Canopy Growth Corporation (WEED) Earnings Call Transcript & Summary

Good morning. Thank you for joining the Acreage Holdings Conference Call. [Operator Instructions] I would now like to turn the conference over to our host, Steve Goertz, Chief Financial Officer of Acreage.

Good morning, everyone, and welcome to Acreage's conference call to discuss our recently-issued press release regarding the U.S. strategic arrangement with Canopy Growth Corporation, henceforth referred to as Canopy. Joining me today is Peter Caldini, our Chief Executive Officer. Today's call will be archived on our Investor Relations website at investors.acreageholdings.com. Before we begin, I would like to remind listeners that today's call contains forward-looking statements subject to various risks, uncertainties and other factors that could cause actual results to differ materially from those forward-looking statements. Any such information and statements should be taken in conjunction with cautionary statements in our press releases and risk factor discussions in our public filings found on SEDAR and EDGAR, as well as our investor website. Any forward-looking statements reflect management's expectations as of today's date, and we assume no obligation to update them other than as may be required by applicable securities law. I will now turn the call over to Peter.

Thank you, Steve, and good morning, everyone. Thank you all for joining us today. This morning, we announced an exciting development for Acreage and a strategic opportunity to accelerate value creation for our shareholders while solidifying our position in the U.S. cannabis market. As shared earlier today, Canopy has announced the creation of a new U.S. domiciled holding company called Canopy USA. This new holding company will bring together the various components of Canopy's U.S. interest and will be comprised of Acreage, Jetty and Wana. We are incredibly enthusiastic about the proposed plan to fast track the development of the -- Canopy's U.S. cannabis ecosystem and look forward to collaborating further with Jetty and Wana following closing to increase our scale, expand our reach to pursue product innovation across the strategic platform of top-tier operators. At this point, I would like to turn the call over to Steve to discuss details of today's announcements, after which I will discuss the strategic benefits of the new arrangement agreement. We will then open the call to a brief question-and-answer session.

