Both of these topics will focus on Aphria’s Inventory management and disclosure.
We at TheCannalysts have long been a fan of disclosure. We have called out bad disclosure when we have seen it, and we have praised good disclosure when we have seen it. We have seen both sides of good and bad disclosure on Biomass Boomerangs and Swaps.
The disclosure I am about to point out is not of near the significance of fluffing your sales without disclosing via Biomass Boomerangs and Biomass Swaps, but it irks me, nonetheless. And it seems part of a larger communication issue between Aphria and their investors.
In last week’s conference call, Aphria’s CFO Carl Merton said the following:
- “In the middle of June, we temporarily reduced our cannabis output at Aphria One, focusing the reduction on our operating facility with the higher of our two cost structures. As a result of cannabis’s 12 weeks grow cycle, this reduction in capacity did not impact harvests until the month of September, and therefore, had no impact on Q1.”
Their May 31, 2020 earnings conference call was July 29, 2020, two months after they actively started throttling the grow. Yet, they do not announce it until October 15, 2020 four months later.
There were two main overhangs going into the May 31, 2020 earnings release:
- Impairments to Goodwill, Intangibles and possibly Inventory and
- The growing imbalance between what Aphria was harvesting and what they were selling, an amount that was being added to a large and growing inventory balance.
The above is what the retail investors were discussing. It was an ongoing discussion on our subReddit, on Twitter and on various other social media. And I have to imagine the analysts were thinking about it given the questions from the conference call.
TheCannalysts have been flagging the mounting inventory at Aphria as an issue that needed addressing as Diamond was ramping production. This was evident in earnest on the February 29, 2020 financial statements when Aphria harvested of 31,000 KGs (over double the previous Q harvest and still ramping) outstripped sales of 14,000 KGs on a two to one basis. And that 14,000 KGs sold included a disclosed 4,400 KG biomass swap, which if excluded would have made the delta three to one.
Irwin and Carl elected to not disclose the throttling of the grow on the May 31, 2020 quarter conference call and MDA. A quarter when they impaired goodwill, intangibles, and some PPE and booked a loss on their supply agreement lawsuit with Aleafia.
Given Irwin booked himself on BNN Bloomberg prior to the May earnings release, and Aphria social media flagged the event for investors to watch, indicates to me that he thought he would be doing a victory lap on a very good operational Q. Which “operationally” it was particularly good. But instead the market reacted very poorly to the May 31, 2020 earnings as a result of the impairments and the announce USD 100 million ATM, and the stock dumped all the pre earnings run up gains.
Why they did not tuck in the fact that they recognized the need to throttle the grow and were indeed throttling it at earnings release? To me, it indicates that Irwin did not want to tarnish what he thought was a very good operational story for Q4F2020 that he hoped would eclipse the negatives of the impairments.
Yeah, this did not work.
The day of the most recent earnings release for August 31, 2020 Irwin lamented on BNN Bloomberg that “Investors are missing our growth story”.
No sir, you are doing a poor job explaining it. Strategically for the last two quarters you have misread the audience. You missed analyst expectations this Q on revenue due to the $17 million decline in sales of CC Pharma. The same thing happened in November 2019 Q when distribution revenue dropped and wiped out the increase on cannabis revenue.
I get that COVID is screwing with businesses in an unparalleled manner. But if your low margin distribution business is causing your stock price to gyrate the market capitalization of your company more than the value of what you bought your distribution unit for… well… maybe it’s time to provide MUCH better guidance on that unit to get “analyst expectations” in line with “actual figures”.
Getting back to my issue with when they disclosed the throttling of the grow… Do you really think that announcing that you throttled the grow in June 2020 on your July 29, 2020 conference call would have caused the market to react any differently than it did? The impairments and the ATM did that.
As a long-term investor, and an analyst, I would have applauded the decision to do what was right operationally. That is the Aphria story: Operational Improvements in a sea of failing businesses! This was a decision whose similar delays have caused your peers to writedown massive amounts of inventory. You had the chance to focus on Aphria making the difficult and right operational decision before they became more problematic, yet you did not think it was worthy of release until four months after you started doing it.
I am extremely disappointed by the delay in this announcement. There has been investor angst about the harvest to sales delta for months.
You caught crap for buying third party inventory in the Feb 2020 Q when it was bridge to absorbing your ramped up cultivation from Diamond. It was the right thing to do strategically. And again, you did not explain it well. You could have mollified the angst. You could have gotten in front of the issue and disclose it. In the case of the throttling, you chose to delay it.
What will the reduction in cultivation do to cash cost per gram? On the CC they did guide to the fact they expect cannabis GM to remain in the 50-54% range, despite throttling the grow AND the increase of lower priced value bulk offerings in the sales mix. In the past Carl had broken out the impact of dedicating Aphria 1 floor space to Mothers for Phase IV/V and Diamond at $0.10-0.20/gram. I hope he does the same with the idling of grow space.
- November 2019 Q they did not communicate or provide guidance for the CC Pharma sales drop that wiped out the cannabis sales increase
- February 2020 Q they did a poor job of explaining how the third party purchasing provided a very good strategy to scale up a sales-bridge to Diamond ramp. The story should have been our brands are so good we can sell our competitors’ products that they cannot themselves sell their own products.
- May 2020 Q they did not announce they had throttled the grow, which could have been tucked in to the other not so flattering non-operational impairments. Instead they incorrectly hoped the operational progress would mute the impairments.
- August 2020 Q they did not communicate or provide guidance for the CC Pharma sales drop that wiped out the cannabis sales increase.
I understand haters are going to hate and Aphria is a polarizing stock… but quit providing them with the torches and pitchforks.
