Canopy Growth Corporation (NASDAQ:CGC) Q3 2024 Earnings Call Transcript

Canopy Growth Corporation (NASDAQ:CGC) Q3 2024 Earnings Call Transcript February 9, 2024

Canopy Growth Corporation misses on earnings expectations. Reported EPS is $-1.79 EPS, expectations were $-0.45. CGC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. My name is Joanna, and I will be your conference operator today. I would like to welcome you to Canopy Growth’s Third 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 Sarah Pare, Vice President investor relations. Sarah, you may begin the conference call.

Sarah Pare : Thank you, Joanna. Good morning. And thank you for joining us. On our call today, we have Canopy Growth’s Chief Executive Officer, David Klein; and Chief Financial Officer Judy Hong. Before financial markets open today, Canopy Growth issued a news release announcing the financial results for our third quarter ended December 31, 2023. News release and financial statements have been filed on EDGAR, 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 this 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 and Canopy’s reports filed with the SEC on the Canadian Securities Regulators 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 remarks by David and Judy, we will conduct a question answer session where we will take questions from analysts. And with that, I will turn the call over to David.

David Klein : Good morning, everyone. And thank you for joining us to review Canopy Growth’s third quarter fiscal ’24 results. Completion of our Q3, marks the dawn of a new era for Canopy, we’re immensely proud of where we are today and feel strongly that Canopy is positioned for lasting leadership. We’re 100% cannabis focused for demonstrating consistent growth across each of our business units. And we have a definitive meeting date scheduled for our shareholders to consider an amendment to our articles to create a new class of non-voting non-participating exchangeable shares, which we expect to advance the Canopy USA structure. Let’s now review our right sized cannabis focused business. With the divestiture of this works in December 2023, our last non-aligned enterprise Canopy — Canopy is now 100% cannabis focused and purpose built for the markets of greatest opportunity.

By focusing exclusively on cannabis and right sizing our footprint, we strengthen our path to delivering sustainable operating profit, and ensure we are well positioned to capitalize on what we feel is the greatest consumer trend of our lifestyle. And while we’re looking to the future with optimism, let’s first review the dramatic and measurable improvements in the performance of our business that these actions have produced. To summarize, we’ve cut Canopy to size and are now delivering on improved gross margins, enhanced commercial execution, and are focused on demonstrating growth across all of our business units. This has enabled us to significantly improve our overall gross margins, with Q3 marking the second quarter in a row of margins in the mid-30s at the total company level.

From this strength in base, we’re generating growth backed by enhanced execution and consistent high quality products. In Q3, our Canadian cannabis business delivered its fourth straight quarter of revenue growth. And it’s up 10% year-over-year when excluding the divestiture of our retail business. There are several contributors to this growth, but at the core, we’re continuing to deliver a great flower and it’s been very well received by provincial cannabis boards, retailers, and most importantly consumers, not to mention our staff. This is further validated by growth in our distribution, with an incremental 900 points added nationally during the third quarter. Thanks to the quality of our flower offerings. I really can’t overstate how proud we are of our flower in demand for our high quality strange – strains, such as Tweeds, Kush Mintz, and Tiger Cake remain at an all-time high, and has a selling every gram we can produce.

When it comes to flower, we feel that our platform is now dialed in. And then we’ve got a pipeline of high quality cultivars in market and soon to come from both Tweed and 7ACRES. And to meet the ongoing high demand for our flower, we’re also working on ways to further increase yield from our production platform. We’ve also developed a robust new product introduction cycle to win market share across priority categories, including pre-rolls, vapes and soft gels. In pre-rolls, we’re going to continue our record of success by launching new large packs, infused pre-rolls and burners over the coming months. In addition, we have an exciting lineup of Tweed and 7ACRES vape products coming to market with differentiated flavor profiles, and we expect to truly delight consumers as we step firmly back into the vape category.