Thank you, Peter. The details of our strategic relationship with Canopy are outlined in the press release. But in today's call, I'm just going to provide a high-level summary. First, Canopy has announced the creation of a U.S. domiciled holding company, Canopy USA, in order to realize the benefit of operations in the United States ahead of federal permissibility. As Peter mentioned, the holding company will be comprised of Acreage, Jetty and Wana. Upon completion of the creation of the holding company, which is subject to the approval by Canopy shareholders as well as additional capital restructuring activities at Canopy, Canopy will exercise its existing option granted on May 15, 2019 and amended on September 23, 2020 to purchase all of Acreage's outstanding Class E subordinate voting shares, also known as our fixed shares, representing approximately 70% of the total shares of Acreage, in exchange for 0.3048 Canopy shares per fixed share. Second, in conjunction with this transformative announcement and in order for Acreage -- sorry, in order for Canopy to obtain 100% ownership of Acreage, Canopy has put forth a new strategic arrangement for the outstanding Class B subordinate voting shares, also known as our floating shares. Pursuant to the plan of arrangement implemented on September 23, 2020 and the arrangement agreement dated April 18, 2019, as amended, Canopy has the option but not the obligation to purchase the floating shares at fair market value with a [ floor ] price of $6.41. Given the current market price for the floating shares, Canopy will irrevocably waive its option to acquire the floating shares under the existing arrangements. As an alternative and to allow it to acquire 100% of acreage, Acreage and Canopy have entered into a new arrangement pursuant to which, following applicable shareholder, court and regulatory approvals, Canopy will acquire all of the issued and outstanding floating shares by way of a plan of arrangement for consideration of 0.45 of a common share of Canopy in exchange for each floating share. The floating share arrangement represents a premium of 17.2% to the floating shares based on the volume-weighted average price of the floating shares and Canopy shares for the 30-day trading period ending on October 24, 2022, on the Canadian Securities Exchange and NASDAQ Global Select market, respectively. Acreage engaged independent financial advisers and appointed an independent special committee of the Board to evaluate this offer. The special committee of the Board, as well as the Acreage Board of Directors, are unanimously recommending floating shareholders vote for the proposed arrangement agreement with Canopy, except for members of the Board required to abstain due to an interest in the transaction. Our belief is that this path provides the best opportunity for shareholders to maximize the value of their investment in Acreage. The special committee of the Board received a fairness opinion from each of Canaccord Genuity and [ A Capital ] to that effect as of the date of such respective opinion. And based upon and subject to the assumptions, limitations and qualifications set forth therein, the number of Canopy shares per floating share to be received by floating shareholders pursuant to the floating share arrangement is fair, from a financial point of view, to the Acreage floating shareholders. Acceptance of the floating share agreement is subject to applicable regulatory approvals and the approval of at least 2/3 of the votes cast by the holders of the floating shares as well as approval of at least a majority of the votes cast by floating shareholders, excluding the votes cast by interested parties and related parties, at a special meeting of Acreage shareholders expected to take place in January 2023. Upon successful completion of the floating share and fixed share transactions, Canopy USA will own 100% of all outstanding Acreage shares. Acreage expects the floating share arrangement to close in the second half of 2023 subject to the receipt of shareholder, court and regulatory approvals, as well as the satisfaction or waiver of all conditions under the floating share agreements and existing arrangement. Canopy and Canopy USA have entered into voting support agreements, with certain of the company's directors and current and former officers holding approximately 7.3% of the issued and outstanding floating shares, pursuant to which they have agreed, among other things, to vote their floating shares in favor of the floating share agreement. Details regarding the shareholder vote including instructions on where and how to vote, will be shared at a future date. Shareholders can find information on the floating share agreement on our Investor Relations website at www.investors.acreageholdings.com. Finally, concurrent with the execution of the floating share agreement, Canopy agreed to issue Canopy shares with a value of approximately $35 million -- $30.5 million to certain current or former unitholders of High Street Capital Partners, LLC, a subsidiary of Acreage, pursuant to an existing amended tax receivable agreement, and issued Canopy shares with a value of approximately $19.5 million to certain directors, officers or consultants of Acreage pursuant to an existing tax receivable bonus plan. Together, these payments reduce a potential liability of approximately $121 million. In the future, and at the request of Canopy, the holders of High Street Capital Partners, LLC units will convert their units into shares of Acreage as per the terms of the related agreements. Concurrent with entering into the newest strategic arrangement with Canopy, we have amended our existing $150 million credit facility. Under the terms of the amended credit facility, $25 million is available for immediate draw by Acreage, with a further $25 million available in future periods under a committed accordion option once certain predetermined milestones are achieved. In connection with entering into the amended credit facility, the lenders have waived the requirement for Acreage to comply with financial covenants, accept a minimum cash requirements until December 2023, and new covenants have been agreed upon in respect of all periods beginning on or after December 31, 2023, reflecting the company's growth plan, financial position and current market conditions. We intend to use the proceeds of the amended credit facility to fund expansion initiatives and provide additional working capital. With that, I'll turn the call back over to Peter.

