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Canopy Growth Corporation (CGC)

Q2 2024 Earnings Call· Thu, Nov 9, 2023

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Transcript

Operator

Operator

Good afternoon. My name is Jovel and I will be your conference operator today. I would like to welcome you to Canopy Growth's Second Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. I will now turn the call over to Tyler Burns, Director, Investor Relations. Tyler, you may begin the conference.

Tyler Burns

Management

Thank you. Good afternoon and thank you for joining us today. On our call today, 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 second quarter ended September 30, 2023. The news release and financial statements have been filed on EDGAR and SEDAR, and will be available on our website under the Investors tab. Before we begin, I would like to remind you that our discussion 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, 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 only. With that, I will turn the call over to David. David, please go ahead.

David Klein

Management

Good afternoon, and thank you for joining us today to discuss Canopy Growth's second quarter fiscal '24. I'm pleased to speak to the positive results we have reported today, that have been achieved through the successful structural transformation of our business, as well as the actions we have taken to strengthen Canopy's balance sheet. As should be evident, the Canopy of today looks fundamentally different than it did a year ago, and we are proud of the results that this transformation is already delivering. During the call today, I will cover three topics: First, the completed transformation of Canopy to a simplified cannabis-focused, asset-light business now anchored by strong fundamentals; second, at building on this foundation, we are now focused on driving the growth of our core businesses supported by high-quality products that are already resonating with consumers; and finally, I will provide a brief update on our Canopy USA strategy and the continued advancement of this high potential ecosystem. Following my remarks, Judy will provide a review of our second quarter fiscal '24 results, including the actions taken to strengthen our financial position and improve liquidity. Let's begin with the transformation of our business. Through bold and decisive actions, we have delivered on our commitment to transform Canopy Growth into a streamlined, cannabis-focused, asset-light business. To recap the core components of this transformation delivered include: divesting our Canadian retail operations, consolidating our cultivation platform from 12 sites to 2, centered at our purpose-built Kincardine and Kelowna facilities, and successfully moving to an adaptive third-party sourcing model for all cannabis beverages, edibles, vapes and extracts, as well as ceasing the funding of BioSteel, which significantly reduced our cash burn and further simplified our overall business. These actions have resulted in a Canopy that looks and operates fundamentally different than before,…

Judy Hong

Management

Thank you very much, David, and good afternoon, everyone. I'll start by reviewing our second quarter fiscal 2024 results, including the significant progress we've made across our P&L this quarter. I'll then discuss additional actions we've taken to delever the balance sheet and improve liquidity, followed by our priorities and outlook for the balance of fiscal ‘24. Let's begin with our second quarter results. Q2 was a pivotal quarter for Canopy as a business transformation we've undertaken over the past year through substantial improvement in profitability and reduction in cash burn. Please note that our financial results in the current period and prior periods now exclude BioSteel results as BioSteel is presented on a standalone basis as a discontinued operation. We delivered consolidated net revenue of $70 million in Q2, which is down 7% compared to Q2 of last year, excluding the Canadian retail divestiture. Main drivers of year-over-year revenue decline were Storz & Bickel, which was negatively impacted by the timing of shipments and U.S. CBD sales, which have undergone a strategic shift over the past year. The Canadian cannabis sales were down slightly excluding retail divestiture compared to a year ago, but up from the prior quarter. Q2 gross margin was 34%, and adjusted gross margin was 33%, a significant improvement compared to negative 1% last year. The biggest driver of improvement was the business transformation initiative executed in Canada, which has meaningfully reduced Canada operational costs. Q2 gross margin also benefited from opportunistic use of certain lower priced inputs in the Canadian business, which may not recur. Q2 adjusted EBITDA was a loss of $12 million, which was an improvement of over 79% versus last year, and 48% improvement versus last quarter. Free cash flow was an outflow of $67 million, an improvement of $32 million compared…

Operator

Operator

Thank you. [Operator Instructions] Your first question comes from Aaron Grey with Alliance Global Partners.

Aaron Grey

Analyst

So now that we get a look at the Company kind of post BioSteel discontinue. Just want to talk a little bit more about the gross margin. Judy, you gave a lot of commentary within there, just want to make sure I have it down correct. So in terms of the gross margin expectations going forward, I think you talked about 35% back half cash gross margins. So I just want to make sure am I thinking about that correctly versus the 34% that you just reported? And you talked about some one-offs in there with some lower cost inputs that benefited you this quarter. So just if you could help us in terms of maybe some of the near term gross margin expectations before you get to what you expect in the back half. Because it sounds like you had some one-offs that also benefited there.