Dripping the soft gels, an area of historic expertise at Canopy, we see significant potential to win share through recently launched and soon to come soft gel products, featuring larger pack sizes and unique cannabinoid ratios. In addition to being a high margin category, soft gels provide consumers a discreet, convenient and affordable method of precisely dosed cannabis consumption. And we feel Canopy is well positioned to achieve categorical leadership. Finally, as the foundation of our edibles portfolio we relaunched Wana in the third quarter across Canada, with very active retailer engagement. We also expect to drive additional growth through the introduction of new Wana products that addresses specific gaps in the current Canadian edibles market.

Shifting to our Canadian medical business. It’s an important margin enhancing pillar of our Canadian strategy. We’re especially proud of our medical team as they continue to drive ongoing assortment expansion in the spectrum store, including a wide range of exclusive products all backed by exceptional patient service. This strategy has led to record revenues on a daily, weekly, monthly and quarterly basis, including in the third quarter. And importantly, these record revenues were achieved while improving margins. Sticking with medical, but shifting to our rest of world cannabis business, we reported another strong quarter with revenues doubling year-over-year. Our Australian team delivered its 12th consecutive quarter of record revenue. Additionally, shipments of proven Canadian strains, including Kush Mintz, Tiger Cake and OG Delux, as well as increased educational training with medical practitioners contributed to growth in our Australia, Polish and Czech medical cannabis sales in Q3.

Finally, we think there’s a ton of growth possible across international markets where we’re already active and expect consistency of our flower supply, and the onboarding of new distribution partners will continue paying dividends across our international medical cannabis business. I’m pleased to report that STORZ & BICKEL also delivered a strong third quarter driven by demand for the new VENTY portable vaporizer, as well as the most successful Black Friday in the company’s 20-year history, generating sales across STORZ & BICKEL entire portfolio. In fact, the promotional week showcased a remarkable 55% increase in the number of devices sold versus last year, including driving strong VENTY sales despite the device not being discounted. Speaking of the VENTY, I really can’t say enough about this device.

It’s the best portable vaporizer experience available. I continue to be amazed by how quickly it heats up. But even more the vapor throughput, which at 20 liters a minute is the closest thing you’re going to get to the legendary volcano experience in a portable option. But don’t just take it from me, the reviews and consumer demand for this device has exceeded all our expectations, and the VENTY is rapidly claiming its hero status within the portfolio. In fact, after our initial production run, we’ve had to add a second shift to further increase capacity and ensure availability matches the consumer demand, which shows no sign of slowing. Much like the iconic volcano we expect the VENTY will be a central pillar of the STORZ & BICKEL portfolio in the long term.

As with the rest of the S&B product lineup, it’s important to reinforce that these products are truly premium and command a price point reflecting their quality. In some our commercial businesses are demonstrating momentum and delivering impressive results. So let’s talk about Canopy USA. Simply put, we’re moving forward. We’re pleased to report that we will be filing our definitive proxy statement on or around February 13. Setting up a special shareholder vote for April 12. Following a successful shareholder vote, Canopy USA will be able to proceed with its anticipated acquisition of Jetty, Wana in Acreage, finding synergies to accelerate growth through a unified multi state operating business. Looking further to the U.S. and the potential impact of regulatory reform on our strategy, as many of you know in August, the Department of Health and Human Services communicated its recommendation that cannabis be rescheduled to schedule 3.

This was a welcome development and we’re cautiously optimistic that the DEA will in the near term provide its recommendation and initiate this process. Moving cannabis to Schedule 3 would be a significant boost for the U.S. assets held by Canopy USA and for Canopy growth. Through the removal of Section 280, we expect value appreciation across our U.S. assets, which would see a significant financial boost through reduced corporate income taxes, improve cash flows and strengthen balance sheets. We also believe cannabis being moved to Schedule 3 would build momentum behind other efforts to reform cannabis regulations in the US. And while we continue to advocate for these high potential catalysts, we remain focused on operating our business and demonstrating growth today.

We are a company with a resolute focus on cannabis, attractive gross margins, lower operating expenses, a growing top line and a significantly stronger balance sheet. Canopy USA is moving forward and we look forward to a successful shareholder vote on April 12. In summary, we believe canopy offers shareholders a unique opportunity to gain exposure to arguably the most exciting consumer product trend of our time into the fastest growing cannabis markets in the world. With that, Judy will speak to further details of our financial results.

