Canopy Growth Corporation (NASDAQ:CGC) Q2 2024 Earnings Call Transcript

Canopy Growth Corporation (NASDAQ:CGC) Q2 2024 Earnings Call Transcript November 9, 2023

Operator: Good afternoon. My name is Jovel and I will be your conference operator today. I would like to welcome you to Canopy Growth’s Second Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. I will now turn the call over to Tyler Burns, Director, Investor Relations. Tyler, you may begin the conference.

Tyler Burns: Thank you. Good afternoon and thank you for joining us today. On our call today, we have Canopy Growth’s Chief Executive Officer, David Klein; and Chief Financial Officer, Judy Hong. After financial market’s close today, Canopy Growth issued a news release announcing the financial results for our second quarter ended September 30, 2023. The news release and financial statements have been filed on EDGAR and SEDAR, and will be available on our website under the Investors tab. Before we begin, I would like to remind you that our discussion during the 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 the news release issued today.

Please review today’s earnings release, Canopy’s reports filed with the SEC and on 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 release. Please note that all financial information is provided in Canadian dollars, unless otherwise stated. Following prepared remarks by David and Judy, we will conduct a question-and-answer session where we will take questions from analysts. To ensure that we get to as many questions as possible, we ask analysts to limit themselves to one question only. With that, I will turn the call over to David. David, please go ahead.

David Klein: Good afternoon, and thank you for joining us today to discuss Canopy Growth’s second quarter fiscal ’24. I’m pleased to speak to the positive results we have reported today, that have been achieved through the successful structural transformation of our business, as well as the actions we have taken to strengthen Canopy’s balance sheet. As should be evident, the Canopy of today looks fundamentally different than it did a year ago, and we are proud of the results that this transformation is already delivering. During the call today, I will cover three topics: First, the completed transformation of Canopy to a simplified cannabis-focused, asset-light business now anchored by strong fundamentals; second, at building on this foundation, we are now focused on driving the growth of our core businesses supported by high-quality products that are already resonating with consumers; and finally, I will provide a brief update on our Canopy USA strategy and the continued advancement of this high potential ecosystem.

Following my remarks, Judy will provide a review of our second quarter fiscal ’24 results, including the actions taken to strengthen our financial position and improve liquidity. Let’s begin with the transformation of our business. Through bold and decisive actions, we have delivered on our commitment to transform Canopy Growth into a streamlined, cannabis-focused, asset-light business. To recap the core components of this transformation delivered include: divesting our Canadian retail operations, consolidating our cultivation platform from 12 sites to 2, centered at our purpose-built Kincardine and Kelowna facilities, and successfully moving to an adaptive third-party sourcing model for all cannabis beverages, edibles, vapes and extracts, as well as ceasing the funding of BioSteel, which significantly reduced our cash burn and further simplified our overall business.

These actions have resulted in a Canopy that looks and operates fundamentally different than before, a Canopy that is purpose-built for the markets and geographies of greatest opportunity. Today, almost 90% of our revenues come from cannabis or cannabis-adjacent categories. Simply put Canopy is more focused and agile than ever before. And while change is ever present in this sector, it has not always yielded positive outcomes. This is why I am especially pleased to note that our actions have led to a dramatic and measurable improvement in the financial performance of our business. Our Canadian business grew revenue for the third consecutive quarter, while we cut our costs by nearly half and reduced our debt by a $1 billion. We have done the hard work to lay a firm foundation for sustainable growth.

Next, I will speak to our efforts to drive profitable growth in our core businesses. Our Canadian business has worked diligently to implement lasting enhancements to the quality of our cannabis flower. We have great flower in the market, and it’s being consistently well received by our consumers, retailers, and the boards. And every day we are finding ways to improve. Our team is passionate about enhancing every step of our cultivation and post harvest processes. And we continue to up our game to meet and exceed consumer expectations. For those who haven’t tried our flower lately, I invite you to go out and experience the incredible quality that our teams at Kincardine and Kelowna are delivering. Further demonstrating the positive reception that our products are receiving, Canopy reclaimed its place as a Top 3 flower supplier in the BC cannabis stores during the second quarter of fiscal ’24.