Judy Hong

Management

Sure. And I'll take that question. So, the target of mid-30%, to be clear, is a cash gross margin in the Canadian business. So, when you actually look at our gross margin performance in Canada in Q2 the reported gross margin was 34%, but you had cash gross margin of about 47%. We did have some favorable benefits that we don't expect to recur in the back half of the year. So, really what we're saying is we're expecting, the target gross margin to be -- cash margin to be around mid 30%. Included in that is depreciation expenses, which is obviously non-cash. That's now running roughly about $4 million to $5 million a quarter. So it is about a 10 percentage-point impact to report gross margin. So, when you think about the Canadian business, I would expect the reported gross margins to be low to mid 20%, cash gross margin to be closer to kind of that mid-30%. When you look at the international or the rest of the world margins, we think that 30% is probably going to see some improvement in the back half as some of the efforts that we're undertaking across our key markets drive better sales in the back half the year. And then Storz & Bickel is the gross margin in Q2 is typically a lower gross margin quarter just because the revenue tends to be lower. So, in the back half, we would expect Storz & Bickel gross margin to be -- to show improvement versus what we have shown in Q2. So I think that should give you a good sense of where we will land from a gross margin standpoint in the back half the year.

Operator

Operator

Your next question comes from John Zamparo with CIBC.

John Zamparo

Analyst · CIBC.

Thank you. Good evening. I wanted to ask about the balance sheet, and I'm trying to get a sense of how you address the debt from here, because even with the significant reduction, it's still a material amount. So is the plan to capture the economics of the U.S. businesses hopefully at some point in the future? And if so, are those free cash flow positive in a normal taxation environment, or do you plan to raise equity to repay that debt? Thank you.

Judy Hong

Management

Yes. So, I'll take that, John. So I'd say, first of all, I want to note that we do not have any upcoming maturity until September of 2025. So as you can see, we've undertaken significant actions to eliminate any near-term obligations from a debt perspective. And we have maintained a strong cash position. We have over $270 million of cash on our balance sheet. So, we think we have an ample runway with the cash balance that we have. We also have additional proceeds that we expect to receive from sale of BioSteel, and we'll continue to look to monetize, businesses or patients that are not core to Canopy. Beyond that, we have a very constructive dialogue with our investors both on the debt side and others to ensure that we can reduce our debt in an accretive manner, which also saves our cash interest costs. So there are active, I'd say plans in place to continue to look for ways of reducing our debt over time. And we'll have more update as we have announcements to share.

Operator

Operator

[Operator Instructions] Your next question comes from Michael Lavery with Piper Sandler.

Michael Lavery

Analyst · Piper Sandler.

Could you -- you touched on TerrAscend’s performance on the call, but you -- as you also pointed out in the prepared remarks, your stake there would be like a 17%. Can you just give a sense of the longer-term vision for that? And by keeping it on investors' radar, is the expectation that you would want to consolidate that someday? And if so, how would you anticipate going about that?

David Klein

Management

Yes. Michael, so, we continue to be favorable on the U.S. market. And so, I would say TerrAscend is just one of the assets that we hold in that market. We like the work that's going on at TerrAscend, especially in markets like New Jersey and Maryland. And we continue to have our other companies interact, a lot with TerrAscend. So, for example, TerrAscend distributes Wana in Maryland, and it is working out quite well for both companies. And so, we look at TerrAscend as just one of the pieces to the puzzle for the U.S., along with Wana and Jetty and Acreage. Acreage has interesting positioning, I think, in markets like New York and Ohio and Illinois. And so, we think those are big opportunity markets, as we go forward. So, we just continue to watch the U.S. market very closely. And we remain committed and impressed actually with our U.S. businesses.

Operator

Operator

I will now turn the call over to Mr. Klein for final remarks.

David Klein

Management

Great. Thank you. As you head into the holidays, I want to encourage everyone to add the latest products from Canopy to your gift list, including things like Wana Quick edibles, Tweed flower, or Storz & Bickel vaporizers. I suspect anyone would be very excited to receive those as Christmas gifts. As a reminder, Investor Relations will be available to answer additional questions. Have a good evening, and thank you for attending today's conference call.

Operator

Operator

This concludes Canopy Growth second quarter fiscal 2024 financial results conference call. A replay of this conference call will be available until February 7, 2024 and can be accessed following the instructions provided in the Company's press release issued earlier today. Thank you for attending today's call. Goodbye.