Q1 2021 Canopy Growth Corp Earnings Call
The five in federal sales business in payroll taxes, and add nearly 1.6 million jobs by 2026.
There is no question that our industry can be a key driver of the United States economic recovery. When we gained control of the pandemic and begin to restart the economy.
Congress seems to have recognized the same potential that we see in cannabis with bills like the more act and with momentum growing across both sides of the health.
It's our vision to unleash these enjoyable and remarkably safe products for adults to consume in a responsible matter.
As we expand our presence in the US we will continue to contribute our knowledge in partnership with the appropriate regulatory bodies in order to ensure safe and effective standards are implemented.
Now, let us discuss the progress we're making at canopy in our quest to create a cannabis focus leading CPG company.
There are four key themes that Mike and I would like to focus on this morning.
First canopy is improving execution in nimbleness in Canada.
We have quickly completed a rollout of our value flower strategy, we have significantly improved our customer order fill rates are cannabis 2.0 portfolio continues to gain momentum and were adapting quickly to the changes in the marketplace and competitive dynamics.
Second we're improving our quality.
We're enhance we've enhanced the moisture content of our flower products and we've launched a number of research initiatives to further improve our flower quality.
Our commercial team continues to engage with Budd tenders and staff at retail stores to drive increased awareness of our quality initiatives.
And consumer feedback on the quality of our cannabis beverages continues to be very positive.
Third we've got a number of exciting developments happening in the U.S market.
We launched our new ecommerce site shop canopy dotcom in the U.S.
Our first in free brand has expanded into Topicals and creams and bio steel ready to drink beverages in Tetra packs are now available just to name a few.
And finally, we continue to focus on financial discipline, while also investing for future growth opportunities.
Let me tie these themes and provide details on the progress we're making to the key strategic priorities I laid out during our Q4 investor call and reinforce during our virtual investor meeting.
We said we're building a world class consumer centric innovation driven company.
So let me give you a few examples of the progress we're making here.
We've completed a nationwide repositioning of our TWB flower, including changes to price pack architecture with higher in more consistent THC ranges, we're seeing improved sales velocity in market share performance with our dollar share increasing nearly five points in value flower in the province Avantec.
Joe during the latest four weeks ended July 19th.
I know some are concerned about the growth of the value segment and potential for further price compression in the industry. So let me share my perspective on this.
First I think the value segment plays an important role in converting illicit sales until legal sales, which should be positive for the broader category.
Second we intend to use our consumer insights to create differentiated quality flower products. So that we can also trade up our value consumers to our mainstream in premium products.
And third our ability to compete in all price segments will help build scale, which will enhance our margins.
In addition to value flower, we're seeing the process of repositioning.
Select mainstream and premium flower brands in the market implementing higher and more consistent THC ranges, while actively engaging with Budd tenders to bring awareness of our product quality.
We've initiated a consumer research initiative to better understand the flower consumer, including how they define overall product satisfaction and the critical elements that drive those perceptions.
This will also serve as a foundation for our design to value initiatives.
We're implementing pricing adjustments on select vape offerings and will be refining our lineup of 510 cartridges with a more focused approach.
We're unleashing our innovation pipeline with our differentiated product portfolio as we now have four beverages in market and if achieved a number one dollar share in beverages accounting for 74% of all ready to drink cannabis beverages sold year to date in Canada.
In fact, we've shipped over 1.2 million units of our beverages since the end of March.
Compared to 4.2 million units sold across all brands throughout the entire use in all of 2019.
We're on track to expand our market leadership and beverages with shipments of houseplant, Lemon and Cuattro CBD beverages in the coming months.
In the US we now have over 25.
Yes, hemp derive CBD skus across our first and free this works in bio steel brands with more to come.
Stores in vehicle is seeing strong consumer pull in both Europe and expanded distribution in North America behind our differentiated volcano classic in hybrid vaporizers, and portable vaporizers, Mighty and crafty plus lines.
In fact volcano classic is celebrating its twentyth 20 year anniversary this year with a limited edition of gold plated volcano classics in 24 karat gold.
And our this works team launched a timely innovation stress check hand, sanitizers that was very well received in the UK market, which we are now bringing to the U.S market.
The second area of our strategic focus is to win in our focus markets of Canada us in Germany.
