Canopy Growth Corporation
Q3 2021 Earnings Call Transcript

Published: 9 Feb 2021

[Operator:]

Good morning. My name is Amy, and I will be your conference operator today. I would like to welcome you to Canopy Growth Third Quarter Fiscal 2021 Financial Results Conference Call. At this time, all participants are in a listen-only mode. I will now turn the call over to Judy Hong, Vice President, Investor Relations. Ms. Judy, you may begin the conference call.

[Judy Hong:]

Great. Thank you, Amy, and good morning, everyone. Thank you all for joining us today. On our call today, we have Canopy's CEO, David Klein and our CFO, Mike Lee. Before financial markets opened today, Canopy issued a news release announcing our financial results for third quarter ended December 31, 2020. This news release is available on our Web site under the Investors tab and will be filed on our EDGAR and SEDAR profiles. We've also posted our supplemental earnings presentation on our Web site for you to follow along during this call.

[David Klein:]

Thank you, Judy, and good morning, everyone. I sincerely hope that you and your families remain safe and well and that we can begin to get control of this pandemic. As I reflect upon my first year as CEO of Canopy, I'm extremely proud of all the accomplishments we've made in positioning Canopy to be the leading cannabis focused CPG company in the world. I started my first earnings call outlining my early insights into our strategy, and also mentioned to all of you that this was going to be a transition year. Now, in our fourth quarter, we're at the end of that transition year and our team has made great progress. Throughout the transition, we had to make difficult decisions to right size our production footprint and say goodbye to teammates. This was typically a very public process. For this fiscal year, we also hired almost 500 people in strategic roles to support a growth agenda into FY22. And as we look forward to the prospects of promising cannabis reform in the US under the new administration and Congress, I'm more excited than ever about achieving Canopy's vision of unleashing the power of cannabis to improve people's lives. Now for the quarter at hand. During the third quarter, we've continued to execute against our new strategy, strengthening our competitive position in our core markets, improving our execution and accelerating our path to profitability. There are four key themes that Mike and I will focus on this morning. First, we're building strong momentum and establishing a track record of winning in our core markets. Second, we're seeing tangible improvements in both our commercial and supply chain execution. Third, we're further accelerating our US growth strategy as we expect significant cannabis reform during this Congress. And finally, we are firmly on a path to profitability. So let's tie these things together and delve deeper into our performance and strategy. First, we’ve further strengthened our competitive positioning in our Canadian recreational business. Our overall share is up 30 basis points to 15.7% in Q3 versus Q2, and we've regained a number one market share position in the Canadian rec market during Q3 based on our proprietary market share tracker. This is led by our share in flower improving 180 basis points to 19.2% in Q3, driven by continued strength in our value flower brand TWD.

[Mike Lee:]

Great. Thank you, David, and good morning, everyone. I'm pleased with our Q3 performance, which again demonstrated that we are building a track record of solid revenue growth, profit improvement and reduced cash burn. To further highlight our results, we generated a record quarter of revenue at $153 million, gross margin improved versus last quarter, our adjusted EBITDA loss narrowed to $68 million, and free cash flow narrowed to an outflow of $135 million.

[Operator:]

The first question is from John Zamparo of CIBC.

[JohnZamparo:]

I just wanted to get a bit more clarity on what you view as necessary to be able to operate without restrictions in US THC? And presumably, Canada removed from Controlled Substances Act. But David, you referenced in an interview recently that may be revised co-memo, combined with safe banking and executive actions would put you in a position to operate in US THC in '21, and it seems like you're reiterating that today. It does seem like that's a bit more optimistic of you than some of your peers. So just I'd like to get a bit more color here. And ultimately, is it up to Canopy to interpret what is and isn't considered federal permissibility or is there input from Constellation and the exchanges? Just anything else on incremental there would be helpful? Thank you.

[DavidKlein:]

We're working literally daily with Constellation, with our government relations team, with our partners at the exchanges and banks, to work our way through this. Because I think the important thing will be, if it's not in the form of some variant of legislation, such as the Booker, Wyden, Schumer work and we were to hit the place where we had some executive action in terms of regulatory change, it would really be dependent upon the wording in a lot of the regulatory documents. So we're working very closely with our lawyers and with our partners to make sure that we are very careful in how we proceed here, but we remain pretty bullish on our ability to be able to step into the US at the right time. I also want to point out two things, really. One is we're not just sitting around waiting for US permissibility. You're seeing a lot of good progress being made at Acreage, a lot of good activity going on at TerrAscend, and we're continuing to build our route to market and production capabilities around our CBD business, which will be helpful post permissibility. So I think there's good action going on today. I think we're going to watch very carefully what happens from an executive and regulatory action fronts and make sure that if we actually meet the hurdles that make our teams comfortable that we then proceed. And clearly, we'll be quite supportive of the work that the Senate and the house are doing to push legislation forward. I'd also like to point out that in our arrangement with Acreage, that a triggering event is defined as straight up legalization in the US or at the discretion of Canopy. So we have a little bit of flexibility there, we're going to be very careful that we don't violate any laws as we move forward.

