Canopy Growth CEO: We need to attract consumers from the illicit market

Canopy Growth CEO David Klein joins Yahoo Finance's Zack Guzman to discuss the company's latest earnings results and the role cannabis is playing in U.S. economic recovery.

Video Transcript

ZACK GUZMAN: Today we got the update from the world's most valuable cannabis company announcing financial results for its first quarter fiscal 2021 here, and Canopy topped expectations on the top and bottom lines, reporting net revenue of just over $110 million Canadian. That was up from 107.9 in the prior period and 22% higher on a year-over-year basis. They also reported a $92 million adjusted EBITDA loss due to lower expenses and an 18% drop in headcount. That was also better than expectations.

And joining us now for more on the quarter and the road ahead is Canopy Growth CEO David Klein. David, good to be chatting with you again. Shares are up about 10%, so investors liking what they're seeing so far. But when you dig into the report, it was a pretty interesting dynamic versus last quarter when you guys admitted you were playing catch up on the value space. Now you're more competitive there on the cheaper end of the price spectrum in the cannabis market, and your gross margins came in at just 6%, so a far cry from where you hoped to be here at the end of the year, around 40%. So how did that factor in, and how is it not proof of a race to the bottom in the cannabis sector?

DAVID KLEIN: Yeah, so I challenged our operations team to make sure that we could drive revenues to make sure that we stayed on shelf with the right level of quality, right level of THC. I challenged them to improve our quality over time and not grow inventory. And it was that balance of not growing inventory which caused us to run our plants at a suboptimal levels that we weren't fully utilizing the facilities capability we have, that really caused the compression in our margins. We will be able to get back to the higher margin, the 40% rate we were at in the fourth quarter of last year. But I think the game really is making sure that we're growing market share in the Canadian market, and our operating costs will come in line.

ZACK GUZMAN: Yeah, and you talk about the entry point of lower end here as well and why it's important for any cannabis company to take share from the black market. As you noted on the earnings call, not a lot of CPG companies out there have to battle with a black market.

But how does that work and maybe drawing people to you in the legal market and how it could also maybe take people down who are spending more money at a high-end price point down to the value brand? How do those work together in your mind?

DAVID KLEIN: Well, I think they're two separate problems. And so think about it like a normal CPG issue, which is consumers, especially when they're going to purchase something that they're going to ingest, they want to make sure that they have appropriate quality, appropriate safety. They want to make sure that the experience is what they want to get from the product, and they're willing to pay for the quality of that experience, right? So that's how you get kind of mainstream and premium and other CPG categories.

For the cannabis space, we need to attract consumers from the illicit market, and so we need to also be aggressive in that value space. And as long as the growth in value is coming from stealing share, if you will, from the illicit market, that's fine because once we get them in the value space, we think that we can trade them up along the experience curve the way other CPG products do on a routine basis.

ZACK GUZMAN: Yeah, I wanted to ask you about the flip side of that too, if those are people who are familiar with the product. You've got a complete opposite opportunity in what you're trying to do on the beverage front. You guys sold more than 1 million units since you launched in March of your cannabis beverages, and you double your throughput in July from June. You said you're going to double that again in August, potentially.

And importantly, you've said that the upside there is even larger than you thought when you joined, came over from beer giant Constellation Brands. But right now, people still need to buy that in the cannabis shop. So how are you kind of looking forward to the strategy there to bring people who might not be prior cannabis users into the space with beverages?

DAVID KLEIN: Well, I think we first need to convince them that it is an equivalent of, say, alcoholic seltzers, if you will. And I think it is. It offers a superior experience. We can do it with no calories. We can make it tastes delicious. And we also eliminate the concept of a hangover.

So, you know, there are a lot of reasons to convince the consumer. We need to talk to them so that they do it.

Then we're seeing post-stores-reopening in Canada, kind of post-COVID, we're seeing that e-commerce sales have continued to stay at a-- reset at a higher level. We think our own e-commerce sales, the e-commerce sales from the provinces and other delivery services will allow many new consumers to come into the category, drawing from that alcohol sector.

ZACK GUZMAN: And when you think about that, obviously the market opportunity is much larger here in the United States. You guys have the agreement with Acreage once cannabis becomes-- the sale of cannabis becomes federally permissible to move into the US market.

So how do you foresee that working with your beverage side of the business, and is that really where you see the biggest opportunity? I know you're looking at this through a beer lens since you came from Constellation Brands, and that's where a lot of the money here came from. But what's your take on maybe which one you're most excited about rolling out in the US?