This performance is a testament to the hard work and commitment of our Canadian team. In addition, having taking control of the distribution of our Wana edibles brand in Canada towards the end of the quarter, we have a robust plan to return to the number one edibles brand in the country. Just this week, we relaunched the brand across Canada and are actively engaging with retailers as well as introducing new formulations that have already been successful in the United States. We have also made Wana gummies available to our registered medical cannabis patients in Canada through spectrumtherapeutics.com to further meet demand for these quality products and drive incremental growth in our Canadian medical platform. In our global medical cannabis business, I am pleased to report that our Australian team has delivered its 10th consecutive quarter of record revenue.

In our other international markets, including Germany, Poland and the Czech Republic, we believe there is an opportunity for Canopy to grow share, leveraging the quality of the products that our Canadian platform is producing, ensuring consistent supply, advanced routes to market and better consumer engagement. As an example, to capitalize on this opportunity, we are shipping five new flower SKUs, cultivated in our newly EU GMP certified Kincardine facility to international markets during Q3. Finally, Storz & Bickel recently launched its new Venty portable vaporizer, a device that sets industry standards for portable performance, including adjustable airflow up to an industry leading 20 liters per minute and a rapid 20-second heat-up time. Storz & Bickel is now focused on following up the limited initial batch with broader commercial availability to meet the demand for this industry-leading device as well as preparing for holiday promotions, including Black Friday, which are expected to drive sales across the brand’s product lineup.

Finally, I would like to speak briefly about our Canopy USA strategy. We believe Canopy USA provides investors a truly novel exposure to the continued rapid growth of the U.S. cannabis market. Importantly, this approach is informed by the lessons we have learned in Canada. We have embraced scalability and capital efficiency, which have resulted in our asset-light and wholesale-focused strategy. As we continue to work closely with the SEC to advance this novel structure, we have been in active discussions with the most recent communication, indicating that there is more work to be done to enable us to deconsolidate the financials of Canopy USA. Meanwhile, we remain steadfast in our journey ahead, buoyed by the continued advancement of Wana, Jetty and Acreage, who are demonstrating impressive growth.

During the quarter, Wana executed two agreements for new state launches expected in Q1 of calendar ’24. Jetty has introduced its award winning vape products in Colorado in coordination with Wana and achieved the number three market share position in the solventless vape cartridge category in the state just three months after launch. Acreage, leveraging their strategy for focusing on high-potential markets like New York, New Jersey, Pennsylvania and Ohio, remains well-positioned for further unlocks and has debuted its Superflux craft cannabis brand in New Jersey. These advancements are complimented by this week’s news that Ohio has voted to legalize cannabis for adult-use. And congratulations to the people of Ohio and to the Acreage team, which is already well-positioned in the state through their retail footprint of five stores.

I’d also like to recognize TerrAscend, of which cannot be owned 17%, which reported its financial results today and generated over $82 million in revenue and over $24 million in adjusted EBITDA during the quarter. To summarize, Canopy Growth is streamlined, cannabis focused, and asset light. We have demonstrated our resilience and strengthened our financial position. We’ve laid the foundation for profitable growth across each of our core businesses with a Canopy Growth that is purpose built for the markets and geographies of greatest opportunity. And we stand apart with our unique exposure to the ongoing expansion of the U.S. market through Canopy USA. I am proud of the transformation that this team has delivered, and I am more confident than ever in our ability to achieve North American cannabis leadership.

With that, Judy, we’ll speak in further detail to our financial results.

Judy Hong: Thank you very much, David, and good afternoon, everyone. I’ll start by reviewing our second quarter fiscal 2024 results, including the significant progress we’ve made across our P&L this quarter. I’ll then discuss additional actions we’ve taken to delever the balance sheet and improve liquidity, followed by our priorities and outlook for the balance of fiscal ‘24. Let’s begin with our second quarter results. Q2 was a pivotal quarter for Canopy as a business transformation we’ve undertaken over the past year through substantial improvement in profitability and reduction in cash burn. Please note that our financial results in the current period and prior periods now exclude BioSteel results as BioSteel is presented on a standalone basis as a discontinued operation.

