Canopy Growth Corporation

Good morning. My name is Sylvie, and I will be your conference operator today. I would like to welcome you to Canopy Growth Second Quarter Fiscal Year 2022 Financial Results Conference Call. At this time, all participants are in the listen-only mode. And I would like to turn the call over to Judy Hong, Vice President, Investor Relations. Judy, you may begin the conference call.

Thank you. Good morning, everyone. Thank you all for joining us. On our call today, we have Canacy CEO David Klein and CFO Mike Lee. Before financial markets opened today, Canacy issued a news release announcing our financial results for a second quarter fiscal year ended September 30th, 2021. This news release is available on our website under the investors tab and will be filed on our EDGAR and CEDAR profiles. We've also posted our supplemental earnings presentation on our website. 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 this morning's news release. Please review today's earnings release and cannabis reports filed with the SEC and CEDAR for various factors that could cause actual results to differ materially from projections. In addition, reconciliations between any DOM gap measures to their closest reported gap measures are included in our earnings release. Please note that all financial information is provided in Canadian dollars unless otherwise noted. Following prepared remarks by David and Mike, we will conduct a question and answer session. To ensure that we get to as many questions as possible, we ask analysts to limit themselves to one question. With that, I'll turn the call over to David. David, please go ahead.

Thank you Judy. Good morning everyone and welcome to our second quarter call. Let me begin today's call with some perspectives on the current state of Canopy's business. I'll follow up with key highlights for Q2 and offer some comments on our priorities. Mike will then discuss our quarterly performance in more detail and provide perspectives on our outlook. While there are encouraging elements in this quarter's earnings, there remain a number of factors that impacted our Q2 performance and overall we're not satisfied with where we are today. However, I'm confident that we've built a focused strategy with a foundation for growth at Canopy. And management, along with the board, continue to believe we're on the right path for long-term prosperity and shareholder returns. And make no mistake, like any new industry where potential is immense, progress is rarely seen in a straight line. The legalized cannabis industry is still in its infancy, and we firmly believe that our strong portfolio of brands, routes to market, and CPG model supply chain will provide Canopy with a competitive advantage. Let me remind you of the reasons why I believe Canopy is well positioned for long-term success. First, our U.S. strategy is well established with a burgeoning ecosystem. Our MSO partners, Acreage and Terrascent, are performing well, capitalizing on strong market growth in their respective states and building their footprints. They're also ideally positioned to realize the untapped opportunity presented by newly legal cannabis markets in the highly populated Northeast United States. In addition, we further enhanced our U.S. ecosystem with a plan to acquire Juana Brands, the number one North American edibles brand, upon U.S. permissibility of THC. Juana's asset light licensing model provides outstanding coverage across the United States. We're continuing to build our U.S. CBD and CPG businesses, which, taken together with our MSO and WANA relationships, ensure we'll have the relationships, organizational capabilities, and routes to market for winning in legal U.S. THC markets post-permissibility. As we know, the U.S. is by far the world's largest cannabis market, and over the long term, we believe the creation of significant shareholder value will be driven by our ability to capture a significant portion of the U.S. profit pool. Finally, we have the backing of Constellation Brands who directly contribute to the strength of our U.S. ecosystem. The relationship continues to pay dividends with distribution for our CBD brands and BioSeal. The second point is that we have strong assets and capabilities across our North American business. Our priority brands are healthy with significant distribution runway as we scale them further. We're seeing strong consumer interest across many of our recent new product launches on both sides of the border, including several innovative products that take advantage of our insights-driven R&D platform. The Canadian market continues to find its footing. While consumer preferences are evolving and competition remains strong, we continue to see strong demand for legal cannabis products. Brands are becoming increasingly important in certain categories, and consumers and customers are becoming more selective in which suppliers they partner with. There will be bumps in volatility, however, we continue to sharpen our focus and work on improving execution in the Canadian market. Let me now offer a review of key highlights of Q2. In the Canadian recreational cannabis market, we maintain market share leadership in the premium flower category and grew our market share in vapes and edibles. We launched several new