastructure. We've continued to hone the purpose and strategy behind each facility. Some facilities are really great at quality. Some are really great at volume. But there hasn't been a good marriage between what that facility is doing today and what it should be doing. So we're restructuring each of our facilities so that they really are purpose-driven with the KPIs that are tied back to that strategy. We're also going to optimize our extraction capacity. Extraction today looks very different than it did 2 or 3 years ago when most of the LPs thought that was going to be a bottleneck capability. Well, today, we've got plenty of capacity, and we have an opportunity to drive savings through rationalizing our extraction capacity. We think that in that same vein, we have tens of millions of dollars of procurement savings, both direct procurement savings tied to procurement items that go into our production process as well as procurement savings on indirect items, meaning items that aren't involved in production but are more around the OpEx side of things. So that's number two. Number three, improving processes and improving our operating model. We've made a lot of progress on fill rates, getting to 90%. But the inverse of that is we're missing 10%. And we believe that we can get to 98% or 99% over the next year to 2 years by optimizing our S&OP processes, honing our demand forecasting and really making sure that we're producing the right product at the right time with the minimal amount of inventory. Increasing productivity is the fourth area of opportunity, and this is around org structure and making sure that we're right-sized for the current state of the organization but also making sure that our supply chain is productive on things like use of backhaul routes that we're paying for or migrating to more competitive common carrier rates or even looking at packaging opportunities using design-to-value, where many on this call have talked to me about some of our packaging being overengineered in the past. So we're going after that. So those are really the 4 pillars of this program, and they're all phased out over the next 2 years. And I can tell you, without getting into the phasing of how this lands in each quarter over the next 2 years, that we are going to pursue as much of this as quickly as possible with a forward-leaning approach on infrastructure. And hopefully, that gives the Street confidence that we've done the homework here, and we're very confident that we can deliver this over the next 2 years. Dave, anything else you want to add?

[David Eric Klein, CEO & Director]

That's good.

[Operator]

Next question comes from Aaron Grey with Alliance Global Partners.

[Aaron Thomas Grey, MD & Head of Consumer Research]

So I want to dive back in terms of the incremental flower sales we saw in the quarter. It was good to see, obviously, a lot of that was driven by TWD and your large-format value segments. Just wanted to get to any color you could provide on the sell through, especially in terms of retail and some initial consumer adoption because, obviously, still a pretty competitive category. It seems like you still saw some market share growth in October from your commentary in the prepared remarks. But just any incremental color you can provide there as there's still a lot of your competitors out there who are also competing in that low-value -- low-price value segment?

[Michael Alan Lee, Executive VP & CFO]

Yes. We're very happy with the progress that we've made on all of our flower products, including TWD and Simple Stash. Simple Stash has been a good opportunity for us to help balance our inventory, and TWD has just been a good value proposition. We're offering that in packages up to 28 grams, and there's been strong demand. We've continued to build out distribution across Canada. I'd say we're just about there in terms of the distribution build-out. So it's -- look, it's a valid category. Our market share intel tells us that it's going to be -- it's around 30% to 33% of overall flower consumption today. And when you take a step back, this category likely would have existed last year at this time had not every LP been short on supply. Every CPG category that I'm familiar with has a value hierarchy, and we think that the value category is here to stay. Big question will be what's going to happen with value category pricing over time? I'm of the opinion that it will continue to move around. But over time, it's going to start to tighten up. But time will tell on that. The key is making sure that we've got the right production strategy behind each tier of product, which ties into my earlier remarks, which is making sure that every one of our facilities is purpose-driven to make sure that we're growing the right product for the right category out of the right facility and hitting the right cost. So we believe, even at the price points that you see in the market, we can hit our margin targets with TWD being 1/3 of our business over time.

[David Eric Klein, CEO & Director]

And the thing I'd like to add to that, Aaron, is that we have a couple of objectives. One is to grow our market share, which means we need to sell the consumers what they want at the price point that they're willing to pay, which is why the insights work that we're doing is pretty exciting because we think it'll position us to drive a little bit of a trade-up on attributes that are relevant to the consumer. And we're also looking to balance our inventory. We're not interested in showing good gross margins this quarter only to have big write-offs in the future. And so we're working toward that balanced inventory. And I would say we, for the most part, achieved that this quarter. And then irrespective of the price points, we're committed to achieving that at least 40% gross margin number that we put out. So we think that the value category is actually helpful on all of those 3 points that I just made, and we're actually really pleased with where we're able to get to in the quarter with it.

[Operator]

Next question comes from Andrew Carter with Stifel.

[William Andrew Carter, Associate Vice President]

I wanted to double-click on the beverages for a second because in the Headset data we have, it showed the sales did plateau early and it kind of declined. And some numbers you've given on shipments, it would suggest you're kind of, quarter-to-date, I think it's 300,000 units. I think you did 150,000 units last week of June. That's what you said at the Investor Day. Doesn't seem like shipments are picking up. So could you help us understand kind of what you're seeing with the traction by the consumer of that platform?