We delivered consolidated net revenue of $70 million in Q2, which is down 7% compared to Q2 of last year, excluding the Canadian retail divestiture. Main drivers of year-over-year revenue decline were Storz & Bickel, which was negatively impacted by the timing of shipments and U.S. CBD sales, which have undergone a strategic shift over the past year. The Canadian cannabis sales were down slightly excluding retail divestiture compared to a year ago, but up from the prior quarter. Q2 gross margin was 34%, and adjusted gross margin was 33%, a significant improvement compared to negative 1% last year. The biggest driver of improvement was the business transformation initiative executed in Canada, which has meaningfully reduced Canada operational costs.

Q2 gross margin also benefited from opportunistic use of certain lower priced inputs in the Canadian business, which may not recur. Q2 adjusted EBITDA was a loss of $12 million, which was an improvement of over 79% versus last year, and 48% improvement versus last quarter. Free cash flow was an outflow of $67 million, an improvement of $32 million compared to Q2 of last year. I’d like to now review the results of our key businesses in more detail, including the progress against our path to profitability. Starting with Canada. Q2 net revenue was $40 million, a third quarter in a row of sequential revenue increase. The Canadian medical sales continued to show steady growth increasing 6% compared to last year, even as the broader medical market is showing a decline.

Our adult-use B2B business was down 6% compared to last year and was broadly in line with Q1. We again saw strong growth from our Tweed, flower and pre-rolled, despite our top selling SKUs being supply constrained due to stronger demand than expected during the quarter. We also had supply challenges in our beverages as our transition to third party contract manufacturers took longer than expected. The beverages are now back in stock and they’re better than ever. Canada adjusted gross margin in Q2 was 34% and cash gross margin, adding back non-cash depreciation cost of goods sold was 47%. Let me unpack this gross margin performance. The biggest driver of year over improvement is the cost reduction from the Canadian business transformation initiatives.

We had targeted $90 million to $100 million reduction in cost of goods sold as part of these initiatives, and we have achieved approximately $80 million of reduction through Q2 inclusive of savings realized during fiscal 2023. Year-to-date, operational costs in Canada have declined by $37 million in the first half or 47% year-over-year with reduction across all areas, including facility cost, labor, both direct and indirect, utilities, insurance, and distribution costs. In addition, we also saw a significant reduction in excess and obsolete inventory expenses as we right sized our inventory. Finally, our Q2 gross margins benefited from opportunistic utilization of certain lower priced inputs, which may not recur. We continue to target cash gross margins in the mid-30% in our Canadian business, and we believe that we’re on track to achieve this margin performance in the second half of the year.

Rest of the world’s cannabis sales were down 15% year-over-year. Australia, which now accounts for nearly 60% of total rest of the world sales had its 10th consecutive record revenue quarter, growing over 20% year-over-year. This was offset by the decline in our German flower sales in part due to the broader market decline. U.S. CBD sales were also down year-over-year, driven by a shift in focus to e-commerce channel for this business. Rest of the world’s gross margin was 30%, reflecting an improvement in our U.S. CBD business post our strategy shift, partially offset by a geographic makeshift to Australia, which carries lower gross margin than Europe. Turning to Storz & Bickel, revenue of $12 million in Q2 was down 11% compared to last year.

Note that Q2 is a seasonally soft revenue quarter for Storz & Bickel, sales were further impacted by the timing of shipments to certain U.S. distributors, which fell in October versus September. In addition, some of the distributors in the U.S. continued to face financial difficulties, and as a result, shipments to those distributors have been disrupted. Year-to-date, Storz & Bickel revenue is up 3% with the second half expected to show acceleration, driven in part by the launch of the new vaporizer, Venty. Storz & Bickel gross margin was 33%, down compared to last year, in part due to lower revenue and associated fixed cost deleverage. On a year-to-date basis, gross margin is close to 40%, which is in line with recent trends. This Works grew its sales 3% year-over-year, benefiting from increased contribution from its body care product line.

