RE:Interview with Canopy CFO Noice. Listening to it now - here is the transcript from the link for those who prefer to read:
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"Canopy Growth Corporation (NYSE:
CGC) Barclays 2019 Global Consumer Staples Conference September 4, 2019 3:00 PM ET
Company Participants Mike Lee - CFO
Conference Call Participants Lauren Lieberman - Barclays
Lauren Lieberman So, for us staples investors, sometimes it feels like not much has changed in a year. But in the case of burgeoning global cannabis industry, a lot can change even in a day. On that note, we're excited to have Canopy Growth join us again, the second year that it's been at the conference with us. Canopy is the world's largest cannabis company with an ambitious growth agenda for expanding international reach.
At the same time, cannabis recreational market nears its one year anniversary, and the company discussed heightened focus on improving profitability in its home market. So we're lucky to have Mike Lee, Canopy's new CFO here with us today to do a little chat. Same as before, I don't expect to have any extra time. So questions will generally be in the breakout session.
So Mike, welcome. Given how new you are to Canopy, I think most people here wouldn’t have had the chance to meet you when you were at Constellation. So it'd be great I think to start out on a higher level -- kind of like get to know you type question or two.
Mike Lee Yes.
Lauren Lieberman So times have changed at Canopy, just in a few months since you've been CFO. Can you speak to your experience so far and kind of how you see your role in terms of enabling the company to deliver on its goals and objectives?
Mike Lee Yeah, sure, thanks for having me. So, yes I've been with Canopy now for a few months. And I could tell you after a few months, everything that I thought about Canopy and this category has held up to be true. I think we've got an amazing opportunity in front of us over the next several years to build a multibillion dollar category in Canada and to be able to take this business model around the world. I'd say in terms of my priorities, my focus, it's really to help the business win. And we are truly at an inflection point in our journey as a company.
Mark Zekulin talked about this on our recent earnings call, that we spent a number of years in this mode of really building the Canopy that we have today. Operating in multiple countries and amassing 5 million square feet plus of licensed capacity. And building an organization and all the capabilities that go with that. And we're now pivoting to operators and that's where I'm excited about the role that I can play going forward.
Having spent 20 years in beverage alcohol, worked for world class companies, it's been amazing, just in the last three months to see how we can put some of the best practices in place to really move the business ahead. So I'm confident that we're going to become the excellent operators that we aspire to be. But there's a lot of opportunity.
Question-and-Answer Session Q - Lauren Lieberman Okay. So you arguably bring a different skill set to the CFO seat, than we had at Canopy previously. So could you share the specific objectives that you laid out for your finance organization? And if we're sitting here in a year, kind of what would you say that it's been a successful 12 to 18 months?
Mike Lee Yes, I can certainly do that. I think about it two ways. So just starting with the macros. When I think about the next 12 to 18 months, I'm focused on making sure that rec 2.0, which is our vernacular for the legalization of a whole new portfolio of products that will be permitted later this calendar year. And then we'll be launching vape products and beverages and edibles. So it's critically important that we get that done and get that done well. We think that's going to be a big catalyst for us.
When you think about other milestones that we're marching toward, the next big one is, we've thrown out our goal of getting to call it $1 billion run rate on our business by Q4. 250 million in revenue with 40% of margin. That's what we're marching toward, as a -- call that interim milestone along the way as we start to build out this multi-billion dollar company. So, that's what I'm focused on now is helping to enable that. If I bring some of my [priorities] [ph] back to my local organization, we're focused on building muscle tissue in finance and technology, and we are rolling out an ERP across the world in all the markets that we compete in. We recently decided to take a step back on our existing ERP strategy and focus more on a tier 1 solution that's going to set us up for the future. So, we're working on that.
We're an IFRS company today, and our expectation is that we will convert to U.S. GAAP by the end of this fiscal year, which we think is going to go a long way to simplifying some of our accounting. We're not SOX compliant today and we want to be SOX compliant by the end of this fiscal year. So, we've got a number of things that we're doing just to build the muscle tissue in finance and technology to support the business going forward.