Judy Hong: Thank you very much, David. And good morning, everyone. I will start by reviewing our third quarter fiscal ’24 results, including the significant year-over-year progress we’ve continued to make across our P&L this year. I’ll then discuss additional actions we’ve taken to improve our balance sheet and cash flow all of our priorities and outlook for the balance of fiscal ’24. So let’s begin with our third quarter results. Q3, like Q2 before demonstrated a substantial improvement in profitability and cash flow reduction that our right size cannabis focused business can deliver. Canopy delivered consolidated net revenue of $79 million in Q3, which is up 6% compared to Q3 of last year, when excluding Canada retail divestiture.

Main drivers of revenue excluding retail divestitures, were, Canadian cannabis revenue increased 10% compared to a year ago, and were up sequentially from Q2. Rest of world cannabis sales grew by 81% year-over-year in Q3, and STORZ & BICKEL grew its revenue by over 50% compared to the last quarter, driven by the launch of VENTY. Consolidated gross margins in Q3 was 36%, a significant improvement compared to 6% last year. The biggest driver of improvement was the business transformation initiatives executed in Canada, which have meaningfully reduced Canada operational cost. Q3 adjusted EBITDA was a loss of $9 million, an improvement of 82% versus last year, and a 25% improvement over the $12 million adjusted EBITDA loss in Q2 of fiscal ’24. And free cash flow with an outflow of $34 million, an improvement of $44 million, compared to Q3 of last year, at nearly a 50% improvement versus the last quarter.

I’d like to now review the results by our key businesses in more detail, including progress against our path to profitability. First, Canada, Q3 net revenue was $40 million, the third quarter in a row of sequential quarterly revenue growth. Canadian medical sales continued to grow strongly, increased 11% compared to last year, driven by increased assortment of high quality products, including the introduction of Wana brands that began in August. Our adult-use B2B business, was up 9% compared to last year, with the revenue growth during the quarter driven mostly by the growth of large pack flower offerings from Tweed, as well as addition of Wana Edibles. Canada gross margin in Q3 was 28% and cash gross margin, adding back non cash depreciation costs and costs was 40%.

Similar to the last quarter, the biggest driver of year-over-year improvement is the cost reduction from the Canadian business transformation initiatives. Our efforts drove reduction in flower costs, direct manufacturing costs and overhead expenses and we continue to see material reduction in excess and obsolete inventory expenses, as we have aggressively right size our inventory. We’re also pleased to see our Canadian business on track to achieve mid 30% cash gross margin performance in fiscal 2024. Rest of the world cannabis sales increased 81% year-over-year. Australia had its 12th consecutive record revenue quarter growing over 32% year-over-year. Poland grew revenue by over 60% and Germany also returned to double digit growth year-over-year year over year, aided impart by improved flower shipments.

Rest of world gross margin was 40%, driven by year-over-year improvement and margin performance in our Australian Business due to product mix, as well as slapping negative impacts in non-core markets during the prior year period. Storz & Bickel revenue of $18 million in Q3 was up 54% sequentially, but down 9% year-over-year. Sales during the quarter benefited sequentially from strong consumer demand for new Venty portable vaporizer that was launched in Q3. Initial demand for Venty exceeded production, those sales were constraints early in the quarter as we added a second production shift to better align production with demand. Black Friday period sales for the Storz & Bickel brand were very strong, resulting in the brand’s most successful Black Friday sales, campaign ever in its history.

Sales on a year-over-year basis were impacted by reduced shipments to the U.S., due to continuous financial challenges faced by distributors. Storz & Bickel gross margin was 51% compared to 45% last year, in part due to lower input costs and a positive mix shift with Venty, carrying higher gross margin than the rest of the portfolio. With the divestiture of this works on December 18, 2023, we included revenue for this work sales between October 1, 2023 and December 17, 2023. As a result, we reported, This Works revenue of $8 million in Q3, essentially flat compared to the prior year, which included the full quarter of revenue. These three fiscal ’24 adjusted EBITDA was a negative $9 million, an improvement of $42 million compared to a loss of $50 million a year ago.