Gross margin remained healthy at 48%. Let me now speak to the progress we’re making on our path to profitability. Due to fiscal ‘24 adjusted EBITDA loss was a negative $12 million, an improvement of $44 million compared to a loss of $56 million a year ago. The improvement is driven primarily by cost reduction of $54 million realized during Q2. We also estimate that Q2 adjusted EBITDA benefited by approximately $5 million from a few non-recurring items, including opportunistic use of lower cost inputs, reversal of bad debt expense, and a favorable legal settlement. Looking at our SG&A expenses more closely, selling and marketing, G&A and R&D expenses declined by a combined $32 million or 45% compared to a year ago, as a result of our cost reduction program.

Acquisition, divestiture and other costs were $10 million, which included $7 million of costs related to the debt amendment transaction we completed in July. Through the strategic transformation initiatives announced in our April 2022 and February 2023, Canopy has realized $227 million of cumulative cost savings. We are tightening the target range of cost savings program to $270 million to $300 million from our previously target of $240 million to $310 million. We expect the full completion of the cost reduction initiatives to position our businesses to achieve positive adjusted EBITDA exiting fiscal 2024. I would like to now review our cash flow and balance sheet. Our cash and short-term investment balance at September quarter-end was $270 million, which excludes BioSteel’s cash.

Q2 fiscal ’24 cash from continuing operations was an outflow of $67 million, an improvement compared to $99 million in Q2 of fiscal ’23. We incurred $28 million of cash interest payments during Q2. Cash from operations also included cash restructuring costs — cost and facility holding costs, including our Hershey Drive facility, the sale of which we did not close until the end of Q2. In addition, while BioSteel’s operating cash flow is not included in this figure, we do note that there are certain cash costs that Canopy has continued to pay for BioSteel during the quarter. We expect our cash flow from our operations to continue to show improvement in the coming quarters, driven by cost reduction initiatives as well as lower interest payments from reduced debt balance.

Second, within cash flow from investing activities, Q2 saw an additional inflow of $69 million from disposition of facilities, including the sale of Hershey Drive facility we closed at the end of September. Year-to-date, gross proceeds from facility divestitures have totaled over a $155 million. Net financing activities resulted in an outflow of $274 million. Debt paid down of $297 million comprised of payments to reduce our senior secured term loan at a discount to par, as well as to settle our July 2023 unsecured notes as part of the July debt amendment transaction. The private placement we completed in September resulted in a net cash flow of $32 million. Turning to the balance sheet. As of September 30, 2023, we had $270 million in cash and short-term investments and total debt of $681 million, resulting in net debt balance of $411 million, down from $474 million at the end of June of 2023.

Following the series of balance sheet actions we’ve completed over the several months, we have significantly strengthened our financial position. First, our short-term debt balance stands at $50 million, most of which relates to the term loan pay-down earmarked from previously disclosed facility disposition. Second, the principal balance on our senior secured term loan is expected to be approximately USD 400 million by the end of the current quarter. This is a reduction of USD 350 million from the original shown amount. We also expect a $100 million of promissory notes held by Constellation to be settled in equity. Reflecting these factors, we expect our total debt to be around $570 million with minimal short-term obligation. We remain focused on executing additional activities to further deliver on our commitment to improve our financial position over the coming months.

I’d like to now provide our key priorities and outlook for the balance of fiscal ‘24. In Canada cannabis, we’re firmly on a path to achieving profitability and are focused on accelerating top line growth on the back of a strengthened product portfolio. In rest-of-world cannabis, we expect continued growth in Australia and are focused on maximizing sales potential in an emerging medical market, such as Poland and the Czech Republic, while working on improving performance in Germany in the back half of our fiscal ‘24. For Storz & Bickel, we expect growth to accelerate in the back half following the launch of the Venty vaporizer, though the pacing may be a bit lumpy, depending on the timing of a full rollout. This Works sales are expected to be stronger in Q3 versus Q4 as we enter the holiday season.