products across the flour, pre-rolled joint, beverage, and edible categories in Canada, and in the U.S. CBD and CBG categories. And in our consumer products business, we continue to expand distribution of BioSteel ready-to-drink beverages in the U.S. We did, however, face some challenges in the second quarter. Competition in the Canadian recreational cannabis market remains strong, with consumer preference continuing to shift. By way of examples, consumers are increasingly looking for higher THC offerings in the flour category and we did not shift our growth strategy fast enough to capitalize on this during the quarter. The distribution ramp up in our U.S. business is taking longer than expected as chain authorizations and shelf resets are happening later than planned for both BioSteel and our U.S. CBD portfolio. As a result of the above, our gross margins have suffered from lower than planned volume, continued price compression in value, and inventory write-downs resulting from our underperformance in the Canadian market. The delayed revenue ramp is causing us to push out our target of achieving positive adjusted EBITDA by the end of the current fiscal year. Improving our Canadian profitability remains our number one focus area, which Mike will discuss in more detail. Now I'll take a few minutes to discuss our performance in key categories and provide a glimpse into our innovation pipeline, which we feel is truly best in class. Starting with flower and pre-rolls. In the highly competitive Canadian recreational flower market, we've maintained our market leadership position in the premium flower category with a 13.2% market share in tract provinces during Q2. And despite continued fragmentation of the premium flour category, our market share is more than double that of the next closest competitor. We launched several new premium flour products with new flour supply starting to build toward the end of Q2. Our Doja brand is gaining traction aided by several new Doja and Doja Craft SKUs. Our pre-roll sales increased 75% in Q2 compared to last year, benefiting from the launch of small format pre-roll joints Tweed Cookies and Ace Alley Pinners. Finally, our flour team is excited about the new flour and pre-roll products coming to market in the next few months, including new strains across all product categories, including the launch of Doja 91K, Tweed Powder Donuts, and TWD Garlic Jelly flour that have been launched in the current quarter. In edibles, we're gaining market share with the help of some Q2 product launches including 8th Valley Dream CBN and Super CBD gummies. Building upon Deep Space success in the beverages category, in the current quarter we introduced the first ever gummy products from the Deep Space brand called Deep Space Express. In keeping with the Deep Space brand, the Deep Space Express gummies mark our first single 10 milligram THC infused gummy in the Canadian market directly meeting a consumer desire for higher THC products. These gummies are available in the original Deep Space flavor and new Limone Splashdown. Turning to beverages. Building on the success of our existing beverage portfolio, we're focused on producing new formulas that offer higher THC potency and taste great. Following our Q1 launch of Tweed iced tea beverages, we launched Tweed Fizz beverages in Q2. These are analogous to seltzers in beverage alcohol and all contain five milligrams of THC. We also expanded our popular Deep Space brand with the launch of Deep Space Limon Splashdown. With additional beverage innovations expected to hit the market over the coming months, we're on pace to more than double our assortment of beverages in fiscal 2022. And in Babeson Concentrates, we grew market share of Babeson Q2 driven by the launch of 1-mil 510 cartridges that began in Q1. We continue to focus on premiumizing our vape portfolio in Canada and bringing additional products to market, including launching premium live resin vapes, as well as live resin dab-friendly concentrates and hash products before the end of fiscal 22. Now turning to our U.S. CPG and CBD brands. BioSteel remains focused on building national chain distribution supporting the Constellation Brands Gold Network and leveraging local marketing activities to build brand awareness and generate trial. Distribution continues to ramp with ACB climbing to 6.5% for the 13 weeks ended October 3rd in IRI. We're seeing key wins in major chain authorizations with over 2,000 doors won in recent months. and active discussions are underway with a number of national and regional chains as we speak. Velocity continues to increase, particularly in key markets such as Phoenix and Chicago. Brand awareness continues its rapid ascent through prestigious sponsorships, becoming the official sports drink of the Los Angeles Lakers and the Miami Heat. Stords and Bickel continues to cement itself as the gold standard in the vaporizer category and recently released several New vaporizers, including the Volcano Onyx and the Mighty Plus vaporizer, which improved charging or would improve charging in a quicker heat up time. Our new Whistle CBD vape launched in Q2. Whistle is a nicotine-free CBD vaporizer with three interchangeable pods, offering uniquely formulated options to help consumers dial into their desired effect, whether that