Canopy Growth Corporation (NASDAQ:CGC) Q4 2023 Earnings Call Transcript

Canopy Growth Corporation (NASDAQ:CGC) Q4 2023 Earnings Call Transcript June 22, 2023

Canopy Growth Corporation misses on earnings expectations. Reported EPS is $-1.28 EPS, expectations were $-0.2.

Operator: Good afternoon, ladies and gentlemen. My name is Michelle and I will be your conference operator today. I would like to welcome everyone to Canopy Growth’s Fourth Quarter and Fiscal Year 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. I would now like to turn the call over to Tyler Burns, Director, Investor Relations. Tyler, you may begin the conference.

Tyler Burns: Thank you, Michelle. Good morning and thank all of you for joining us today. On our call, 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 fourth quarter and fiscal year ended March 31, 2023. In addition, we filed our comprehensive annual report on Form 10-K for the fiscal years ended March 31, 2023 and 2022, which contains our audited financial statements for the fiscal year ended March 31, 2023 as well as restatements of the following previously filed periods. Audited consolidated financial statements for the fiscal year ended March 31, 2022 originally included our annual report on Form 10-K for the fiscal year ended March 31, 2022 and audited consolidated financial — unaudited consolidated financial statements for the quarterly periods ended June 30, 2022, September 30, 2022, and December 31, 2022, originally included on our quarterly reports on Form 10-Q for such quarterly periods.

The news release and financial statements are available on our website and under the investor tabs and have been filed on EDGAR and SEDAR. Before we begin, I would like to remind you that our discussions 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 and 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. With that, I will turn the call over to David.

David Klein: Thanks Tyler. Good afternoon, and thank you for joining us. I’d like to acknowledge that today’s call is taking place later than originally planned. And I’m appreciative of the collective patience and flexibility of all the attendees on this call this afternoon. During the call today, I’ll cover four key topics: First, the progress of our transformation plan and the performance of our Canadian cannabis business in fiscal ‘23; second, addressing the BioSteel Review and our strategy to accelerate the BioSteel business; third, an update on Canopy USA and the progress on entering the U.S. cannabis market; and finally, the path forward for fiscal ‘24. Following my remarks, Judy will provide a brief review of our fourth quarter and fiscal ‘23 results and share an update on our path to profitability.

She’ll also discuss our balance sheet and the actions we are taking to strengthen our financial position and improve liquidity. Fiscal ‘23 was a challenging yet transformative year marked by substantive change. The Canadian cannabis industry continued to be challenged by systemic regulatory issues, a continued battle with the illicit market and delays in government action on both sides of the border. And internally at Canopy, we faced executional challenges as we transitioned our genetic strategy and cultivation practices, which led to delays in achieving commercial scale. I’m proud to say that we’re now delivering consistent quality as evidenced by consumer demand for the iconic Tweed brand. And we’ve taken the necessary actions to simplify our business by undertaking a complete transformation through the following initiatives: The full divestiture of our national retail operations; exiting cultivation in Mirabel and Smiths Falls; moving post-harvest manufacturing to our former beverage building in Smiths Falls; adopting a flexible third-party sourcing model for cannabis beverages, edibles, base and extracts; and reducing headcount across the business with approximately 1,200 positions eliminated.

Our team has worked diligently over the past fiscal year to complete the majority of these initiatives on or ahead of schedule. A transformation of this magnitude takes time to demonstrate its full results, but we’re already seeing effects of our actions with SG&A expenses and COGS already delivering a combined $125 million through the end of fiscal ‘23. We expect to reduce overall costs by $240 million to $310 million in total by the end of fiscal ‘24. Through continued discipline and stable commercial performance in Canada, along with further simplification of our business, we’re on a path to realizing profitability. I’ll now address the BioSteel Review. As we disclosed earlier this spring, during the preparation of our financial statements for our 2023 Form 10-K, we identified certain trends in the booking of our sales for our BioSteel business unit.

With the oversight from the Audit Committee, we launched an internal review together with independent external counsel and forensic accountants. Based on the results of the review, we’ll be implementing several remedial actions to strengthen our controls for the BioSteel business, which are outlined in the 10-K. We felt it was important to act swiftly to provide stability to the business at this pivotal time. To this effect, we have exited several members of the BioSteel leadership team and are considering all legal remedies available to us, including litigation to recover damages and costs associated with and resulting from the findings of the BioSteel Review. Despite this, we have great confidence in the BioSteel brand, which saw a 101% revenue increase in fiscal ‘23.