From a cash flow standpoint, we expect our cash from operations to continue to show improvement driven by expected narrowing of adjusted EBITDA loss, lower interest expenses, and our stepped-up focused on working capital management. We’re also focused on remaining costs related to shuttered locations and certain contracts we’ve exited. In closing, we believe that Q2 results demonstrate that we’re well underway to achieving our target of positive adjusted EBITDA across our businesses as we exit fiscal 2024, setting a firm foundation for the core businesses to drive profitable growth and enhance shareholder value over time. This concludes my prepared comments. We’ll now take questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from Aaron Grey with Alliance Global Partners.

Aaron Grey: So now that we get a look at the Company kind of post BioSteel discontinue. Just want to talk a little bit more about the gross margin. Judy, you gave a lot of commentary within there, just want to make sure I have it down correct. So in terms of the gross margin expectations going forward, I think you talked about 35% back half cash gross margins. So I just want to make sure am I thinking about that correctly versus the 34% that you just reported? And you talked about some one-offs in there with some lower cost inputs that benefited you this quarter. So just if you could help us in terms of maybe some of the near term gross margin expectations before you get to what you expect in the back half. Because it sounds like you had some one-offs that also benefited there.

Judy Hong: Sure. And I’ll take that question. So, the target of mid-30%, to be clear, is a cash gross margin in the Canadian business. So, when you actually look at our gross margin performance in Canada in Q2 the reported gross margin was 34%, but you had cash gross margin of about 47%. We did have some favorable benefits that we don’t expect to recur in the back half of the year. So, really what we’re saying is we’re expecting, the target gross margin to be — cash margin to be around mid 30%. Included in that is depreciation expenses, which is obviously non-cash. That’s now running roughly about $4 million to $5 million a quarter. So it is about a 10 percentage-point impact to report gross margin. So, when you think about the Canadian business, I would expect the reported gross margins to be low to mid 20%, cash gross margin to be closer to kind of that mid-30%.

When you look at the international or the rest of the world margins, we think that 30% is probably going to see some improvement in the back half as some of the efforts that we’re undertaking across our key markets drive better sales in the back half the year. And then Storz & Bickel is the gross margin in Q2 is typically a lower gross margin quarter just because the revenue tends to be lower. So, in the back half, we would expect Storz & Bickel gross margin to be — to show improvement versus what we have shown in Q2. So I think that should give you a good sense of where we will land from a gross margin standpoint in the back half the year.

Operator: Your next question comes from John Zamparo with CIBC.

John Zamparo: Thank you. Good evening. I wanted to ask about the balance sheet, and I’m trying to get a sense of how you address the debt from here, because even with the significant reduction, it’s still a material amount. So is the plan to capture the economics of the U.S. businesses hopefully at some point in the future? And if so, are those free cash flow positive in a normal taxation environment, or do you plan to raise equity to repay that debt? Thank you.

Judy Hong: Yes. So, I’ll take that, John. So I’d say, first of all, I want to note that we do not have any upcoming maturity until September of 2025. So as you can see, we’ve undertaken significant actions to eliminate any near-term obligations from a debt perspective. And we have maintained a strong cash position. We have over $270 million of cash on our balance sheet. So, we think we have an ample runway with the cash balance that we have. We also have additional proceeds that we expect to receive from sale of BioSteel, and we’ll continue to look to monetize, businesses or patients that are not core to Canopy. Beyond that, we have a very constructive dialogue with our investors both on the debt side and others to ensure that we can reduce our debt in an accretive manner, which also saves our cash interest costs.

So there are active, I’d say plans in place to continue to look for ways of reducing our debt over time. And we’ll have more update as we have announcements to share.

Operator: [Operator Instructions] Your next question comes from Michael Lavery with Piper Sandler.