be focus, calm, or winding down. Whistle has been available on ShopCanopy.com since mid-September and is available in over 3,500 Circle K stores throughout the United States. While it's still early into our launch, it's encouraging to note that Whistle has already achieved the number three position in the CBD vape category, according to IRI, in the four weeks ended October 3, 2021. Martha Stewart CBD remains one of the fastest-growing CBD brands across all formats. Martha Stewart is now the number three CBD supplement brand in the food, drug, and C-Store channels. In this quarter, we launched a number of new confectionary products aimed at capturing holiday shoppers, including the Snowflake Winter CBD Gummy Gift Box and Martha Stewart CBD Peppermint Ribbons. And even though we're pleased with the performance of our new products in the U.S. CBD market, our primary challenge is growing our distribution to expand our business. A potential unlock for distribution for our CBD products is the recent signing of Bill AB 45 in California. This legislation establishes the regulatory framework for CBD ingestible products that's necessary to encourage broader retail participation in the CBD market in California. I'd now like to take a minute to speak about our path to profitability and our commitment to achieve breakeven by the end of fiscal year 22. Recognizing our challenges in the Canadian market, coupled with the slower than expected ramp up of our U.S. business, we're postponing our timeline for achieving positive adjusted EBITDA. And while our top priority continues to be achieving profitability, we must place our focus on the following. Number one, stabilizing our Canadian business by taking steps to improve our mix of supply to better meet consumer preferences for higher THC offerings. This will take time. but we're starting to see some benefits and expect that our new supply will be fully realigned by the beginning of next fiscal year. In the meantime, we're focused on accelerating new product launches across vapes, edibles, and beverages. Number two, continue to build distribution of our U.S. CBD portfolio, leveraging both our distribution and retail partners, including seizing the opportunity presented by a newly unlocked market in California. And number three, on BioSteel, We remain confident in our growth opportunity and will continue to invest in building brand awareness and generating trial while partnering with the Gold Network to drive distribution and build a national chain presence. In summary, the combination of volume growth, improved portfolio mix, and the previously announced cost savings should allow us to turn profitable in our Canadian operation while we continue to scale our U.S. business. And with that, I'll turn it over to Mike. Thank you, David, and good morning, everyone. Let me dive right into the review of our second quarter fiscal 22 results. In the second quarter of fiscal 22, we generated net revenue of $131 million, representing a 3% decline over the prior year. Excluding acquisitions, our net revenue was down 13% versus the prior year. Our reported gross margin in the second quarter of fiscal 22 was a negative 54%. impacted by a material inventory write-down related to our excess Canadian cannabis inventory as a result of underperformance in sales relative to forecast, as well as our updated expectations for near-term demand. Our adjusted EBITDA loss during the second quarter of fiscal 22 was a loss of $163 million, widened by 90% versus prior year, and again was impacted by the inventory write-downs. Excluding these write-downs, our adjusted EBITDA loss would have been $76 million. Free cash flow in the second quarter of fiscal 22 was an outflow of $101 million, representing a 47% improvement over the prior year. Let's now dive into Q2, starting with the global cannabis segment, which increased 1% year-over-year to $95 million or down 14%, excluding acquisitions. Our total Canadian REC business declined 4% year-over-year to 59 million, driven by a 1% decline in our B2B channel and an 11% decline in our B2C channel. Our Canadian medical cannabis declined around 6% to 13 million as higher average order size was offset by a lower number of orders. Our international and other cannabis business increased 21% year-over-year to 24 million driven primarily by the growth in our U.S. CBD business, partially offset by declines in C3 and our German flower business due to increased competition, as well as negative FX impacts. Looking into our Canadian REC business in a bit more detail, B2B revenue declined 1% year over year, primarily due to insufficient supply of flower products with in-demand product attributes, as well as continued price compression and the valued flower category, and was partially offset by contributions from Ace Valley and Supreme Acquisitions. Excluding the impact of acquisitions, B2B sales would have been down 34% compared to the prior year. Our REC B2C cannabis sales in the second quarter of fiscal 22 decreased 11% versus the prior year, largely driven by increased competition from the opening of additional third-party retail locations. Revenue from other consumer products declined 12% versus prior year to $36 million in net revenue. Stores and vehicles declined 34% driven by supply and logistics challenges