Lauren Lieberman So, next is when we get to a more pointed conversation about recent financial performance and just given the market's reaction to results in August. So, Canopy came out of the gates very fast in Canada rec and since then the business has really stagnated. Growth has been slower than a lot of the peers, past couple of quarters and gross margins have been continue to be under pressure. So, I know it's been few months then, but could you speak to maybe what execution issues there have been, that have kind of led Canopy to be in this relative position?
Mike Lee Yes. Sure. I think there is a bit of a postmortem on this, but I think it's important for the audience to understand that there is a really important decision that Canopy made about 18 months ago, when it was acquiring its large, anchor greenhouse facilities. We have about 4 million square feet across three greenhouses, two of which are in Vancouver, one of which is in Quebec. And when we acquired these facilities, there was a decision to make on whether or not we start grow immediately, which would position us for a fast start with robust inventory come October when recreational cannabis sales opened up or we could have elected to take a step back, optimize those facilities for cannabis grow; and then once the optimization is done, we knew that we would have a slower start to recreational cannabis and we elected the former as a company.
We elected to move quickly to build an inventory that would allow us to have a fast start and I think the postmortem on that is that we did have a fast start. We established roughly 30% market share on day one. We are able to meet the demand from the provinces, from the retailers early on. So, we're quite proud of the progress we've made in those early days. But starting in September of last year, as the harvest were occurring across those three facilities, we started taking each of the rooms down to put them through a retrofitting, to get them set up to produce at the throughputs that we wanted and the yield that we wanted over a long haul. And as a result, our harvests came down for the last several quarters as we work through that. That led to some stranded overhead. That led to some deleveraging of the facilities that impacted our gross margins.
So for the last three quarters, our gross margin has been reported in the 15% to 22% range as we've worked through that retrofitting. But to be 100% clear, this business demonstrated margins in the high 40s before those retrofitting efforts started and we're confident that we'll get back to that 40% range in the near future.
Lauren Lieberman Okay. I think previously you've reaffirmed getting back to 40% by Q4 of fiscal '20. I just want to confirm if that's still the case and kind of walk us through the bridge that gets us there?
Mike Lee Yes. So, I'll start with Q1. So in Q1, we reported a margin of 15%, and if you adjust Q1 performance for all of the costs related to stranded overhead and underutilization of facilities, our normalized margin during the quarter was around 32%. We also know in Q1 that our product mix was skewed to be more bud, less soft gels than what is a normal mix of products that affected our margins as well.
So if we adjust for normalized cost of the retrofit, adjust for product mix, we're clearly in the mid-30s, mid-to-high 30s on a normalized basis, and we haven't even gotten started yet with the optimization in these facilities. So, we know there's 200 to 300 basis points of productivity to come and then you layer on the benefits of rec 2.0 with vape and beverage and edibles, all of which are expected to be margin accretive to our existing portfolio, gives us confidence that we're going to get to that 40%.
Lauren Lieberman Okay. And do you think -- I wanted to talk about 2.0, but just to stick with the theme on gross margins. So you think that in fourth quarter, just given timelines, regulations and the supply chain, obviously, is going to play gummed up across Canada on rec 1.0. So do you think there'll be enough in the market so this could be actually mixed accretive in the fourth quarter?
Mike Lee Yes, look the biggest trial we have right now on the overall size of the industry is the number of stores, and we're around 460 stores in Canada today, that number is changing every minute. But our projections say that we'll be around 600 by the end of the fiscal year, our Q4 is Jan, Feb, March. So, I think it's been announced, we think there's a runway to get to that 600. We hope for more obviously, but a lot of that's going to come down to the industry's ability to properly supply the provinces with products, so that they in turn can properly supply the retail environment. So, the entire industry is making a concerted effort to improve fill rates in that regard.
When I think about headwinds to that 40% run, I would say the one piece that we're still getting a handle on is our start-up costs related to rec 2.0. We've talked about that previously. We don't expect that to be a large headwind. It could be a modest headwind. But as we're standing-up, our beverage lines, our edible lines, our vape manufacturing, there could be some start-up costs that are non-inventoriable that can serve is a bit of a headwind, but we're pretty comfortable with the 40% as it sits today.
