Canopy Growth Corporation (WEED) Earnings Call Transcript & Summary

Okay. So rounding out our presentations for the day, we have Canopy Growth Corporation. There's been tremendous change at Canopy, and more broadly in the global cannabis market over the past year as many companies have shifted gears to improve profitability and hone in on their key product lines in market. For Canopy, this pivot has come under the direction and leadership of its new management team, CEO David Klein, and EVP and CFO Mike Lee. And they're going to do a Q&A with me, so we'll just get right into it. So David and Mike thanks so much for being with us today. And I'll start off by saying I hope we get to do it in person next year.

So David, it's been 8 months since you've taken over as CEO of Canopy, so like a lifetime ago. But could you just update us on the progress you've made on your key priorities?

Yes. So -- and first of all, thanks for having us here. It's cool to be a cannabis company at the Barclays conference after attending it for a long time as an alcohol person. So anyway, yes. So when I arrived at Canopy, it was a company that had a lot of the core building blocks in place, but it required focus in a bit of strategic direction. And my view is we wanted to create a cannabis-focused CPG company, which could then really understand its consumer and deliver products that meet consumer needs, including needs maybe the consumer didn't even know that they have. I wanted to make sure that we could create the focus for the business, and I wanted to improve our overall execution and then, clearly, deliver on the promise of a path to profitability, which was kind of job 1 as given to me by the Board. So if I kind of work my way through those items, I think we've made a lot of progress on the -- on building a consumer insights organization, basically from scratch, but we've made a ton of progress in that area. On top of that, we had an R&D organization that was maybe more focused on high-end pharma sorts of applications for cannabis. And we've now focused them back on to consumer rec and maybe OTC kinds of medical applications of cannabis products. So we feel really good about where we are on that. From a focus standpoint, we've exited some of our international operations and focused our business on the U.S., Canada and Germany because those markets really make up about 90% of what we expect the total addressable market to be over the next several years. And from an improving execution standpoint, I think we've made a lot of progress in streamlining our SG&A infrastructure which Mike can talk about and even exiting some production facilities. So feel pretty good about how all of those pieces are coming together at this point.

Okay. Great. And just as a follow-up, I mean how has COVID impacted your ability to implement your new strategic plan?

Well, you wouldn't plan to do all of this. Look, you can aspire to be the leader of a company, you wouldn't say I want to do it and then I can't actually meet any of the people on my team in person on an ongoing basis. You wouldn't plan it that way. However, I would say that because of technologies like Zoom and so forth, we've been pretty effective, I think, in being able to drive the business forward. On a positive side, really, cannabis was very early on in Canada and then subsequently in some states in the U.S., deemed essential by the local government. And so we had a short period of time where we closed our retail shops, but they then reopened and we're -- in some ways, we are able to move the needle on online servicing by the provinces and even driving things like click and collect and local delivery. So in some instances, it was a bit of a -- created a bit of a tailwind for us. We had to do a lot of work from an operations and SG&A standpoint in the company. And I would say that COVID slowed that down a lot. It's just hard to get through that kind of work when you're doing it via Zoom, but we're now maybe coming to the tail end of that sort of activity. So in retrospect, yes, it maybe it took a little longer but, otherwise, COVID has been kind of a bit of a both a positive and a negative for us.

Okay. Great. And Mike, David mentioned and identified achieving profitability is a key priority. So can you just speak to the efforts that you've collectively undertaken to the company towards that goal?