According to Nielsen, BioSteel’s share of isotonic beverage sales in the Canadian national convenience and gas channel reached 11% in the fourth quarter of fiscal ‘23, up from 3% in the year prior. We’re continuing to drive momentum in the Canadian market by doubling down on the food, drug and mass market channels, as well as club accounts with prominent BioSteel displays at Costco this summer. In the U.S., IRI data shows BioSteel’s ACV at 38% in the fourth quarter of fiscal ‘23, up from 19% in the prior year. Growth drivers include the BioSteel NHL partnership, which delivered incredible visibility for the brand during the Stanley Cup playoffs. As we look ahead to the strategy to sustain brand growth, we’ll be tightening the geographical focus in the U.S. to prioritize key regional markets and place a sharper emphasis on the specialty retail channel such as gyms to build loyalty with athletically inspired consumers.

At the same time, we also must address BioSteel’s drag on our profitability, which Judy will speak to further in her remarks. As we focus on our core cannabis business, we’ll continue to evaluate all options for BioSteel. With the groundswell of momentum behind the brand in North America, we anticipate strong top line growth leading to profitability in the years ahead. Next, I’d like to spend a few minutes discussing the performance of our Canadian cannabis business in fiscal ‘23. Overall, our adult-use cannabis B2B revenue in the fourth quarter of fiscal ‘23 ended slightly higher sequentially compared to the third quarter of fiscal ‘23. We view this as a positive given the challenging dynamics in the Canadian market and the scale of internal change that our team managed during the quarter.

One of the most important achievements driving this performance was the strong resurgence of the iconic Tweed brand in the flower and pre-roll categories, which continue to dominate the Canadian adult-use market. The primary driver of this comeback has been a marked improvement in flower quality, fueling strong consumer demand, propelling Tweed’s rise to the number 9 brand spot in the Canadian adult-use market in the fourth quarter of fiscal ‘23, up from number 16 in the year prior. As we look to the year ahead, we’re excited to have taken another significant step forward to unify our North American house of brands. In late May, we announced that Canopy now controls all distribution, marketing and sales of Wana branded products in Canada.

Our sales team is eager to represent Wana, which has held the top spot for edibles in Canada for the past three years. We’ve planned an ambitious brand growth strategy in Canada and are working with the Wana team to deliver industry-leading innovation like the passionfruit pineapple CBG gummies. With the addition of Wana, we expect incremental gains to our adjusted EBITDA as we cement Canopy as Canada’s leading edibles company. Now, I’d like to speak briefly to our progress on our entry into the U.S. cannabis market through Canopy USA, which I firmly believe is the best approach to gain exposure to the rapidly growing U.S. market. To advance this strategy, we filed a revised proxy statement with the SEC in the current quarter, which outlines revisions to the structure of our interest in Canopy USA in order to ensure continued compliance with NASDAQ’s listing rules.

Following regulatory review, we plan to subsequently file a definitive proxy statement that will pave the way for a special meeting, during which shareholders will be asked to approve the creation of a new class of nonvoting exchangeable shares. Upon receiving the required shareholder approval and the conversion of Constellation shares from common to exchangeable, Canopy USA is expected to exercise its rights to acquire Acreage, Wana and Jetty. Our primary objective for Canopy USA is to optimize the value of our entire U.S. ecosystem by leveraging their brand portfolios, routes to market and operations. Overall, we continue to believe the Canopy USA platform positions us favorably for the continued evolution of the U.S. market. Finally, I’d like to outline our business priorities for fiscal ‘24.

Our priorities are designed to deliver sustained revenue and adjusted EBITDA growth for all key business units. For our Canadian cannabis business, that means prudently managing expenses to deliver a stable to growing top line. We see this being driven by continued gains across the Tweed brand, including flower and pre-rolled joints. We’ll apply the same enhanced cultivation processes that have improved our flower quality across the Tweed brand to strengthen the competitive positioning of Doja and 7ACRES. On the medical side of our Canadian cannabis business, we expect that Canopy will continue our momentum by focusing on driving insured patient registrations. For our international medical cannabis business, we’re focused on the continued growth of our Australian and European sales by improving the consistency of supply of high THC flower strains and the sales of new products, including the increased distribution of our medically certified Storz & Bickel vaporizers.