[Operator:]

Your next question comes from Vivien Azer of Cowen.

[VivienAzer:]

My question is on guidance. And David, I think in particular for you, you and I go away back in alcohol and your work at Constellation. I've always known you to be appropriately conservative in offering external guidance. However, perceiving your entry into the Canadian cannabis industry, like the doesn't have a great track record on that front. So I was just hoping that you could offer some color on how you thought about embedding conservatism into these financial targets? And where do you think you've kind of expressed that most appropriately, either from a geographic or segment perspective? Thanks.

[DavidKlein:]

One of the things that I talked to the leadership team at Canopy about is we need to develop a little bit of credibility, because it's somewhat lacking in the space at least there was a year ago. And so we've tried this year to ensure that we deliver as expected as we've gone through the year and we've done an okay job of that. There's a lot more volatility in cannabis than there is in a large alcohol company. But I think we've done a nice job of staying on track as it relates to this FY '21 being a transition year and so forth. And so as we look forward, we very carefully vetted where we see the Canadian market going. And we know that there's significant growth just from the channel shift in the Canadian market. And so our first assumption was that we would hold share as that market grew, but then gain share as we continue to execute well. And I'm happy to say that those things are happening. Like we're seeing the legal market grow at an increasing pace in Canada, and we're seeing our execution from a sales execution and operational execution standpoint, deliver up to the expectations of our provincial and retail partners. So I think Canada is, while the targets aren't easy to achieve, we see a very clear path to achieving the Canadian targets. The next area really is the United States. And in the US, we brought the Martha Stewart CBD brand to the market in early September. And we wanted to demonstrate that we could actually bring consumer preferred CPG like brands to market and breakthrough, and really proud of the performance of the Martha Stewart branded products. And as we've said, we believe Martha is one of the top selling brands in the CBD space, in edible space, in particular in the US. I will say that while we're getting better and better each week literally on data collection in Canada, data collection in the US is still a little sparse. But we think that we have a good path to growing a very solid CBD business in the US and we're kind of extrapolating our current trends into future product offerings and ultimately our sales targets. The other area in the US that we're seeing really strong growth is through Storz & Bickel as distribution has grown for Storz & Bickel, and I personally believe it's the best device on the planet, and we get that response from consumers all the time. It also happens to be not super well known. So we're working on that in a typical CPG fashion to expose people to this really well constructed, high performing brand. And then the last area in the US that we're looking for, for growth is in our BioSteel business. With access to Constellation brand’s Gold network, which is their beer distribution network, we see tremendous upside to BioSteel beginning in FY22, quite honestly. In fact, the products are beginning to be available at retail, literally as we speak in terms of the ready to drink hydration products. So I think we were reasonably conservative. And literally, we built out our forecasts almost on an ACV basis taking into account velocity. So points of distribution and velocity. And then we're assuming we continue to grow along with the German medical market. So a lot of moving parts, Vivien, but we feel that we've got our arms around enough of the detail to have a high degree of comfort in being able to put these numbers out. We've been working on this for a while but we held off a little bit putting these numbers up because we wanted to see how long we would be affected by COVID and what those impacts would be. And so yes, maybe took a little longer than everyone would like for us to come out with this kind of future estimates of where we'll be, but we feel real confident in it. Mike, I'd ask you to dive in as well?

[MikeLee:]

Just to build on that when you go beyond the top line and look at the guidance around cost structure, this too has been a long standing body of work for most of calendar '20, starting with the end to end supply chain review that we announced last spring. But even delving into each function across the organization to really make sure that every function was aligned to our overall strategy and making sure that we were achieving best in class benchmarks in terms of cost structure, making sure that we have good spans and layers in place, making sure that we've got the right band in place across the organization. So we've been retooling the organization behind the scenes for a better part of seven to eight months. We haven't talked a lot about it publicly other than announcing some of our restructuring, but the work has been done. And that gives us the confidence on the cost structure side of things. Now all of that being said, there's some risks out there. And this is why we were pretty broad on our direction around the top line and providing a three year CAGR because some years are going to be stronger than others. We do have a high fixed cost structure so our margins are somewhat sensitive to changes in volume. But we do believe that we've built this with the bottoms up approach that is a balance point of view that gives us the confidence that we can deliver on these. So more to come but we feel like we're definitely headed in the right direction. And I would also emphasize that we're going to grow into this, that in Q1, Q2 of next year, we're likely to continue to see EBITDA losses as we scale up the business. And when you think about breakeven points that $250 million revenue per quarter starts to be that magical number where we start to get across the breakeven point from an EBITDA perspective. So with that, scale is going to continue to be really important.