Thank you, Steve. Since entering in the initial plan of arrangement with Canopy, the markets have significantly changed and faced many challenges including cost inflation, price declines, lagging developments and federal legislation, and lingering issues related to COVID-19 pandemic. But despite these challenges, Acreage has continued to perform strongly and remains well positioned in our core markets and poised for significant growth. Our strategy to accelerate growth in our core markets, drive profitability and strengthen our balance sheet has served us well. Focusing our team on maintaining a disciplined financial approach with strong operational capabilities has successfully guided us through more challenging market conditions. We are confident that the floating share agreement from Canopy represents an ideal opportunity for our shareholders to maximize the value of their investment in Acreage. This new agreement is a logical next step for Acreage as we have completed a major transformation of our business over the last few years, delivering profitability and focusing on expanding our business in highly attractive Northeastern markets in preparation for considerable industry growth. The integration of Acreage into Canopy's U.S. ecosystem will allow shareholders of both companies to participate in the strategic market opportunity with aligned interest. An exciting evolution is now taking place in the U.S. cannabis industry, and the time is now to accelerate our union with Canopy and leverage a solid foundation we have built to fully participate in an unmatched U.S. ecosystem alongside other market leaders. Acreage is a valuable addition to what Canopy is building, and we are thrilled to collaborate more directly with Jetty and Wana following closing on product innovation, market expansion, creating an even stronger position ahead of federal permissibility as part of the leading North American branded powerhouse. We analyzed the proposal from Canopy for the acquisition of our floating shares, and our Board is unanimously recommending to our floating shareholders that they vote in favor of the proposed floating share agreement with Canopy. The new agreement with Canopy to acquire both our fixed and floating shares reduces the risks of our floating shareholders, compared to Canopy only completing the acquisition of our fixed shares as it allowed under the existing arrangement agreement. This 100% acquisition of Acreage by Canopy USA will eliminate the unnecessary costs, restrictions and risks associated with the minority ownership of acreage by public shareholders while control rests with another company. Moreover, Acreage's Board of Directors and a special committee of independent directors of Acreage assessed the relative benefits and risks of various alternatives reasonably available to our holders of our floating shares given that prior to the floating share agreement, Canopy was not obligated to acquire the floating shares. As part of that evaluation process, the special committee and the Board concluded that first, to continue as a stand-alone public traded company, Acreage would need to raise capital due to the nature of Acreage's business and its cash flow requirements. And second, the ability to execute on Acreage's existing Board-approved strategic plan would be affected by the difficulty and cost of obtaining capital, given the challenges associated with the current environment for cannabis issuers and the restrictions of Acreage's ability to operate its business. Given the restrictions in the existing arrangement agreement with Canopy, we believe it is unlikely that any other party would be willing to acquire the floating shares on terms that are more favorable to the floating shareholders from a financial point of view than the proposed agreement from Canopy. Given the potential pathway following the fixed share option exercised by Canopy, the floating share agreement represents what we believe to be the best value creation opportunity for our floating shareholders while having the ability to remain invested in the high-growth cannabis industry to one of the world's largest operators. Receiving Canopy shares in exchange for floating shares will provide the floating shareholders with significant increased near-term liquidity as well as equity ownership in Canopy shares, one 1 of the world's largest cannabis operators. Canopy shares trade an average of more than $50 million a day compared to less than $100,000 for each of the fixed and floating shares. This is a highly unique opportunity for shareholders to participate at the onset of Canopy USA and allow Acreage to immediately leverage Canopy's strategic platform and participate in the revenue and cost synergies expected to be achieved by Canopy USA, and strengthens Canopy's position as a brand powerhouse ahead of a potential U.S. federal permissibility. The creation of Canopy USA will capitalize on the significant opportunity to solidify Canopy's U.S. cannabis ecosystem by uniting 3 top-tier operators who will leverage the best of each other's capabilities to further accelerate growth and profitability in the maturing U.S. industry, which is estimated to be over $50 billion market by 2026. Finally, the approval of Acreage amended credit facility, which was made concurrent with the floating share agreement, will allow Acreage to fund expansion plans with the ability to immediately draw $25 million and take advantage of the opportunities within its markets and provide us with more flexibility under the updated debt covenants. We are extremely excited for the future of the industry and the opportunity this transaction presents to our valued shareholders. With that, I will now have the operator open the line for a brief question-and-answer session. Operator, please go ahead.

[Operator Instructions]. Our first question comes from Aaron Grey with Alliance Global Partners.

So just actually one for me, just want to talk from Acreage perspective, just in terms of why. You mentioned sometimes in your prepared remarks, but in terms of the timing of the transaction, right, because you have the potential for SAFE and [ lame-duck ] session or how that played into the decision, and also your Northeast opportunities just kind of starting to come to fruition with New Jersey starting, now New York, Connecticut and so others on the horizon there. So it sounds like capital was a big part that played into this, so were some of the other options in terms of getting capital just more expensive in terms of the redefined credit agreements that you mentioned? Or were they just not available, and that kind of puts you into this decision because of the prior agreement that you had with Canopy? So just more color in terms of the timing of it and how the access to capital kind of played into it.

Yes, Aaron, thanks for the question. I think timing was really driven by 2 things. First off, although there's been some rulings on SAFE Banking and then we have a Biden tweet a few weeks ago. I think most industry observers would say federal permissibility is probably sometime away, and that would mean that we'd have to continue to operate within the current structure that we've got with Canopy, which isn't optimal for Acreage because of the restrictions that it poses and isn't optimal to Canopy, given they've made significant investments into U.S. THC assets that they're actually not able to report on, to realize or to interact with. So the timing was really if we wait until the agreement hit its normal course, i.e., hitting federal permissibility, we could be waiting and staying in limbo for quite a significant extended period of time. So we wanted to get this done so that both acreage and Canopy, as well as Wana and Jetty, can advance and become a much bigger, better organization over the long term. The second element was truly capital. We all know that capital is constrained for cannabis companies in this market. Equity markets are at low point, so that's not an attractive option right now. Cost of debt has moved up quite considerably if you can get it, and covenants are quite restrictive. So our ability to continue to fund this business under the status quo would have been limited. So this new structure, seeing us align 100% with Canopy, will afford us more opportunities to continue to fund the business as we move forward.