Here I'd like to take this opportunity to outline a number of exciting developments in the U.S market the biggest cannabis market in the world.
First we recently launched shop canopy dotcom, the new ecommerce website dedicated to our growing portfolio of us hemp derive CBD product lines.
We believe this website offers our consumers a convenient one stop destination to explore in purchase over 25 product SK use from brands, including first in free this works in bio steel.
The site will continue to feature canopies, new brands, including the highly anticipated launch of Martha Stewart branded CBD products, which will take place within the next month.
Second we're very excited about the traction bio steel is getting in the U.S market bio steels ready to drink non CBD hydration sports drinks have been launched and environmentally friendly Tetra Pak packaging and are currently available for sale online in the U.S.
In addition, we're actively engaging with major retailers as we look to expand distribution of bio steel products across the U.S.
And finally last week Bios deals signed a multiyear partnership with Patrick Mahoney, a Super Bowl a Super Bowl MVP.
Patrick joins the bio steel roster of elite athletes as a partner and we're thrilled to have such an influential sports thought leader on the bio steel team.
Turning the acreage we announced in June and amended plan of arrangement with acreage that solidifies our path forward.
We believe the updated arrangement, which must be approved by acreage shareholders provides cash for acreage to develop and grow its federally legal tempt to rise CBD business, while reducing canopies purchase obligation and conserving 65 million shares of cannot be growth stock.
Acreage will continue to target delivering profits in growth by narrowing its focus on key profitable operations.
Canopy is already license acreage with rights to certain canopy, IP, including IP related to our beverages in base as well as our brands as part of the original agreement.
Acreage has in fact launch our tweet branded flower in Illinois main Massachusetts in Oregon.
Acreage has rights to launch canopy is best in class products and brands into the U.S market, including our cannabis infused beverages, and we expect to hear more about this from acreage shortly.
In addition to acreage Terrace and provides us with additional optionality in the U.S THC market upon federal Permissibility.
Harrison also owns arise bioscience in the US a leader in the production and distribution of have derive health and wellness products with access to over 10000 retail locations nationwide.
The third strategic priority for us is quality execution, and we're making progress here as we improve our execution and increase our agility throughout the organization.
We've got a number of flower quality improvement programs underway based upon consumer insights to name just a couple we're optimizing our drying processes to raise the moisture content of our flower products.
And we're also looking at maximizing aroma and turpin profile throughout our drawing ensuring processes and working with sensory panels to ensure that our products along with consumer preferences.
The new organizational structure is largely complete with our product teams now organized by gold by global product lines of flower Bates edibles and beverages in skincare and Topicals supported by our insights in innovation teams.
The new commercial team will work closely with the product and insight teams to keep our pipeline of amazing products flowing through all of our sales and distribution channels.
Our new operating model is already driving quicker decision, making and increased agility as an organization.
We've made strides in our supply chain, ensuring that we can better fulfill our customer orders with the right products at the right time just to highlight a couple of examples for our Canadian medical business confidence in supply of spectrum yellow oil is at a level, where we've decided to reduce the cost of this medical product by 25%.
For patients in need.
And our beverage production has increased significantly more than doubling from June to July and is expected to nearly double again in August to ensure we keep our beverages fully stocked at retail.
Finally, we're improving our cost structure and financial discipline, Mike will provide more details in this area, but just to highlight a few examples our headcount is down more than 18% since the beginning of the year. Our total opex declined by 23% compared to a year ago, and we've reduced our cash burn by.
More than 50% from the prior year period.
During our virtual Investor day in June we provided you with key metrics to gauge our progress and I'm going to update you now on how we're doing against those metrics.
First our weve, winning with the consumer as measured by market share in our core markets in net sales growth year over year.
In Q1, we've maintained number to market share in Canada medical and number one market share in the German flower market.
In Canada recreational remain we remain top three in most provinces. However, we're not satisfied with our current positioning.
To that end you will see continued improvement in flower quality and performance continued optimization of our SKU offerings and product portfolio.
Improved sales and operational execution to ensure that we're continuously on shelf at retail.
And consumer promotional activity, which builds on the strength of our Tweed Tokyo smoke in house plant brand names.
Second our we improving our execution as measured by increases in our customer order fill rates and reducing out of stocks at retail.