[Operator:]

Your next question is from Bryan Spillane of Bank of America.

[BryanSpillane:]

Maybe just a question about the medium term goals and maybe just two things I was interested in. One is just the product mix that you're assuming. So do beverages, how do you see the mix evolving with beverages and Rec 2.0 products versus or -- and maybe, David, if you could just give us some perspective on where we stand now in beverages in terms of market penetration, trial repeat, like you mentioned with Martha, is it bringing new consumers in? Just an update there as well would be helpful?

[DavidKlein:]

Yes, so when we think about how the product mix is going to evolve over the next 12 to 18 months, still going to be a very dominated flower pre roll business. We're modeling it around 79%, 80% in terms of overall flower pre roll mix. Vape, we have modeled in at high single digits. Again, this is our product mix projections. Beverages and edibles, again, continuing to grow but on beverage is a little bit muted in that until consumption lounges and consumption occasions open up, we're largely governed by the points of distribution that exists through the dispensaries. And look, the flower and pre roll business is still going to be a big part of the business for the next year to 18 months. And hence, we're really focused on driving share, driving quality, making sure we're cost competitive, but also making sure that we're competitive in the market in terms of retail prices, because it's going to continue to be important and it's just foundational to our overall Canadian business.

[MikeLee:]

And on drinks, Bryan, in terms of performance in Canada, there are a couple of things that are holding us back. One is the equivalency rules, which limit the quantity that someone can take away from a retail store. But even with that, we think that because we're limited in the amount that an individual can take away that we're not getting into new new consumers the way we would like. We think that over the next several months, we'll see movement in that regard in terms of equivalency, where people will be able to purchase maybe up to 24 cans of a beverage. And we think that will help us when we start talking about bringing in new consumers into the space. That said, our brands are still sitting even with a lot of competition coming into the space. We have the top three brands in the marketplace. And our drinks are commanding higher velocity per SKU than the competitive set. And we feel good about what we're offering. But we think that the near term unlock will be a change in the equivalency rules in Canada.

[Operator:]

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

[TamyChen:]

I wanted to ask on the medium term targets. How did you or did you factor in price compression, particularly in the flower segment in Canada? Within that, 40% growth you expect the market to have in fiscal '22 and then the figures you provided onwards? And then subsequent to that, I'm just wondering if you can help us understand when you did this projections and arrive at these targets, what level of market share in Canada? And what level of expansion in that market share did you expect that for you to achieve in order to hit these targets? Thanks.

[DavidKlein:]

The price mix is something we're looking at almost on a monthly basis as we get our data. And it's been quite interesting over the last three to four months because the flower pricing has started to stabilize. As I mentioned in my remarks, we've seen 1% to 2% price compression across most of our price categories, looking at Q3 versus Q2. Mix continues to be an opportunity for us with some of the smaller sized packages like the 3.5 gram and the medium-sized 7 gram. But 28 gram overall, pricing hasn't moved a lot in the last several months. Our math says around 1%. So when we looked at our algorithm for next year, we wanted to be conservative so that we built an algorithm that gave us confidence in being able to achieve not just the top line but also the margin. Because as you guys know, excise taxes and things like that can be somewhat regressive in in the category. So we've built in high single digit price compression across the market. And we think that's a safe assumption, some of that might be in vape because vape continues to reset a little bit as many are tracking. But from a flower perspective, Tamy, it's stabilized. I don't think we're out of the woods yet, but it has stabilized. In terms of market share, we haven't made any aggressive assumptions on share. It's assuming flat share with some improvements, tactically across certain categories like on vape, where we're under indexed relative to where we'd like to be, but we're not making aggressive market share assumptions across the board.

[MikeLee:]

And maybe one thing that I would add, and maybe this is circling back a little bit to Bryan's question. One of the things that we're continuing to do in our projections is to build in continued investment around innovation and R&D activities because we think that it's a big unlock for us. We have what we believe is the best in industry science capabilities and some of the NPD, the Cannabis 2.0 products, and maybe arguably the Cannabis 3.0 products that we have in the pipeline are pretty exciting. And while we didn't build in upside as a result of the output of this work, we fully expect that it will provide maybe a little bit of buffer for the projections that we've put out there.