Lauren Lieberman So, rec 2.0. So vape products are seen by many to be pretty critical segments. To my knowledge Canopy hasn't said much to-date about plans for vape. So if you can talk a little bit about what the strategy is and why do you think it's the right one?
Mike Lee Yes, this is an area where we've taken a very different strategy from our competitors. Many of our competitors have chosen to license technology from some of the existing players in the space and Canopy has elected to go at it on our own. And this is really just the fruition of I think, our mindset quite generally is to try to innovate in every category that we're competing in. But I would say that, two years ago, when our leadership really looked at the market and looked at the features and functionality, we became pretty confident that this is an area that we think we can innovate across.
So, we decided to go at it on our own. We hired some of the best researchers and engineers and scientists we could get to build a vape team, and we're looking at this as an opportunity for us to differentiate from our competitors. So, we're coming out with plus or minus 15 SKUs, multiple devices, a variety of price points. And I can't steal the thunder from announcements coming later this year, but we think that it's going to be a very competitive portfolio of products that, yes, we think will grow the category, perhaps convert some of the illicit market into the legal market. And we do see this becoming third of the category, 30% of the category over time. So it's very, very important.
Lauren Lieberman Okay, great. Now on other hand, beverages, is a market that you've been very vocal about. Can you talk a little bit about the plans for beverages? Why there's so much excitement internally and I guess where you've gotten to try to think formulation work at this point is locked and loaded. So where you've gotten to in terms of onset, offset, some of the key features they talked about?
Mike Lee Yes. So, we have been vocal about this. This is one of the areas that I think led to Constellation wanted to invest, is that, this is a very attractive, exciting category. We've been doing R&D on beverages for a couple of years. We feel confident that we've got the right taste, profile, the right outcome, that is going to I think bring non-cannabis users into this space, more so than anything that's in the market today.
Not everybody wants to smoke bud, not everybody wants to use a vape device. So for non-cannabis users, consumers that want to try our product, this is going to be a great vehicle, it's a non-threatening format. Drinks are a social lubricant as we all know, so we're very excited. We think that we have the right onset, offset times. It's very, very important that these products have a predictable outcome. I want to be able to self regulate and I want to know exactly what outcome I'm going to have based on one beverage and we believe that we've nailed that down.
We're continuing to debate price points and things like that. But we're excited about it. We've built a beautiful facility in Smiths Falls. We take possession of it from our contractors in next couple of weeks. Everything is on track. And with that facility, we've got plenty of room to grow. So in our minds, we are ready to launch in Q4. And in my mind, the sky is the limit. I think that the only real throttle on beverages in Canada will be points of distribution and making sure that we've got the refrigeration assets deployed properly, right, so that when consumers do go into a retail location that, they can get a refrigerated product. So we're working on that.
But at some day in the future and it would be nice to have these products available in on premise environment. So we're continuing to discuss that and lobby for that, but that's down the road, but we're very excited.
Lauren Lieberman Would that be rec 3.0?
Mike Lee Maybe, maybe, it could be a really exciting time. I think that's really where you start to offer the consumption opportunities that can take this from 2% or 3% of the category to something much- much bigger.
Lauren Lieberman Yes. Okay, great. So, let's shift gears to talk about the U.S. a little bit. So let's first talk about kind of what's possible, what's feasible today under your direct control which would be CBD? So, since you've got a commitment to have CBD product in the U.S. by the end of March, so your Q4. I think it will be great for me, I hope for everybody, to understand kind of your preparations to bring CBD product to market. What kind of specific category segments you're looking at applications for CBD?
Mike Lee Sure. Yes, so we are moving very fast in U.S. We announced back in January that we were going to build the industrial hemp park in New York, but I can assure you that we've done many other things over the last six months to build up our infrastructure in the U.S. We are planning to introduce a CBD based soft gels, oils, topical creams, beverages, all in this Q3, Q4 timeframe. It's probably going to be more backend loaded, but we're racing to market.
At the same time, we know that the regulatory environment in the U.S. is continuing to evolve, at both the state and the federal level. We are very pleased that the FDA has expressed its own sense of urgency in helping to provide a regulatory framework for companies like us that want to sell CBD based products, and the FDA has announced that there will be a framework, the beginnings of the framework this fall. So, we're expecting all of this to line up so that we can launch our portfolio later this year.