caused by global supply chain difficulties, a negative FX impact tied to the strong Canadian dollar, as well as a tough overlap to prior year driven by the strong demand experienced during the COVID-related restrictions. This works grew 15% year-over-year due to continued strong Amazon and third-party e-commerce sales. BioSteel grew 47% year-on-year due primarily to the launch of BioSteel ready-to-drink beverages in the US. Let's now move on to an analysis of gross margin. Reported gross margin in the second quarter of fiscal 22 was negative 54%, impacted by several items. First, we recorded inventory write-downs of $87 million, primarily related to Canadian cannabis inventory, resulting from underperformance relative to forecast, as well as declines in expected near-term demand. Second, we booked charges totaling $3 million related to the flow-through of inventory step-up charges associated with the acquisition of Supreme Cannabis. And third, we continue to see pressure on gross margins from lower production output and price compression in the Canadian REC business, notably in the value-priced flour category. In addition, we incurred higher third-party shipping, distribution, and warehousing costs in North America. And these factors were partially offset by payroll subsidies in the amount of $7 million received from the Canadian government pursuant to a COVID-19 relief program. Excluding inventory write-downs, step-up inventory charges, and other one-off items, including the subsidy, Q2 gross margin would have been approximately 12%. Turning to our OpEx, our overall SG&A in the second quarter fiscal 22 decreased 15% versus the prior year. G&A expenses declined 49% year-over-year, primarily due to reductions in staffing, and professional fees and payroll subsidies. And excluding the subsidies, our G&A was down 34% versus prior year. R&D expenses declined 38% year on year, principally due to project timing. Sales and marketing expenses increased 49% year over year, primarily due to a return to more normal advertising and promotional spending compared to last year when we delayed or canceled various product and brand marketing programs tied to COVID-19. In addition, we incurred higher sponsorship costs associated with BioSteel's partnership deals as well as increased A&P spending to support the launch of new products. Through the end of the second quarter, we have generated approximately $70 million of savings across COGS and SG&A, including $32 million in the second quarter. With savings that we have recognized to date, and our analysis of future savings we are confident that we will recognize the 150 to 200 million dollars in savings by the end of q1 of next fiscal year our net loss during the quarter was a loss of 16 million dollars inclusive of other income of 196 million most of which is tied to non-cash fair value adjustments related to our various financial instruments driven mainly by the decline in canopy share price during the quarter Our free cash flow in the second quarter of fiscal 22 was an outflow of 101 million, representing a 47% reduction over the prior year. CapEx declined to $15 million, down 46% versus prior year. As David mentioned, given some of the challenges we're facing in our Canadian B2B business and the slower than expected distribution ramp up on BioSteel and our USCBD business, we expect revenue to fall short of our $250 million breakeven range and therefore no longer expect to achieve positive adjusted EBITDA by the end of the current fiscal year. So let's spend some time detailing the actions that we're taking to improve our business. First, in our Canadian B2B business, we are focused on stabilizing our market share during the balance of the fiscal year. The key actions we're taking include the following. increasing supply of flour products with in-demand attributes, accelerating our pace of new product innovation, and optimizing our portfolio to ensure commercial and operational efficiency with a focus on premiumizing our portfolio. So let me dig into each of these items in more detail. First, we have undertaken steps to increase supply of new high THC flour. Our acquisition of Supreme Cannabis increased our capacity to produce high quality high THC flower and our efforts to improve cultivation and post harvest processes across canopy are underway, including expanding our hang drying programs at our Smith Falls facility. We're taking additional actions to increase our internal flower supply with higher THC levels and improvements to other attributes such as terpene profiles and aroma with a target of internally harvesting 100% of our premium and mainstream flower requirements by Q1 of fiscal 23. Additionally, our new genetics and sourcing strategy will leverage our internal R&D capability, as well as third-party partners, including craft growers, to quickly scale up production in support of evolving consumer preferences. And our goal is to reduce the cycle time of new stream development from 12 months to three months, which will dramatically improve our response time to the ever-changing consumer preferences. We're encouraged that the flour products with in-demand attributes have begun to enter the market and supply is expected to build throughout the remainder of fiscal 22 and into fiscal 23. Second, the acceleration