Yes. Just Aaron, just to add a little bit more. I mean from a regulatory standpoint, I mean, clearly, there's positive momentum. But as it relates to federal permissibility, the feeling that we're going to take still some time, and there wasn't exactly clarity around that. So it's really an opportunity to really jump start what we believe we can do with the ecosystem and really establish very strong growth, and so once that federal permissibility happens, that we're already well along our way at that point.

Our next question comes from Vivien Azer with Cowen.

Congratulations on the announcement. In your prepared remarks, you guys called out cash needs and future CapEx plans a couple of times. But earlier this morning, David did note the benefits of a broadly asset-light model for some of the other assets that will get sold into Canopy USA. So I'm just curious, as you guys are thinking about your CapEx investments that you've articulated today, what motivations have you had with Canopy about that? Are they in a position where they can influence some of those decisions or help you think through them as they ultimately try to architect an ideal portfolio in the U.S.?

Yes. So thanks for the question, Vivien. We -- our current view is to continue to build out the opportunities we see in front of us. We talk about New Jersey, we talk about New York, Connecticut. We have significant opportunities in front of us that's going to require capital investments. So in terms of influencing, we do have a lot of engagement with Canopy and there's a lot of positive discussions so there's clear visibility in terms of what we need to do, and I think they're fully aligned with that approach. There's a significant opportunity for us to get -- establish very strong market share and really build our business in the Northeast markets, and we need to kind of use the capital in order to do that. I think when you look at expanding beyond that and looking at an asset-light approach, I think that will come into play over time. But in terms of what we're trying to do over the next 18 months, it's really going to continue to exploit the opportunities we have in the markets, and Canopy is fully supportive.

If I can add -- I was going to add, if you look at the structure, both Wana and Jetty are really focused on innovation, focused on brands and launching new products. Well, that is important to Acreage. We're an integrated MSO, so we've got brick-and-mortar production facilities and cultivation facilities on the ground in the States. So it actually presents a nice overlap where we've got the production facilities, they've got the expertise and innovation and brands and products. So that when we're eventually put together, creates a cohesive unit without a lot of redundancies in facilities that you have to deal with.

Certainly. Just a follow-up, though. Understanding you guys are articulating a 18-month plan going forward today, I'm curious just to get your perspective on how that plan might or had changed over the last 12 months? Because certainly, as you look around your kind of biggest opportunities in the Northeast, New Jersey and New York, there's been quite a lot of price deflation almost kind of universally across the country in legal cannabis states. So how is your thinking around those investments involved?

I would say it's developed as markets have developed. New Jersey has proven to be a very large opportunity. We missed the mark a little bit when it went to adult use. We weren't fully prepared with our cultivation facility, so we're taking steps to address that. And we think New Jersey is going to be a fantastic market for the company. New York, we're probably a little bit more muted on now. Originally, New York was going to go live with adult use, probably nearer than it is going to now, and there's some challenges in that market with the regulations that are still evolving. So the opportunity in New York is probably a little bit more muted than we thought 6 to 9 months ago. Offsetting that's Connecticut. It looks like a very good market for us. It is today. I think it properly represents more of an opportunity when we first estimated. So as we watch the regulations evolve in Connecticut, we're probably spending a little bit more time and attention into that market. Our focus though still is truly on the Northeast. That's where we've got the footprint, that was where we have the presence, that was where we have the brands, so we'll continue to evolve our presence in those markets that have announced moves to adult use and look forward to similar announcements in other key states for us, Pennsylvania, Ohio, as we move forward.

Yes. Just -- just to add -- just to add a little bit more to that. I think one of the -- what we're seeing across the industry and it evolves is the price compression, and it becomes more and more important to really be positioned in that premium segment. And I think that's -- what we're really excited about the partnership is having 2 players that are dedicated in their segments, that are premium position that really enables us to leverage that. Which I think as the industry continues to evolve, it's all going to be about differentiation, and we want to make sure that we are in that premium segment to take advantage of it.