Lauren, yes, I can absolutely do that but I just want to say hello. Thanks for having me back. Yes, as much as COVID did impact the timing, I can assure you that we've been extremely busy in really resetting our strategy as a business and getting our operations and supply chain realigned to not just where we are today, but where we see ourselves going over the next 2 to 3 years. And almost immediately after David joining, we focused on our footprint. We had a surplus of capability that it was really absorbing a lot of our cash and contributing to our cash drain as an organization. So we immediately rightsized our cultivation facilities that resulted in us electing to exit a number of international markets that we felt will help to conserve our capital spending for the foreseeable future. But we did it in a strategic way because we do have an incubator footprint in a number of markets around the world that give us the optionality, that give us the presence in some of these high-potential markets that maybe are a few years out, but certainly we want to maintain a presence there so that we do have a pathway to grow and markets in the southern hemisphere, particularly. So we've done a lot of work on our footprint. From an OpEx perspective, we've reduced headcount by 18% since the beginning of the year. Some of this was driven by the reduction in our cultivation assets, but some of this was really driven by restructuring our organization to be in line with where the business is today, but also really designing our organization to be more nimble, more focused to allow us to move more quickly as an organization in terms of making decisions. And we've now completed most of our commercial parts of the organization. We still have some additional work to do on the back end. But we've moved really quickly. And as you can see in our results from Q1, our G&A was down 18% sequentially, which highlights the progress that we've made. We're also focusing our R&D resources to be more focused on the consumer and consumer innovation. And that's helped to focus our resources even further as an organization. So in a nutshell, I think we're doing a much better job of focusing our resources against the core markets that David laid out, Canada, U.S. and Germany. And I think focusing ourselves on that adult-use market and the medical market allows us to focus those resources even further. I would also highlight that our CapEx continues to moderate. Fiscal '20 was a big investment year as we were building out our Canadian infrastructure. We're also building out some advanced manufacturing capabilities in the U.S., and a lot of that's behind us. So we believe that our capital expenditures and our overall free cash flow is going to improve as a result. So I think we're making really good progress.

Okay. Priority market. So let's maybe talk about Canada. So David, kind of current state of the industry, and what do you see as the key drivers of industry growth going forward?

Yes. So like current state is I think the industry is starting to kind of hit its stride a little bit. You see more and more stores opening for a while. The store growth was constrained in Ontario. That blockage has effectively been removed. There are roughly 1,000 stores open today. And in Ontario alone, there are about 160 stores open, and I think there were about 30 at the beginning of the year. So lots of progress in getting that access to the consumer, which has helped -- 2.0 products have helped bring people into the market. And then the growth of the value segment has helped whole people from the illicit market into the legal market in Canada. And so we think that the market is kind of trending toward just slightly under $3 billion on a full year basis, medical and rec. And so feeling pretty good about the basic market. I think the drivers going forward are going to be similar, in my mind, in that we expect to see continued store growth, in particular, in Ontario. In fact, the government has indicated that they will be accelerating their licensing process, which we think will be good for the industry. And then from a canopy perspective, we expect to be able to leverage our insights and Innovation capability to continue to develop products that pull share from the illicit market and maybe even over time, more importantly, to develop those 2.0 products that bring non -- like noncurrent cannabis consumers into the market. I often said there, I think in Canada, but across North America, there are just millions of consumers that probably love cannabis, but just don't know it. And they're unlikely to enter the category through inhalables. And so that's why I think there's a path to dramatically expanding the overall market by bringing these consumers in through things like drinks and gummies and so forth.

Yes. Okay. And there has been some volatility in market share performance among the Canadian companies. So could you just update us on the actions you've taken to improve your market share position in Canadian rec?

Yes. So I think my initial observation that I had when I arrived at the business, I think, still holds, which is it's all about execution. I think 1 year ago, 1.5 years ago, it was just kind of cool that people could buy cannabis legally. And so if a product were on the shelf, it would sell through. And then companies didn't do a good job of continuing to refill the orders from the provinces or from the retail stores. And so we've done a lot of work to get that order fulfillment rate up to where it should be in a CPG company. That's helped a lot. We've improved the quality of the product that we were bringing to the shelf so that we can start to differentiate our brands on the shelf. And we're seeing some real early wins as we are more aggressively participating in the value segment. We're seeing our share of value grow. We're also, however, seeing our share of mainstream in premium categories growing. So I think those make us really bullish on our ability to grow share in Canada. And then you add on top of it, where we think we're going to go with some of the 2.0 products. In particular, you see the effect our drinks are having in the marketplace. We have -- and I don't believe this is sustainable, but because we were the first in the market with a really strong set of ready-to-drink offerings, we're sitting here today with about a 75% share of the drinks market in Canada. And we -- I don't suspect we hold that 75% share, but I do think that we'll retain a lot of consumers as that market continues to grow.