of our pace of new product development is critical to our success. And as David mentioned, several new products have entered the market with more to come in future months. Meanwhile, we are focused on reducing our cycle time for new product development to improve our flexibility and nimbleness as an organization, while increasing our overall capacity for new product development. Lastly, we recently optimized our portfolio so that we can better concentrate our resources against the skews with the highest potential, which ensures that we're getting the best ROI on new distribution while also reducing supply chain complexity and improving inventory management. Now, before leaving Canada and in light of the inventory charges recorded in our Q2 results, I would like to briefly cover some of the changes that we're making in our Canadian operations and supply chain that will help to improve our inventory management. Recognizing that a portion of our inventory charges are a result of poor demand signals, we are implementing a new demand planning process that will improve our back-end processes that lead to production and inventory planning. We recently implemented a new inventory management process that will increase our visibility on finished and semi-finished goods inventory in a more real-time basis. And we're in the midst of a full business transformation that will result in a full deployment of SAP across Canada, which will further improve our end-to-end process flows, our access to timely information, and improve our ability to manage risks proactively. Each of these initiatives is underway, and we are receiving the highest levels of support from our executive team. Let me now spend a couple of minutes on BioSteel and our USCBD businesses, where the focus is really about accelerating distribution. Chain authorizations for BioSteel are happening more slowly than expected, resulting in lower than expected sales for the fiscal year. Despite being four to six months behind where we expect it to be, the sales discussions that we're having with the national and regional chains have been productive. And as a reminder, we're heavily supported by Constellation's Gold Network to activate these new points of distribution as they materialize. And our goal is to achieve a 20% ACV for RTD distributions in the U.S. by the end of this fiscal year. And the good news is that brand awareness continues to increase, customer interest remains strong, and the velocity levels from where we are in market is in line with our expectations. When you look at our U.S. CBD business, despite strong brand propositions, bricks and mortar distribution continues to lag expectations. And we're focused on accelerating Martha Stewart and Quatro CBD distribution, working closely with Southern Glazers Wine and Spirits, focusing on new states as they open up for CBD products, and further developing distribution with partners in certain channels and markets outside of Southern's coverage. Whistle is off to a good start, and it's expected to continue to build momentum with Circle K and we are currently working to further build distribution across the U.S. market. Let me now provide some perspective on the near-term outlook. From a top-line perspective, in our Canadian REC business, we're focused on stabilizing our market share with improved supply of new strain and high THC flour expected to build over the course of the balance of this fiscal and into fiscal 23. We expect our European medical sales, including C3, to be down on a year-over-year basis due to increased competition for C3 and German flower business. Our U.S. CBD business in Q3 is expected to be down versus prior quarter due to a whistle load-in during Q2. BioSteel Momentum is building. And shipment to our distributors will largely depend on the timing of chain authorizations and the associated shelf resets. Stores and vehicles off to a good start in Q3, which is typically a seasonally strong quarter. However, we are facing parts shortages due to global supply chain difficulties, which could temper growth for the balance of the fiscal year. From a margin perspective, we expect increased volume throughput and positive mix shift in Canada to contribute to a gradual gross margin improvement. Additionally, headwinds from startup costs in the U.S. should abate as we scale up our CBD and CPG businesses, though we continue to invest for brand activation given the sizable growth opportunity that we see for brands like BioSteel. We're on track to achieve our cost savings target, including $45 to $50 million reduction in SG&A expenses this fiscal year compared to last year. And we are taking steps to reduce or delay discretionary spending to further tighten our G&A expenses. Finally, we intend to mitigate impact to free cash flow by further reducing our CapEx, with CapEx now expected to be in the range of $100 to $150 million down from $200 million. In conclusion, we recognize we are behind our plans for the year, but we believe we're taking the necessary actions with a sense of urgency to drive market share in Canada, accelerate distribution in the U.S., accelerate our new product development, and ultimately improve profitability. This concludes my prepared comments. Operator David and I would be happy to take questions from the analysts.