Lauren Lieberman Okay, great. And then in terms of THC, you've got the relationship with Acreage, so can you talk a little bit about what you are doing to -- what Canopy is doing to set itself up in terms of THC standpoint?
Mike Lee Sure. Yes, we're very excited about the Acreage deal. For folks in the room that aren't familiar, we entered into an agreement earlier this year to acquire 100% of Acreage's outstanding shares upon federal permissibility. So, this is a transaction that is core to our U.S. strategy, and upon federal permissibility, we will immediately become the largest player in the U.S. So what we are focused on today is making sure that all of our integration plans are in place and making sure that between now and federal permissibility, whenever that's going to occur, that we are making the right investments, in the right locations, to avoid any potential redundancy of investments upon federal permissibility. So we're really focused on being clear with what we're doing on each side.
And then for those who follow Acreage, Acreage discussed on their last earnings call that in 2020 next year, they will be rolling out Tweed and Tokyo smoke-branded retail locations. They will be rolling out Tweed branded adult use products in their stores. They announced that they will be introducing our spectrum medical therapy portfolio in their stores and this is all permitted as part of the arrangement with Acreage where they have full access to our intellectual property. So, this was the entire intent, is to make sure that we are operating within the boundaries of the law, but also making sure that on day one of federal permissibility, we've got a strategy ready to be executed and to make sure that in this interim time period, we're doing what we can to build our brands in the U.S. through acreage. So, it's really exciting time.
Lauren Lieberman And that dynamic has allowed because they're not paying for it because there's no finance.
Mike Lee Free license, correct, that's correct. So no cash is exchanging hands on that.
Lauren Lieberman So just back to the financials, looking at both near-term and medium-term commitments and just trying to understand the path to get there. So first for the fiscal year, on the Q1 call in August you've talked about the billing in annual run rate by the fourth quarter. So that's kind of growing from a quarterly run rate of around 90 million, and I think most recently to 250 million in Q4. So can you walk us through the drivers?
Mike Lee Yes, I can. It's really two things. And you know, it does sound like a big ramp up. But I think folks need to remember that this is a very immature industry. Coming up on our year one anniversary, the supply chain is continuing to stabilize. I would not describe it as stabilized today. The provinces are still building their capacity to distribute products. So there are learnings happening up and down from seed to sale in this entire industry, I can guarantee you that. And we're certainly part of that.
In terms of that ramp-up, you first have to have supply to ramp-up, and we feel with the retrofits largely complete that we're going to be well positioned on supply. The next two catalysts to getting to this $250 million quarterly revenue target is we need more stores. And going back to the earlier discussion, there is a chicken and egg dynamic going on in Canada, where the provinces are responsible for issuing new store licenses. And they're reticent in some cases to issue more licenses until they're assured that there's a stable supply.
And we think that that improved supply situation is going to unlock some of that gridlock that's occurred. So, we expect more stores to come and today we have 460, we think 600 is in the realm of possibility, it's already been announced. But we think Canada can handle 1,500 stores and that's not going to happen in the next 6 to 12 months, but can we have 1,500 stores in the next couple of years? Absolutely. So that's one catalyst.
The other catalyst is rec 2.0, which I keep coming back to, but it is a critical critical milestone for the entire industry to really build out that offering. Because at the end of the day, what's in Canada rec today is dry buds, soft gels and oils, a pretty limited assortment. And rec 2.0 allows us as an industry to really round out that assortment with a more CPG like set of offerings that allow for more competition and more differentiation.
Lauren Lieberman And then going out one year further to fiscal '21, so you've talked about delivering positive adjusted EBITDA on a quarterly basis in Canada, so how do we get there from here and why is that an important milestone for Canopy?
Mike Lee So folks that know Canopy, know that our aspirations are to be a global leader. In order to be a global leader in this space, you need to fuel R&D. And our prior leader Bruce was a big proponent of research and development because this is a category that is not well researched. It has not been well researched because it's been prohibited and in many ways there is this first mover opportunity to build this economic mode in this industry through patents that come from the research and development. And we're going to continue to invest in R&D for this foreseeable future.