And speaking of Storz & Bickel, we anticipate growth in the North American market with dedicated sales resources in place in the U.S. along with new product innovation coming to market in fiscal ‘24. And for BioSteel, FY24 is expected to mark a year of growth as the brand focuses on expanding its North American market position. These priorities, in addition to monitoring continued value creation through Canopy USA will lay the foundation necessary for Canopy to achieve positive adjusted EBITDA and position us for long-term North American brand-driven leadership. That is our primary objective. With that, I’ll now turn it over to Judy.

Judy Hong: Thank you very much, David, and good evening, everyone. I’ll start by discussing our balance sheet. I’ll then briefly recap our fourth quarter and full year 2023 results, including additional details around restatements related to BioSteel. I’ll then review our fiscal 2024 priorities and outlook. Let’s start with the balance sheet. As of March 31, 2023, we had $783 million in cash and short-term investments, and total debt of $1.3 billion, of which $557 million was classified as current portion of the long-term debt. Subsequent to March 31, 2023, we’ve taken a number of additional actions to strengthen our balance sheet. In April 2023, we paid down USD 93.75 million of our term loan at a 7% discount as part of the second paydown related to the October 2022 agreement.

Also in April, we refinanced $100 million of the 4.25% unsecured July 2023 notes held by a subsidiary of Constellation, which we intend to negotiate converting into shares. In addition, the USD 100 million related to the February 2023 convertible debentures has now mostly been settled through equity. Adjusting for the payments made in April, the Constellation notes and the February 2023 convertible debentures, our cash and short-term investments would be $666 million and current portion of the long-term debt would be $237 million, due in July ‘23 plus accrued interest. With that in mind, I’d like to address the growing concern disclosure in our 10-K. We ended fiscal ‘23 with $783 million in cash and short-term investments, and we believe that we have a number of options that are executable over the next several months that will ensure we have sufficient capital to fund our ongoing operations and meet our financial covenants.

For one, we’ve already taken meaningful actions to reduce the operating cash burn in the businesses. These include the business transformation program announced during FY23, which is expected to reduce total operating expenses by $240 million to $310 million by the end of fiscal 2024 inclusive of the $125 million realized during fiscal 2023. Cost reduction initiatives underway at BioSteel that are expected to further reduce our overall cash burn. Additionally, we’re also working on other options to improve our liquidity. These include facility dispositions, several of which have already closed and additional agreements have been signed that are expected to generate up to $150 million in proceeds fees by the end of September 2023. So far during Q1 of fiscal ‘24, we received proceeds of $56 million.

We’re also exploring additional options to monetize our noncore assets and businesses, and we’re also in discussions with our lenders on various options to reduce our debt in an accretive manner. I’ll now review our fourth quarter and full year fiscal ‘23 financial results. In Q4, we generated consolidated net revenue of $87.5 million and full year fiscal 2023 revenue of $403 million. Full year revenue declined 21% over the restated prior year period. When adjusting for the impact of divestitures of C3 and the Canadian retail business, revenues declined 11% and the declines moderated in the second half of the year. Reported gross margins during Q4 were negatively impacted by restructuring charges and sizable inventory write-offs, most of which relate to our strategic shifts in Canada and BioSteel.

Adjusted gross margins of negative 18% were impacted by additional inventory write-offs at BioSteel. Adjusted gross margin, excluding BioSteel, was 11% in Q4. Adjusted EBITDA loss of $96 million during Q4 FY 2023 included approximately $12 million of inventory write-offs at BioSteel and $1.5 million of bad — debt expense in Rest of the World cannabis. Excluding increased investments at BioSteel, adjusted EBITDA improved relative to Q3 FY23, demonstrating progress against our business transformation plan. On a full year basis, our adjusted EBITDA loss was $350 million, driven by negative gross margins in Canada and BioSteel as well as significant investments at BioSteel. Included in the full year adjusted EBITDA losses are approximately $50 million of costs that are onetime in nature or not expected to recur given the significant changes that we have made to our businesses in fiscal 2023.