We made progress during Q1 with our supply attainment rates, averaging 87% in Q1 versus 56% in Q4.
In recent weeks, our supply attainment rates have risen above 90%.
And our internal checks suggest we've reduced out of stock issues at retail and we're looking for further improvement in this area to help us gain shares I just outlined.
Mike will address the key financial metrics in his remarks.
We know there's more work ahead of us and we continue to expect fight 21 to be a transition year for us.
But I'm confident that our renewed focus in new operating model, along with a talented team and a strong balance sheet will power our transformation into a world class consumer centric organization and deliver on our commitment for strong topline growth while improving profitability.
And now Mike will review, our Q1 financial results.
Thank you David and good morning, everyone.
Against a volatile Mike macro backdrop, and a continued dynamic market cannot be delivered resilient financial performance in Q1, driven by diversified revenue sources and stronger cost discipline.
In Q1, our net revenue increased 22% versus prior year and total opex declined over 23% year on year and Capex continued to moderate both on a year on year basis and quarter on quarter basis.
Our free cash flow was an outflow of 181 million, which is over 50% improvement versus prior year and we also maintained a strong balance sheet with 2 billion in cash and short term investments at year end.
Now, let me review Q1 performance in more details starting with net revenue.
We generated a 110 million of revenue or 22% growth versus prior year, our global medical revenue increased 54% over the prior year period, and we're continuing to see strong growth in both our international flower business with year on year growth of 181% and.
Three with year on year growth of 75% in part to the due to the recognition of a full quarter of revenue in Q1 of this year versus a partial quarter last year due to acquisition timing.
Adjusting for the timing of acquisition, our international medical sales grew 43% on organic basis versus year ago.
Our Canadian medical business grew 19% year over year as we lapped last year supply challenges, but enjoyed higher average basket sizes in Q1 of this year in part due to pantry loading as a result of cobot 19, but we are pleased with our continuing ability to attract and retain veteran patients and.
Over the past year, the number of veterans that have registered with spectrum has increased by 77%.
Revenues generated by our strategic businesses increased by 70% driven primarily by stores and vehicle, which grew 76% year over year and the increase was driven by strong consumer pull as well as expanded distribution in the U.S.
This works and bio steel performed inline with expectations and the restricted cobot 19 environment for bio steel and increase in sales from our E. Commerce channel was offset by a significant decline in traditional retail sales caused by the closure of many brick and mortar retailers in Canada due to covert 19.
But we expect improved performance from bias deal driven by the easing of Cobot 19 retail restrictions in Canada as well as expanded distribution in the us in coming months.
Our Canadian rack never net revenue decreased 11% year on year due in part to the restricted cannabis retail operating environment in response to the cobot 19 pandemic as well as increased competition.
Our b to B net revenue decreased 10% over the comparison period last year with sales of new wreck 2.0 products being more than offset by declines in flower and pre roles driven by increased competition and decrease market share. However, our rack b to b business saw six.
Winchell improvement through the quarter driven by four factors.
First adjustments to our cultivation planning and supply chain drove short term improvements and our ability to fulfill customer peos with supply attainment, increasing from 56% and Q4, 287% in Q1 and in recent weeks our supply attainment performance has exceeded.
90%.
Second the continued rollout of our 2.0 product portfolio drove 13% of our B to B net revenue in Q1 up from 2% in Q4.
Third and as David highlighted earlier, our nimbleness to react quickly to the growing value segment drove improved performance for our value brand Tw D. Starting in June with further improvement throughout the current quarter.
And lastly, we believe the continued pace of retail store licensing and openings in key provincial markets, especially Ontario contributed to increased sell end during the quarter.
And total active store count nationwide grew by 130 stores in Q1 versus Q4, with Ontario, seeing 61 additional stores to now over 100 stores operating.
Looking ahead, we expect the pace of store openings in Ontario over the next number of months to continue to have a positive impact on the sectors sell in and to that province, and the province is delivering on its commitment to license 20 stores per month, meaning we can expect an additional 100 stores to be licensed by the end of this calendar.
Our year.
Moving on.
We are no longer providing our kilograms sold an average selling prices as our business shifts to a more diversified product line from flower. So let me offer you some color on price and mix impacts during Q1.