I would note that this is our best adjusted EBITDA quarter since fiscal 2017. The improvement is driven primarily by additional cost reduction of $36 million realized during Q3 as well as focused execution driving profitable growth across our businesses. Now, looking at our SG&A expenses more closely, selling and marketing G&A and R&D expenses declined by a combined $26 million or 38% compared to a year ago, as a result of our cost reduction program. Through the strategic transformation initiatives announced in April ’22 and February 2023, Canopy has now realized $262 million of cumulative cost reductions, well in our way to achieve our targeted cost savings of $270 million to $300 million. Our cost discipline, along with the expectation for continued growth in our businesses, give us confidence in our target of achieving positive adjusted EBITDA in all of our business units exiting fiscal ’24.

I’d like to now review our cash flow and balance sheet. Free cash flow with an outflow of $34 million in Q3, which includes $21 million in cash interest payments, and a $1 million in CapEx. In Q3, we further deliver the balance sheet, reducing an aggregate principal amount by $65 million for a cash payment of $63 million, with the proceeds from the asset sale, including the proceeds from the Bio Steel assets completed during Q3. In January, we also completed a USD $35 million private placement, majority of which we expect to use towards additional debt reduction. Now turning to the balance sheet. As of December 31, 2023, we had $186 million in cash and short term investments and total debt of $612 million, resulting in net debt balance of $426 million.

Following the series of balance sheet actions, we’ve completed over the past year, we have significantly strengthened our financial position. First, while the short term… [Technical Difficulty] …this mostly relates to the promissory note with Constellation brands. We expect this note to be settled in equity, those preserving cash on our balance sheet. Within our long term debt balance, our senior secured term loan now stands at USD $383 million and is due in March of 2026. This is a reduction of USD $367 million from the original loan amount. We have been focused on executing additional activities to further deliver on our commitment to improve our financial position over the coming months. And reflecting these factors, we expect our total debt to be around $520 million at the end of fiscal ’24 with minimal short term obligation.

I’d like to now provide our key priorities and outlook for the balance of fiscal ’24 and into fiscal ’25. In Canada cannabis, we remain firmly in a path to achieving profitability and are focused on accelerating top line growth on the back of strengthen product portfolio as we close our fiscal ’24 and enter fiscal ’25. In rest of world cannabis, we expect to see growth in our key priority markets of Australia, Germany, Poland and Czech Republic and we remain focus in ensuring consistent supply of high quality products, as well as launching new products into these markets in the near term. For Storz & Bickel, with production of the new Venty portable vaporizer, having ramped up during Q3, we expect to see strong Venty demand to offset the seasonally softer sales that we typically experienced in the fourth quarter.

S&B Australia sales will also see some impact on the upcoming regulation changes on vapes. From a cash flow standpoint, we expect our cash from operations to continue to show year- over-year improvement driven by further reduction and adjusted EBITDA loss of lower interest expenses. In closing, we believe our Q3 results reinforce our confidence, but we now have a solid foundation in place to achieve profitability and drive profitable growth and enhance shareholder value over time. This concludes my prepared comments, will now take questions from analysts

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Q&A Session

Operator: [Operator Instructions]. First question comes from Michael Lavery from Piper Sandler, please go ahead.

Michael Lavery: Thank you. Good morning. And congrats on a lot of the progress you just laid out. We’d love to just get a little bit of better market color on the pricing environment in Canada. And just some of the ways you’re managing that and how that outlook looks?

David Klein: Yes. So I think Michael, there’s still price compression in some of the categories. And the way we’re really managing and I think is making sure that we’re thinking about pricing almost from a tiered standpoint. So there are some areas where we need to be price competitive, because the market is taking us there. And then there are some areas where, where we can’t produce enough product to meet consumer demand. And so we’ve actually had some instances where we take price increases. So it really is kind of managing the mix across the portfolio. But, yes, there’s still some pressure in the marketplace.