SG&A expenses, excluding acquisition costs and depreciation and amortization expenses saw a decline of 3% on a full year basis inclusive of the significant increase in this year’s marketing investments at BioSteel. Excluding BioSteel and adjusting for the Canadian wage program benefit received last year as well as the impact of dispositions, SG&A expenses would have declined by 21% or approximately $94 million year-over-year. Free cash flow of a negative $143 million was a 13% increase in outflow compared to Q4 of fiscal 2022, driven by increased investment in BioSteel and costs related to the formation of Canopy USA. Now let’s take a look at the results from each area of our business for Q4. Canada cannabis revenues declined 8%, excluding the retail business we divested during Q3 of fiscal ‘23.

Importantly, our adult-use B2B sales increased slightly compared to Q3 and medical sales increased 8% compared to a year ago period and was stable relative to Q3. Canada cannabis’ adjusted gross margins was negative 1% but adjusted cash gross margins improved to 33% when normalizing for the impact of depreciation and inventory write-downs. Canada cannabis’ gross margins have now improved for four consecutive quarters, and we expect additional improvements in fiscal ‘24 as we execute on our cost reduction program. Rest of the World cannabis segment, excluding C3 divestiture, was down 19% year-over-year. We saw another record quarter of revenue in Australia, which was offset by the impact of shipments to Israel in Q4 FY 2022 and a decline in our U.S. CBD business on a year-over-year basis.

Within our consumer products businesses, Storz & Bickel revenues declined by 28% in Q4 fiscal ‘23 versus Q4 fiscal ‘22, with last year’s Q4 benefiting from sales of new products. We did see sales improve during the second half of the fiscal 2023 versus the first half and full year gross margins in this business remained resilient at 40%. This Works’ revenue decreased 10% in the current period compared to the prior year due to continued challenging UK retail dynamics. We are seeing signs of stabilization in this business and adjusted gross margins improved to 44% from 40% in the prior year period. I’d like to now spend a few minutes discussing BioSteel’s performance. After a thorough review that David alluded to, we have restated the historical financials with the overall correction of the revenue misstatement, resulting in a decrease of approximately $10 million in net revenue for fiscal year ended March 2022 or 2% of consolidated net revenue and $14 million in net revenue for 9 months ended December 2022 or 4% of consolidated net revenue.

A majority of the restatements relate to international sales, which we have exited already. Our consolidated adjusted EBITDA has also been restated by a similar amount for fiscal 2022 and 9 months through fiscal 2023. The restated financials for fiscal ‘22 as well as quarterly financials for Q1 and Q3 of fiscal ‘23 are included in our 10-K. During Q4 of fiscal 2023, BioSteel generated net revenue of $19.3 million and full year fiscal 2023 revenue of $69.6 million. Q4 gross margins were significantly impacted by lower than forecasted sales during fiscal ‘23 as well as our decision to exit international businesses and refine our U.S. commercial strategy. We also faced increases in sales and marketing costs related to endorsements, sampling and trade marketing programs.

With BioSteel being a significant drag to our overall profitability, addressing its cost structure is an important part of Canopy’s overall profitability plan. We’ve already undertaken additional cost reduction initiatives at BioSteel that is incremental to our company-wide restructuring actions initiated in fiscal 2023. First, we have a number of gross margin improvement initiatives that are well underway, including exiting unprofitable customer programs and reducing the depth and frequency of certain promotions, transitioning to a new warehouse model that will eliminate significant fixed cost obligations and reduce shipping costs, reduction in inventory to lower our storage costs, and new contracts with more favorable product costs across our powder and ready-to-drink products.

These initiatives are expected to generate significant year-over-year improvement in gross margins in fiscal 2024 and put the business on a firm path to achieve gross margins comparable to other premium beverage businesses over time. Second, following stepped-up investments in sales and marketing during fiscal 2023, work is well underway to significantly rightsize our marketing spend. We have already exited or have not renewed a number of third-party marketing contracts. We’re reviewing our endorsement to ensure we have a focused approach. And we’re reducing costly sampling programs that don’t generate returns. And we’re exploring additional options available to us to ensure that we can further minimize cash burn at BioSteel. I’d like to now discuss our fiscal 2024 priorities and outlook, and our actions to achieve profitability across the businesses.

In Canada cannabis, we believe we have rightsized our operations to achieve positive adjusted EBITDA at current run rate revenue of $35 million to $40 million per quarter. Our cost reduction program is well underway with majority of the savings expected to be driven by reduced headcount, which we’ve already implemented and elimination of facility costs that we’ve closed. In Rest of the World cannabis, we expect continued growth in Australia and Poland as well as improved performance in Germany, driven by new supply of high THC flower. We also expect improvement in profitability as we further streamline the business by shifting to a distributor model in the UK, and we do not anticipate bad debt expense of over $3 million to recur during fiscal 2024.