Our flower BTB business saw sales decline, 20% in Q1 compared to Q4, driven by volume decline of 5% and an average selling price decline of 15% the decline in the SP is mainly driven by geographic mix.
As product sales in Alberta were lower and product sales in Ontario were higher.
As well as a migration toward higher size packaged offerings.
In Q1, TWB accounted for 40% of our flower sales up from 26% in Q4, and we expect continued declines in ASP in the current quarter as we've completed our value flower price pack architecture and now are in the process of resetting prices in certain mainstream flower products.
In addition, with the expectation of a large number of stores opening in Ontario over the coming quarters. We would expect this to be reflected in geographic mix shift toward Ontario that will put further downward pressure on asps.
We plan to provide volume price mix changes by key format, beginning with our Q2 financial results.
Our BDC sales decreased by 12% over the prior quarter, primarily as a result of the continuation of store closures in response to Cobot 19 pandemic through mid May is worth noting that sense R 22, corporate stores reopened and the latter half of Q1 Bdcs sales have returned to pre.
Coated levels.
With this let's now move on to a full analysis of gross margin for the quarter.
Gross margins at 7% was below target. The biggest driver was an estimated 18 million dollar impact related to under absorption of fixed costs, resulting from lower production output stemming from reduced demand and our SKU rationalization activities.
Our Canadian cost structure relies heavily on throughput as we have built a large scale infrastructure and to put this in context. We believe the current infrastructure in Canada can support growth for us to become a $2.5 billion to $3 billion business without much additional capital spending we've.
Already proven that we can deliver 40% plus gross margins and are confident that we will return to that level as we work toward higher capacity utilization across our facilities.
Taking beverages as an example, with a robust demand were seeing for our beverages, we are ramping up production and the throughput of our beverage facility has doubled in July from June and we plan to double again in August and based on the continuing strong consumer pull we are seeing our beverage facility could reach.
Capacity much sooner than expected.
In addition, overall cannabis legal sales are continuing to grow as more retail stores open up and new value offerings are helping to convert the illicit market and as we capture our fair share of this industry growth. We expect further improvement in utilization of our facilities.
In the meantime, we have a number of initiatives underway both in the short term and the medium term that we believe will further bolster our margin performance and the short term, we're looking at ways to reduce our variable costs, including labor in the medium term. We're focused on further optimizing production through a full end to end strategy.
EBIT looks at people and process technology and infrastructure that we believe will lead to best in class margins over time, and we plan to share details of this project at our next earnings call.
Q1 margins were also negatively impacted by an estimated $11 million charge related to manufacturing variances, which included out of spec production that did not meet new targeted THC ranges.
In the quarter, we also recognized an inventory provision of $5 million based on revised forecast.
Relative to our inventory holding policies.
Now, let me briefly cover our operating expenses.
Overall, SGN a decreased by 7% over the comparison period last year.
Sales and marketing expenses decreased 25% year on year, and 44% quarter on quarter, driven by a couple of factors.
First marketing and promo expense declined by over $10 million versus the prior year due to delayed or canceled activities. As a result of cobot 19, as well as elevated spending from last year to capture retail space.
Second compensation expenses increased year over year due to higher us investment, but Canada compensation expenses decreased due to head count reductions and relative to Q4 compensation expenses declined by $4 million following our corporate restructuring actions.
And the temporary furlough of corporate retail staff due to the closure of our corporate stores.
GNS costs increased by 2% year over year, but decreased 18% quarter over quarter due in part to a decline in professional fees lower facility expenses and lower travel costs.
R&D expenses increased 61% year over year, mainly driven by research studies that did not begin until Q2 of last year and increased activities to support cannabis 2.0 product development.
R&D expenses decreased by 34% quarter on quarter as we are now reallocating our R&D efforts to focus on projects that have high commercial return potential with less emphasis on pharmaceutical driven clinical trials.
Stock based compensation expense in Q1 decreased 63% versus prior year up to 228.6 million in part due to the forfeiture of options, resulting from staff reductions that occurred during the quarter.
Stock based compensation is expected to increased to approximately 45 million in Q2 as forfeitures are not expected to occur at the same level.
Next I would like to discuss free cash flow.