We want to make sure we're driving the right type of R&D. And we need to have KPIs on R&D, there has to be a pathway to ROI on this, but that's a clear strategy for us. The other part of our strategy is to expand globally. So we've talked about the U.S. CBD, we've also invested in Europe, we're investing in Latin America, we're investing in Asia Pacific. And in order for us to have the runway to make those investments, we need to demonstrate to our shareholders and to future investors, potential investors, that this is a viable economic model.
And we consider Canada to be our proving ground for that model. And we believe with the expected growth coming in the form of new stores, rec 2.0, that we've got a pathway to profitability in Canada by the end of FY '21. And that's what we're focused on demonstrating.
Lauren Lieberman Okay, that's great. We're going one more, further year out, one more year out, fiscal '22. So, yearend in March '22 you said Canopy will adjust to deliver positive adjusted EBITDA on a total company basis. You've planted a lot of seeds. Tried not to make that pun. So how do you plan on getting to profitability?
Mike Lee No, I didn't bring any samples. That's [indiscernible].
Lauren Lieberman [indiscernible].
Mike Lee So again, this isn't profitability on a net income basis. This is on an EBITDA basis. But we have a big war chest and that war chest is meant to be used for acquisitions and for helping us to achieve that leadership position, but we can't lose money forever. We need to demonstrate that this business generates its own cash flow. And we believe based on the runway that I just talked about in Canada, the growth that we're expecting in the U.S., the growth that we're expecting in Europe, that the cash flow that comes off of those regions will help to fuel things like R&D, fuel whatever investments we're making in Latin America and Asia Pacific, to help us get to that positive EBITDA level, which then gives us the flexibility we need to continue to make those investments. So it's going to come with growth Lauren, it's going to come with growth and we believe we're on a runway to get there.
Lauren Lieberman I mean, you mentioned war chest, so I'm going to go to balance sheet and uses of cash, so you received an injection of 4 billion from Constellation last fall. Cash decreased from 4.5 billion to just over 3 billion in the last reported quarter. So just a couple of pieces to this, so first what are you doing with the cash?
Mike Lee And I'll talk Canadian. So everybody has to do the math in their head. But so yes, we got a $5 billion investment from Constellation almost a year ago actually. And this was meant to be an investment to help grow the company, right? So it was always meant to fuel capital spending to build the infrastructure, is always meant to help fuel R&D, it will help to fuel acquisitions. And over the last quarter in Q1, we had a number of acquisitions that we've been working on for a period of time.
And as you know, with deal flow, you can always pick the timing. So we were actually very quiet in Q4. We didn't consume a lot of cash in Q4 and then in Q1 a lot of these deals came together. So the first one was Acreage I talked about that. Acreage, the deal was for a $300 million option, CAD 400 million. So we closed on that at the end of Q1. We also acquired a company called C3, which was a division of a broader company called Bionorica, and C3 was an important acquisition for us because it is a pharma-grade cannabis-based therapy company, that produces a product called cannabinol, which allows us to really shore up and build out our medical business in cannabis and we close on that in Q1 as well.
Most of, all of C3 sales are in Europe today, but we expect to grow that internationally, and we are very excited about that. The last acquisition that we had in the quarter was This Works which is a health and beauty topical cream company that is now going to be the foundation for some of our CBD products coming to market later in the year.
So, there are a number of acquisitions. I think if you run that math, it's about $800 million of the $1.2 billion in uses of cash during the quarter. We also had a couple of hundred million dollars of capital spending in the quarter that tie back to finishing our bottling facility in Canada, finishing our advanced manufacturing building in Canada and also starting to see some of those investments in the U.S.
So, that being said, we are acutely aware of our burn rate and hence are focused on getting our businesses to profitability over the next couple of years.
Lauren Lieberman Okay. So, second part of the question, would you sort of touch on what's typically you're doing in terms of optimizing capital allocation and given the burn rate, are you confident that you have enough cash to fund future investments before you reach profitability?