Judy Hong: I’d also say despite the price compression. And obviously, we are also seeing that in our P&L to some extent, but we’re definitely seeing gross margin improvement, in part because we’re shifting our mix. So product categories where it’s more profitable, we’re really leaning in there with better margins. And also we’re looking at ways of continuing to save — find savings from our costs. So our cultivation costs are down year-over-year, but we’re looking to even improve our costs more. So as we’re seeing some of that price compression, we can more than offset that and see the variable margins improvements across our portfolio. And then I think, lastly, our medical business, as you know, is that a very high margin business to begin with. And we’re also actually seeing margin improvement in that part of the business with some of the product mix improvements that we’re seeing in that platform as well.

Michael Lavery: That’s helpful. And where you’ve been able to take price, can you give a sense of the magnitude? I’d imagine it’s relatively modest, but maybe I’m wrong?

David Klein: It’s really just, yes it’s really just, Michael, it’s aligning kind of the, with the competitive set and with kind of consumer expectations. And so there, I guess I was so hard to come up with a specific example. But if you look at, say our Wana offerings, we’re going to be very competitive with our classics from a pricing standpoint. But as we bring innovation to market, like our quick formulation, we make sure that we’re pricing that at a premium. So really it’s, it’s almost on SKU by SKU basis.

Michael Lavery: Okay, great. Thanks. I’ll pass it on.

Operator: Thank you. The next question comes from Tamy Chen at BMO Capital Markets. Please go ahead

David Klein: Hi, Tamy.

Judy Hong: Tamy, are you on mute?

Tamy Chen: Sorry about that. Hi, good morning. This is Tamy Chen.

Judy Hong: Good morning.

Tamy Chen: Yes, good morning. I hit the wrong button. Thanks for taking my question. So as we know, yesterday, one of your competitors acquired their Australian Medical business. And you pointed out in your prepared remarks that the rest of the world gross margin was really primarily driven by the Australian gross margin there. And we noticed that in Q3 this quarter, the margin really jumped versus the previous two quarters, so it was 30ish percent, and now this quarter was 40%. So we really want to dig into maybe the puts and takes in that gross margin number. And also, what are your plans that you want to share with us about Australia that can talk about the attractiveness of that market for you? Thank you.

Judy Hong: Sure, I’ll start, Tamy. So if you looked at our rest of the world business, I would point out a few things. One, historically, you’re right, that there’s a lot of lumpiness in the gross margin performance, and they’re mostly driven by non-core markets. Frankly, I think, you know, we include our U.S. CBD business in that line item. And we’ve really tightened our focus and went through some strategic changes in our U.S. CBD business and the changes there have impacted the gross margins, as well as the revenue in some of the quarters. We also have historically had a bulk shipment to some of the markets outside North America and that also created volatility in the gross margin performance as well. So I think when you look at Q3 performance, I’d say it’s relatively a clean order and engaging on gross margin performance.

We are looking at Australia on a year-over-year basis being improved margin performance as their product mix is improving. But even in Europe, we are also seeing the margin improvement there as well. The one thing to call out from an Australian business standpoint, in our Australian business, we also have Storz & Bickel sales that go through just from a reported segments standpoint, to the Australia sales as part of the rest of the world sales, and that Storz & Bickel business, frankly, has really grown strongly in Australia. So I think the combination of really strong growth in the flower business in Australia, as well as growing business in Storz & Bickel. But now the improvement we’re seeing in markets like Germany, give us confidence that the margins that we’re seeing today should be sustainable going forward.

Tamy Chen: Great, thanks so much.

Operator: Thank you. The next question comes from Aaron Grey at Alliance Global Partners. Please go ahead.

Aaron Grey : Thank you very much for the questions. First question for me, we can certainly appreciate the ongoing situation back and forth between the SEC and the exchanges regarding Canopy USA. So just wanted to clarify just in terms of some of the disclosures in the MD&A, it seems like some of your combos with the OCA from the SEC that you expect with the new agreement that they’ll didn’t agree with the deconsolidation of Canopy USA. So first, can you just clarify that you believe with the filing in February, you will be able to get more clarity on that before the vote in April? And then second, could you provide any additional color in terms of the level potential supplemental information like to provide in terms of how the company would look with Canopy USA on a pro forma basis, even if it’s not going to be consolidated. Thank you.