Our free cash flow in the first quarter of fiscal 21 was an outflow of 181 million, which is over 50% improvement compared to the prior year.
Our working capital declined year over year due to lower inventory levels and importantly, we ended the quarter with inventory of 389 million slightly down from the prior quarter and while we have more work to do we believe this demonstrates our effort over the past few quarters to better align our supply and demand.
Capex declined to 62 million down both on a year on year basis, and a quarter on quarter basis.
As you can see in our quarterly results, we are making progress against our key financial metrics that we presented at our June Investor meeting.
On profitability, we delivered a reduction in SGN a load is a percentage of sales.
While we are working to get back to our 40% gross margin target and on cash flow, we achieved a decline in both working capital and capital expenditures.
Before I close I would like to offer a Q a few key factors to consider on Q2.
First from a net revenue standpoint, we expect gradual improvement and our Canadian wrecked business as store openings in Ontario should provide continued tailwind.
Our strategic businesses should continue to see solid growth from a new product launch and expanded distribution, while we expect stores and vehicle to see more normalized growth in the second quarter.
Secondly, we expect our gross margins to continue to be pressured by under absorption of fixed costs in the near term and believe Q2 market margins are likely to come in below 20%.
Third while we expect a sequential pickup in marketing expenditures and trade promotion activities as cobot related restrictions are lifted we expect to see additional benefit from reduced head count as we complete our organizational review in coming months.
So to summarize.
We are progressing against our strategic priorities, we remain focused on strengthening our commercial and operational execution, while maintaining our financial discipline.
This now concludes my review of canopy gross financials for the first quarter of fiscal 2001.
Operator, David and I would be happy to take questions from analysts.
Thank you.
He would like to ask a question. Please press Star then the number one on your telephone keypad.
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Please request that you limit yourself to one question.
Your first question comes from the an answer from Cowen. Please go ahead.
Hi, Thank you good morning.
Okay on your outlook for optimal pricing David you noted.
Hi, realignment honorable remembering layered on top of that obviously the value so.
Welcome to evolution of pricing.
All of negative mix drivers just from a pullback kind of order of model, where you will see most question on the topline.
Please.
Thanks.
Yes from a topline standpoint, Viv I think that we'll continue to see the value flower category grow.
And.
Again, I think that is good news to the extent that we're taking share away from the elicit market I think what we have to do at canopy is a better job of articulating some of the differentiating characteristics of our products that fit above value right. So I think.
You can see we will see value continue to grow.
But again I believe that's just a healthy evolution in the market.
I also just want to comment on that as well as like the as as we continue to work through challenges as it relates to gross margins. Our objective is to deliver that.
Well above 40% gross margin, even with a growing value segment, which means we just have to evolve our production assets. So that we can deliver profitably where the consumer wants to spend and Thats, where Mike talked about the strategic review we were we were doing.
Along are within our production footprint, that's really what we're trying to get as the right that right mix adjusted production footprint. So that we can deliver topline growth by taking share from the illicit market.
While at the same time deliver the margin the margins that we said that we would get too.
Thanks, maybe you could just comment on the base.
Hi, gentlemen, you listened.
Yes, I think I think we still have.
At the market so young its it feels different to me then more established markets, where you see a trend to begin and then people have to follow I just think that when we start looking at price per consumer experience, we're probably not where we need to be from of eight standpoint and.
We don't think that puts a lot of pressure on our topline because we're just not all that large and vape and we believe we have the margins to be a little bit more aggressive which is why we're going to be a bit more aggressive and five tense.
That's helpful. Thanks.
Your next question comes from Tami Chen from BMO capital markets. Please go ahead.
Thanks, Good morning, Thanks for the question.
I wanted to touch on the the new high TC hurdles that you said on your product quality for flowers still when I think about your current grow assets. Many are quite large and summer labor intensive than I think the focus for the company previously had Dan.
Candidates as an ingredient so 2.0. So my question is.
How can these facilities I guess like the new high case, the hurdles that you said, we're flower consistently at scale and do it at better margins than you're doing now, particularly if pricing pressure continues to intensify.
Yes, semi so I think Mike correct me, if I'm wrong here, but I think like 88% of.
Of our output in the quarter was high THC flower. So the facilities are clearly.
Capable of producing at that level. We're also doing a lot of work around.