Mike Lee So in terms of capital allocation, we are acutely aware that, that's our number one risk is misallocating that capital, so we are acutely aware that. And we get asked a lot, what's changed in your strategy with the leadership change with Bruce's departure, has anything changed in your strategy? And I would say, not a lot, but if there's anything that we're doing, anything that I am asking for from the organization is, let's preserve capital where we can.
So, for example, when we do clinical research, we don't always have to fund it on our own. We can partner with others. When we invest in places like Latin America, if there are options to partner with a local firm, we should consider that. When we think about building capacity, we should always lean toward taking a phased approach on capacity, build what we need, not what we want. And in doing that, we've given the business all of the assurance that if we can prove out demand, prove out the size of the market, prove out the timing of the cash flows, that more capital will flow to create the capacity and vertical integration that we want to deliver on that 40% to 50% margin profile that we want out of each of our markets. So, it's really just a tightening up, honing of the strategy I would say around capital allocation.
And then, part two of your question was, are you going to run out of cash? And the answer is no. But, just to elaborate, we are looking at taking on some debt, and we've talked about there is probably for too long but Bruce was talking about this back in March and April and talking about doing a REIT perhaps a sales lease back. So, we have about $1.4 billion of PP&E on our balance sheet today. And we do think there is an opportunity to monetize that through either a private placement debt offering or perhaps a sale leaseback. We're going to do something. But before we do that, I'm asking the organization to take a pause, because I want to revise and essentially nail down our five year plan. That's going to be the first step of any due diligence if we do on a debt offering and given my newness at the company and given the evolution of this space, it's time for us to really just firm up our 5 YP. But we're going to work on that, and we're going to come back and do a debt project.
Lauren Lieberman Okay great, two questions I want to sneak in. So first is just, Canopy is currently engaged in search for a new CEO. So, it'd be helpful if could just provide some thoughts on the profile of the ideal candidate for this role and kind of any expectations on when we might get some news?
Mike Lee Are you throwing your hat in the ring?
Lauren Lieberman Absolutely not. I'm just running a talk show.
Mike Lee Got it. Look, I've had an opportunity to work with the board in helping to align on the competencies that we're looking for, which is great. And I can tell you we're moving fast. This is I think one of the more desirable opportunities out there. So, I think we're going to have an abundance of choices to make here. But in terms of profile, we do want someone that's experienced in scaling companies. We expect to transform ourselves year-in and year-out for the foreseeable future.
So we need an experienced leader that's been through transformation, that's been, experienced in things like operating model design. How do we design ourselves to have an efficient cost structure as we grow? What resources do we want central? What resources do we want deployed? Those are really important decisions to make as we scale the business. We need someone that is experienced in not just building brands, but building categories because we are building categories.
So when I think about that, I could be someone from a big multinational CPG, perhaps, could be someone from tech, it could be. We've also talked about having some pharma experience, which could be useful as we think about our aspirations in the clinical medical space.
At the end of the day, we want someone that's experienced that can take us forward, help us become an operator as I talked about early on and we're confident that we're going to have someone in the seat by the end of the calendar year, which will be great as we set up ourselves for FY '21 budgeting and beyond.
Lauren Lieberman And the final question is, just given you are a relative newcomer to the industry. Any thoughts you'd like to leave us with on the cannabis sector and kind of what you expect Canopy's role over there?
Mike Lee Sure. Yes, look I would say, this is an amazing opportunity as an industry and the regulations are evolving more and more every day and there's a sense of inevitability around the eventual opening up of markets all over the world, and we think that we are well poised to win in that future state environment. That being said, this is a young industry and we're a young company.
We've been around for six years, but mostly as a medical cannabis company and with rec we've reinvented ourselves and we've got a lot of work to do right and we're acutely aware of that work and I'm confident that we've built an amazing organization which is incredible talent. I put our talent up against anybody in the industry and in my mind the biggest challenge is, how do we maintain the nimbleness that we've enjoyed while scaling this business to a much more complex multinational business overtime? So I'm excited and I'm thankful to have the opportunity to be able to help shape where we go in the future. So perfect time.
Lauren Lieberman Perfect timing. Thank you so much for this Mike, and I will go over to breakout for anyone who wants to join."
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PlantManager013 wrote: Lots of interesting details. We just need to be patient.
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