[DavidKlein:]

And Tamy, just to clarify that high single digit price compression is reflected in our margin goals as well. So we've already factored that in as part of our cost agenda.

[Operator:]

Your next question comes from the line of Pablo Zuanic with Cantor Fitzgerald.

[PabloZuanic:]

David, just going back to the US. I appreciate your conviction that you will be able to sell cannabis in the US before year end. I mean if that's the case and looking at the context of the Canadian stocks in January, February have actually outperformed the US stocks, why not lock other deals right now with other MSOs, right? Because, sure, we could say way to take control of Acreage, year end and then use that an acquisition vehicle. But by then, valuations will even be higher for the US stocks, of course, right? So just that's the question. The other thing I’d add also maybe a reminder why Acreage and TerrAscend are the right assets for you in the US? In TerrAscend, it's only a 20% stake, you have Jason while doing business with Bruce Linton at Gauge Cannabis, Acreage, it's a bit of a retrenchment mode. So just some color there would help?

[DavidKlein:]

So some good points there, Pablo. So I think as it relates to the US, we think that Acreage has put itself on a really strong path, especially with its concentration on the Northeast, if we think that we have permissibility or legalization actually in New York state. A massive market, likely in our view, will be only second to California over time. And so we like that positioning there. And as I said in my prepared remarks, we like Peter Kelvin. We think he's a really strong operator. And so we don't rule out Acreage actually looking at other potential acquisitions in the US to expand their footprint. And as it relates to TerrAscend, we think that's just a really well run business. And we're highly respectful of what Jason Wild and Jason Ackerman have been able to do in that business. And we think that those businesses in and of themselves can create a lot of value for us at some point down the road. In the interim, we're somewhat limited in what we can do in the US, but that doesn't mean we're not doing things like building out our routes to market, building our production infrastructure and keeping our eye very closely on the market, developing products specifically for North American consumers that will test out in Canada and be able to bring to the US. So we feel like we have a lot of good things going on that will unlock value for our shareholders even if we can't be in the plant touching business during this calendar year. But if we can, we think then that's a super exciting position to be in.

[Operator:]

Your next question comes from the line of Doug Miehm with RBC Capital Markets.

[DougMiehm:]

First question, again, has to do with the US, and in the event you have the ability to launch on the THC front. Can you maybe walk us through your capabilities in terms of getting product to the market? I expect that the demand would be significant. And we saw the issues in Canada what they already launch. I know it's different because of the MSOs, but perhaps you could go into a bit of detail there?

[DavidKlein:]

So again, I think our ability to quickly enter the US comes as a result of the arrangement we have with Acreage. And so immediately upon permissibility, we would trigger our rights to purchase 70% of Acreage. We would then be able to deploy our balance sheet and our knowhow to help them rapidly take advantage of the US market. And look, I think there's a nuance here when we start looking at the ability to compete in the US. Early on in Canada, we learned that just being on the shelf was enough. And that kind of carried a lot of LPs for the first year, and I see a little bit of that happening in the US. Ultimately, in my view, the game is going to be won by whoever produces the best experiences for the end consumer. And that's going to be using all of the kind of CPG bag of tricks, if you will, like having a really robust supply chain. That includes interstate commerce, by the way, that has strong routes to market, that has experience innovating and understanding the consumer and building brands. And we think that Canopy with our capabilities, combined with our partners in the US, combined with the capabilities that beverage alcohol behemoth like Constellation has, we think that creates a powerful competitor in that US marketplace upon permissibility.

[Operator:]

And this concludes our question-and-answer session for today. I turn the call back to the presenters for any closing remarks.

[David Klein:]

Yes. Thanks, again, for joining us today. Despite the challenges faced over the past year, our business transformation is on track. Our new strategies in place, our organizational change is complete and our operational cost savings program is now underway. Our products are winning consumer mind share, and I hope all of you get to experience our amazing products. For those in the US, send Martha Stewart CBD Gummy Sampler to your loved ones and/or give your pets or Martha and/or SurityPro CBD pet products. For those in Canada, pick up our newly released CBD TWD strawberry gummies. And everyone should check out our BioSteel ready to drink drinks when you see them in your local store. Thanks again for your interest in Canopy. Our Investor Relations team will be available to answer any additional questions. Have a great day.

[Operator:]

And this concludes Canopy Growth's Third Quarter Fiscal 2021 Financial Results Conference Call. A replay of this conference call will be available until May 10, 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.