DAVID KLEIN: Well, so with Acreage and our restructured deal with Acreage, we think that they have a lot of runway in front of them to develop their business with the core cannabis products, mostly flower. And they've started to bring our brands to the US using our Tweed brands and Tokyo Smoke in the US.

They also have the right to bring our drinks to the US market, and I'm hopeful that we hear from them over the next few months about their plans to bring our drinks to places like Illinois because I think it would be really exciting to get kind of the game on in the US with our drinks and see how they actually do in a market such as exists in Illinois.

ZACK GUZMAN: When you stack up those statistics on your customer data, when you think about beer and what you're seeing there, you talked about repurchase rates the last time we talked about the beverages. What are you seeing on that front and how they compare to maybe some of the big names that we know in Corona and all the other beers attached to Constellation Brands? How impressed are you actually?

DAVID KLEIN: Well, so I think it looks a lot like it could get the sort of legs that the seltzer greats have. People aren't-- people a few years ago weren't really sure what seltzers were. Then they started to understand, OK, I can get a refreshing drink, yet I don't get a lot of calories.

Now what they need to understand is they can get the same thing. We can make our drinks taste better than seltzer tastes. We give you a little bit of a different effect from alcohol, which I think is beneficial. And we know we're hearing lots of stories about non-cannabis-users in Canada trying cannabis drinks and deciding they feel better than they have in a decade. They sleep better than they have in many, many years, right?

So we think that that there is just tremendous opportunity, and we think that-- you know, that we can start to look at ourselves and compare ourselves from a trajectory standpoint and a volume standpoint with some of the seltzer producers as that business has evolved over the last three years.

ZACK GUZMAN: Yeah, and when we think about the opportunity there, obviously it's no surprise that it would be much larger if you had more states come on board or if it was federally legalized. And you've been operating with the timeline assumption of that happening by about 2022.

But as you noted on the earnings call, there's a lot of discussions right now being held here in the US about criminal-justice reform and cannabis legalization potentially helping fill the revenue issues that we're seeing states grapple with here. And as the odds of Democrats taking the Senate continue to rise, I'd be curious to know if your timeline for federal marijuana legalization has moved up with what you've seen play out so far.

DAVID KLEIN: No, but I've never really been more bullish about Canopy's prospects that I am right now, and part of it is on the back of this sort of momentum we see in the US. You know, when I was listening to your segment with Doug Holtz-Eakin earlier, I was thinking that, you know, our industry-- legalizing our industry across the US can bring something north of $175 billion worth of revenues to the federal government between now and 2025, and we think it creates something like 1.6 million jobs. That seems like the right medication to a recession.

ZACK GUZMAN: But considering that, you're not anymore optimistic? I mean, if that's the silver bullet here, you're not anymore optimistic that it would get passed?

DAVID KLEIN: I think it will take time because I think any legislation needs to come with a federal regulatory framework and some pretty aggressive social-justice initiatives. And I just think that even though right now 55% of Republicans and 78% of Democrats are in favor of permissibility in the USA, I think it will take a little while to hammer out.

ZACK GUZMAN: Yeah, and so much comes down to what we see play out in the Senate this year as well. But lastly, before we let you go, I mean, the stock's down about 10% since you took the helm here. As you've said, you're still in the throes of your strategic review and transition phase. Probably not helped, obviously, by a pandemic and stores getting closed down. But considering you were able to cut Canopy's losses in that environment, what do you think investors might be overlooking when you think about the opportunity that you lay out as you see it ahead here?

DAVID KLEIN: I think we had a situation in cannabis where there was a lot of exuberance early on about how big the space could be and how lucrative it could be for investors. People were thinking like maybe they thought about if they'd only invested in tech stocks, you know, at the right time in their evolution.

I think that we've now gone through that reset in people's thinking about cannabis stocks. I think this is the point where the real winners start to separate themselves. And so you see businesses like ours where we've cut our cash burn in half. We still have $2 billion in the bank that we can spend against growth initiatives. You see permissibility coming faster in the US. You see-- you see things like our 2.0, our products like our drinks starting to take off. I really feel that momentum coming behind our company, and I do believe that it's time for people to reassess cannabis stocks.

ZACK GUZMAN: Well, you cut the cash burn in half, and today with the 10% move, you also cut the year-to-date losses in half as well. But David Kline, appreciate you joining us, as always. The CEO of Canopy Growth, thanks again.

DAVID KLEIN: Thank you, Zack.