That's great. And I want to ask about the cannabis beverages. Do you have any insight into kind of consumer uptake kind of like, I don't know, is it a consumer awareness? What does penetration look like? I think there's just a lot education-wise, frankly, for people to understand that these products exist, what they're about. If you could tell us a little bit about that, it would be great. And also just capacity expansion. I just wasn't sure where you sit on that, when you will need it and if you have the -- that in the -- easy to do from where you stand today?

Yes. So I'll hold the capacity question really for Mike. But from an uptake -- consumer uptake perspective, I think when people up to this point have looked at the cannabis beverages versus the cannabis market, they assume there's a small percentage of a current cannabis users portfolio, share of mouth, whatever you want to call it, is going to go into beverages, right? And that's how a lot of folks have been thinking about it. And of course, when we rolled our products out and we put them into cannabis shops in Canada, that's who we were selling to. The interesting thing is that we are starting to see consumers who aren't typical cannabis consumers start to use the products as a result of being exposed to it by current cannabis consumers. So our early research in the space suggests that when people try our products, they say -- 75% of them say that they will buy the product again, and they will recommend it to their friends and family. And we're just seeing that kind of that slow growth from sort of word of mouth. I do think there is that education though that's required a normal consumer pull activity to try to bring people in. And we're a little limited in Canada in terms of how much we can speak about the products, but we certainly can do that in age-gated environments like movie theaters and such, which again, have been kind of restricted as a result of COVID, but we see using that as a tool to bring in nontraditional cannabis users into the space. And the last thing I'll say before I turn it over to Mike, one of the issues that we've had is even getting high-quality consumer insights data back because we've struggled up until about a few weeks ago to keep the product on the shelf. And to have that product available consistently for consumer repurchase so that we could then test what's happening, who's consuming our product and kind of get that multiuse feedback. And so we've been doing an awful lot to try to kind of keep up with the market demand. And Mike, you can touch on kind of where that's headed.

Yes. And I would just remind everybody, beverage alcohol category in Canada is a $25 billion category. If we could get a 5% share, you're talking about THC beverages being a $1 billion category to compete in, and we think that we've got market-leading quality. So it's very exciting. That being said, we have been focused on maximizing production because we are growing distribution across Canada pretty rapidly. We've tripled our beverage production just since June. We've now shipped over 1.6 million cans. And we want to make sure that service levels remain high. So we're really focused on building distribution at a point where we can ensure replenishment in a real-time fashion. And we have 20 million cans of capacity at our facility today just with 1 shift, and we now have the capability to dial up multiple shifts. And we have line of sight to 35 million to 40 million of capacity just with our existing assets. And if this category goes beyond that, we can certainly dial up capacity even further with more production assets. So we're very happy with where we are.

The fascinating thing that I would add, Lauren, is that we talk about cans, not cases. And I come from a beer company where we talked about cases. So to put Mike's statement in perspective, in Canada, the beer industry probably sells about, I don't know, somewhere between 5 billion and 5.5 billion cans, right? And so we're talking about, we've shipped 1.6 million cans since the end of March, really, but put it in perspective across the U.S., 4 million cans were sold in the entire calendar year of 2019. So we think we've got some real momentum just in Canada where we're going to start eating into those 5 billion cans, I'm convinced of it.

Yes. Okay. Mike, I wanted to just ask, large-scale infrastructure in Canada for Canopy, and that has negatively impacted gross margin performance last quarter. So can you just talk a bit to the gross margin outlook near term and the path to getting back to 40% margins?