Storz & Bickel is focused on returning to growth in fiscal 2024, driven by new product launch later this year and renewed focus in the U.S. with additional resources expected to drive enhanced presence in that important market. We expect Storz & Bickel to maintain healthy margins in fiscal 2024. For BioSteel, the focus in fiscal ‘24 is further building on its strong momentum in Canada, refining its U.S. strategy and improving gross margins while rightsizing its marketing spend. This Works is expected to stabilize top line while improving profitability in fiscal ‘24. So taken together, we expect to approach positive adjusted EBITDA across all of our businesses, except for BioSteel as we exit fiscal 2024. We also expect BioSteel to show meaningful reduction in its adjusted EBITDA losses in fiscal 2024 as we execute on our growth plan and cost reduction initiatives.

Liquidity preservation and strengthening our financial position is also a key priority in fiscal ‘24. To this end, we’re focused on executing against announced cost savings program, mitigating operating cash burn at BioSteel, maximizing proceeds from asset divestitures and reducing our debt and interest expenses in an accretive manner. We believe the combination of these actions, along with our existing cash balance and expected proceeds from facility divestitures should provide us with flexibility to drive our businesses forward, while meeting all of our debt obligations. In conclusion, with significant transformation underway, we believe we now have elements in place to achieve profitability in Canada and significantly reduce our cash burn for the total company while we work towards strengthening our balance sheet and driving continued focus on our core cannabis business.

This concludes my prepared comments. We will now take questions. Operator, David and I are now happy to take questions from the analysts.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question will come from Tamy Chen at BMO Capital Markets. Please go ahead.

Tamy Chen: I wanted to go to your target for EBITDA by the end of fiscal ‘24. You don’t break out the EBITDA by segment. So, it’s a bit hard to assess your path to achieve the targets you’ve set out here today. So, I’m just wondering, is there anything more you can share with us about how the cannabis segment, at least maybe the Canadian business P&L starts to look, now that you complete your asset-light transition? For example, like I’m not sure what the margin can look like, now that you’ve outsourced a lot of your manufacturing — extract products and closing the challenging growth facilities you have as well, it’s hard to kind of assess what your SG&A is — how much of that is the Canadian business and all the asset-heavy infrastructure that was there before. So, anything additional you can share about how the P&L of that business starts to look going forward would be helpful. Thank you.

Judy Hong: Sure. Thanks, Tamy. I’ll start with just a comment that I agree, just when you look at our P&L, it’s very difficult to clearly understand what’s happening with all the moving parts and us not being able to really provide clear details around the segment profitability. We are working at ways to address that going forward and we’ll hopefully be able to give you more clarity on that on a go-forward basis at some point in the future. But to come back to your question about Canada, I think — I would say a few things. Number one, what we have done from a business change standpoint is really rightsize all of our operations and SG&A cost structure to be able to be profitable at $35 million to $40 million per quarter revenue run rate.

I think you’ve seen us now do that for a couple of quarters. And we think with the revenue of that level, we are now rightsized to really deliver the adjusted EBITDA that would be breakeven to positive on that basis. And I think there are really a few elements to that. Number one, obviously, we have taken significant cost out of our cost of goods sold. We had headcount reductions that we have implemented already. We’ve closed the facilities, both — in a number of locations that save us not just the costs like insurance and taxes and just the non-people costs that really are costly when you have significant footprint just from an operational standpoint. So a number of those closures that we’ve already made are going to start to flow through, through our P&L.

We are, I think, tracking actually a little bit earlier than expected in terms of exiting cultivation in Smiths Falls. So once that happens, by the end of this quarter, we should also see additional cost savings flow through from a cannabis standpoint. So, I think that’s going to drive really a cash gross margin in our view, closer to that high-30% that we’ve always talked about in the past. And then, from an SG&A standpoint, we’ve made a number of changes on the sales and marketing side, and working — and even on the G&A side to ensure that we are, again, profitable with the revenue at $35 million to $40 million on a quarterly basis.

Operator: Your next question comes from Vivien Azer at TD Cowen. Please go ahead.