Optimizing that footprint will look for some products.
Four to rely maybe a bit on outdoor grow as we go forward. So.
I think it's less about what we're capable of producing and maybe even less about.
The margins in each facility, but as Mike mentioned in his comments its throughput and so for US we have to get the throughput up in our facilities through growing the top line.
And or completing that strategic review of our facilities. So that we we have that right set of assets going forward, but it's not really a function of being able to produce high THC flower now, it's really dialing in the Cogs and it probably warrants a bit of a discussion about cogs that I'll tag team a little bit with Mike.
We.
When I when I was brought in I was passed by the board to too.
Ensure that cannot be is a multiyear growth story with the path to profitability right. So for me job one was to make sure that we had the appropriate output coming out of our production assets.
And and not have so many empty shelves or skews stocking out at retail in Canada, and I think the team has responded well in Q1 I asked them to increase quality. So that we can improve consumer pull over time.
And that includes the THC component and the team has responded well, but it takes a while for that to pull through a retail so you're not even necessarily seeing the results of the work that we've done on shelf at retail yet and then I asked them to give us a strategy to get us to best in class margins that works is still underway and.
As Mike mentioned, we hope to have some.
Things to talk about on on our next earnings call and so.
And then lastly, I also asked them to not build inventory so that.
We could have more attractive gross margins, if we put more throughput through our plants, but we would just be building inventory. So I think that we've executed on the near term components of the plan I think from here is where is we have some work to do and Mike I'd like you to maybe walk through a built in your mind.
And from where we where we ended in the quarter from a GP standpoint up to have to our margin target, yes, I think really looking at the 7% gross margin report in the quarter I think it's easy to bifurcate out between volume impacts on lower production volume versus extraordinary activity.
Fees that come back to execution and the 7% is really a reflection of around $18 million of.
Fixed cost absorption tied to lower volume than originally planned for the year and when you adjust for that and look purely at what should have happened for the quarter just based on those impacts.
That brought us to around 17, or 18% margin for the quarter and we think thats a good proxy of what to expect over the next quarter or so.
As volume starts to ramp back up we see a clear path to getting back to the high Thirtys that we demonstrated for Canada Bakken in Q4, the other thing that dragged our margin down is really just executional item. So getting our pack dates right. So that we can ship product with enough shelf life before it goes to the province.
There was some production challenges in terms of getting the phasing of production lined up in such a way that allowed us to up to provide for adequate shelf life. So it gets back to what David talked about countless times, which is we've got to have the right quality and quality as a function of just not THC level intervenes, but it's also had a.
At the right shelf life remaining and Thats, where the complexity of our operation comes into play and this is where the SKU rationalization is really providing us with a much simpler framework to run our supply chain off of so.
My view is when you look at the supply chain in Smis falls, we clearly have a large scale facility and as this business matures as the industry matures. The fixed cost leverage that were that were expected to see here provides us not just runway to 40%, but we see.
Going north of that overtime.
Thank you very helpful.
Your next question comes from Andrew Gardiner from Stifel. Please go ahead.
Good morning, I, just wanted to ask and kind of pursuing the amendment acreage I appreciate potential reduction in dilution for can be in the downside protection here, but the disclose business plan from acreage suggests just 1% us market below your kind of 10% to 15% I guess given the interest by cannot be in pursuing other option along not much work done to date.
Could you help us understand the incremental commitment here of at least $87.5 million versus kind of letting this agreement run its course potentially having full flexibility to pursue other options. Thanks.
Look we think that.
That acreage.
By their own admission isn't where they would they want to be they have a really strong plan to.
Two two to correct those shortcomings and we feel pretty good about that plan.
I'd also say Andrew that.
That the.
Trend the original transaction last very.
Little wiggle room in terms of outs in so it wasn't as simple as.
Letting letting it play out in walking away it was really.
The challenge for us and for the acreage team was to really.
We crafted a deal that would give them the maximum the highest probability of success because the the the other scenario, where they they kind of limit the long.
Okay.
Wasn't palatable to acreage in their shareholders or canopy and our shareholders. So I.
I think it was really.
Actually a good a good approach to to keep cannot be with the with the.
The ability to get a fast start in the us.
Upon permissibility, which by the way I think is coming faster than.