[David Eric Klein, CEO & Director]

Yes. So I think what we're seeing is we continue to get strong consumer response. I would say that as competitors come into the space, we do know that we're getting trial across the competitive entrants, but the repurchase rate on our product remains pretty high. And as Mike said, I think bringing as -- the point here is we have to grow the whole category. And so I would say the biggest barrier to growing the category is really going to be related to equivalency standards changing over time in Canada so that people can buy more than a couple of units at a time. And then we think the entire category gets to grow. And right now, I believe the latest data I saw, we have 5 of the top 7 SKUs in the marketplace. And we feel pretty good with our positioning. But yes, we are looking forward to being able to grow the entire category which means we're going to need to see a bit of a move from a regulatory standpoint.

[Michael Alan Lee, Executive VP & CFO]

And just some of our consumer insights on beverages are quite compelling. Our data tells us we have a 70% to 80% satisfaction rate, that we have greater than 75% satisfaction with taste across Tweed and Houseplant brands. 60% of customers are recommending our product to other consumers. And at the end of the day, it's a bit of the remarks that I made earlier, which is building this category is a positive thing because the biggest gating item is points of distribution. So we're optimistic that, that will start to open up over time. And then from a production perspective, we're ready to grow. We've done a lot of work within our beverage facility, and we can grow this business significantly with no additional CapEx. So we're excited about it and look forward to continued growth.

[Operator]

Next question comes from John Zamparo with CIBC.

[John Zamparo, Associate]

I wanted to ask about the other revenue line. I know you don't disclose exact numbers, but can you give some sense of order of magnitude on the 3 largest business units in that category. It does seem like it's growing quite materially, so it would just be helpful to get a better understanding of those 3.

[Michael Alan Lee, Executive VP & CFO]

Yes. We -- sorry, we don't disclose that. Maybe at some point, we will start to disclose it, but for the time being, we're not.

[Operator]

Next question comes from Glenn Mattson with Ladenburg.

[Glenn George Mattson, Vice President of Equity Research]

On the medical side, can we just talk about that for a little bit? First, on Canadian, you said, I think that it was up 7% sequentially, I believe, in Canada, due to higher order sizes. So curious what drove that, like, maybe people are stocking up because of pandemic reasons or maybe it's transitory? So anything on that? And then the international side, I realized, like, might be a little bit hard to forecast in the next -- in a very short period because of various countries going to shut down and things. But maybe you can give us some detail or some color on how you think your stack competitively as the markets have matured a little bit.

[Michael Alan Lee, Executive VP & CFO]

Yes. I guess, taking the Canada medical business. I mean, it's another strong quarter in Q2, matching performance in Q1, and it's up 7%, 8% over prior year. And look, I get it, Health Canada continues to report declines in the medical market and the count of registrations continues to go down. I think there was an extension, an auto extension of prescriptions up through, I think, certain patients that have subscriptions -- prescriptions could extend up through December. But look, we see growth across all the products that we're seeing in the medical channel in Canada. Vapes are starting to materialize in the category. Softgels and oils continue to grow. Flower continues to grow. It's been a healthy business for us. That being said, over the next 5, 7 years, the business is probably going to moderate as more and more patients convert to the rec channel. But for now, it's been a very healthy and profitable business with strong gross margins. Internationally -- did you want to add something, Dave? Internationally, look, we have seen some more competition on the C3 business. I think the first new entrant into the dronabinol business came in Q2. And we know that with the prescription model in Germany, that providers are required to provide the lowest cost alternative, which is something that we've modeled out over time. But with the gross margins that we have on C3, we've got plenty of opportunity to compete, and we're committed to keeping our #1 position. And then in Q2, we did have a bit of a production disruption really tied to a one-off that has already been remediated. So we would expect C3 to return to growth. And then for the flower business in Germany, again, there has been a little bit more disruption from COVID-19. We haven't had our sales guys on the Street as much over the last few months as there's been a bit of a lockdown, and we did have a small supply interruption there as well. But again, we've been very encouraged with the German flower business and the C3 business over the last year, and it was really the beginning of an inflection point about 6 months ago when our German flower business really started to grow. So we still think it's a big growth opportunity for us growing -- going forward, and we think it will be a profitable growth opportunity going forward.

[Operator]

And at this time, I will turn the call over to Mr. Klein.

[David Eric Klein, CEO & Director]

Thank you, again, everyone, for joining us today. As we approach the holiday season, I hope that all of you get to experience our amazing products, including Martha Stewart CBD gummies in the U.S. and our newly released Quatreau drinks in Canada. And our Investor Relations team will be available to answer any additional questions throughout the day. Have a great day, everyone.

[Operator]

This concludes Canopy Growth's Second Quarter Fiscal 2021 Financial Results Conference Call. A replay of this conference call will be available until February 7, 2021, and can be accessed following the instructions provided in the company's press release issued earlier today. Thank you for attending today's call, and enjoy the rest of your day. Goodbye.