When your peers have reported earnings that were “full diapers” with massive operating losses and additional impairments in their earnings reports, yet they beat “analyst expectations”, their stock price increases. Aphria reports very good growth across numerous metrics in the engine segment of future growth and the stock facepalms.
Every Canadian LP would have traded their last quarter for the quarter Aphria just announced.
It is time to come to grips with the reality of this industry and its Trim issues. Tilray and Organigram have already indicated changing their treatment on trim.
Trim has been this industry’s dirty little secret. The fact that 2.0 products were delayed for a year meant cultivators had to find a home for trim as they want to “use the whole animal” and improve their gross margins by expanding their yield and capturing revenue. The problem was without 2.0 products for an outlet for trim between legalization and 2.0 , unless you swapped trim for extract that you would use at a later date, who were you going to do sell it to?
Some put it in pre rolls. And social media had a field day with “floor sweepings” and “hotdog water”. If you wanted to protect your brand, stuffing trim into them might not be the healthiest thing to do.
Aphria has slowly been winding down the dollar value per gram of their trim. Cost and Fair Value Increment has been walked down from a high of $4.50/gram in February 2020 Q to $0.19/gram (no FVI anymore) on the most recent Q.
I always wondered how much of Aphria’s quarterly harvest was trim. OGI had mentioned one quarter that their sweet leaf trim was 30% of their harvest. Tilray, when they decided to no longer include trim in their harvest numbers, harvest numbers dropped 1/3 QoQ.
This quarter Aphria saw their trim increase to 32,000 KGs from 16,000 KGs from their last harvest. This would indicate that at a minimum, without purchasing trim or extracting trim, Aphria generated 16,000 KGs in trim from this quarter’s harvest. Aphria is now carrying its highest ever inventory of trim by KGs but only $6 million in cost versus $15 million at its peak in February 2020 Q.
This quarter Aphria decided to stop reporting harvested KGs.
Hey, if you are going to provide open and closing inventory by KGs and what you sold in KGs for the month, an analyst can impute your harvest. And I did… it was 57,365 KGs.
Again, why remove the disclosure of harvests, yet still tout your annual capacity? A step further… if you cannot sell your trim why are you including it in your harvests and on your balance sheet?
So, if Aphria generated 16,000 KG minimum in trim on a harvest of 57,000 KGs, that is 28% of the harvest. If you cannot sell trim or transform it into a saleable 2.0 formats it is time to quit announcing that you have capacity to grow 255,000 KGs a year. You have the capacity to grow 183,600 KGs per year (72% of stated capacity).
This adjustment to annual capacity and quarterly harvest should be spread across the cannabis industry, not just Aphria.
The strange thing about trim is that while it is 28% of harvest this past Q it was only 5% of the harvest by cost. Aphria’s Trim is valued at $0.19/gram or based on 16,000 KGs of harvested trim at cost was $3 million. The balance of the harvest is 41,000 KGs at $1.32/gram cost (not including FVI) or $54 million. This makes the quarterly harvest of Aphria $57 million on a cost basis.
If Aphria elected to spread that $3 million costs across the 41,000 KG flower harvest the cost per gram would increase by approximately $0.07/gram from $0.87/gram to $0.94/gram. This would crimp gross margin as well. (BTW… If you are wondering how they get their overall cash cost to under $1.00/gram when flower is costed at $1.32/gram, part of it is the they have oil and vapes that help reduce overall cost profile plus they have amortization – this past Q it was $0.27/gram sold – included in the $1.32/gram.
This past Q Aphria sold 17,000 KGs of flower of which they wholesaled 3,000 KGs. (Note: Flower inventory to Q $ sales is 3.6X.) They sold an additional 4,000 KGs equivalents in oil and vape products for total sales of 21,000 KGs. That 21,000 figure looks a lot better sitting next to a harvest of 41,000 KGs than a harvest of 57,000 KGs, ESPECIALLY when they have:
- Decided to throttle the grow (not sure by how much) and
- They are selling large format bulk offerings. BINGO alone moved 6,340 KGs in the pipeline fill. A full Q of BINGO and Good Supply bulk formats could move a lot more flower by weight.
Both of these actions will shrink the harvest to sales delta and help balance inventory.
So, what do I want out of this rant?
Disclosure and a better game plan for managing analysts’ earnings expectations.
Do not wait a quarter to tell me that you reduced cultivation.
It is time to rethink how harvest are disclosed. And I do not mean by removing the metric (Yes, I am looking at you too Canopy. Taking out the red flashing bulb does not solve the problem.) Tell me the harvest amount broken down into saleable flower, extract grade flower and trim. And then tell me how much of each you sold. If you are not selling enough trim through your conversion to extracted formats it should be removed from the balance sheet. Show me the progress you are making in managing your inventory. Do not extract trim and have it sit in a too large a supply of extracted inventory to obfuscate it (at least if it is in Oil I can do an inventory turnover, which the last Q was quite high at 26,000 KGs in oil and vape extracts versus this Q’s oil and vape sales of under 4,000 KGs. At least Oil including vapes inventory only increased 481 KGs QoQ. Hoping that new 2.0 products draw down that inventory to a more reasonable turnover).
Tell me how you plan on converting that $3 million in trim cost a quarter into sales? Are you getting the kief off it for additions to pre rolls, hash or??? Or should I expect you to write off your trim as others have done.
Quit talking about 255,000 KGs capacity, especially on TV interviews, when you have no outlet for 30% (or whatever that number is on a non-imputed basis) of that harvest because it is trim. Having excess capacity, which is overstated because of trim generation, is not a positive until sales ramp domestically and via exports to absorb same.
And deliver better guidance to analysts on CC Pharma. Twice in the past four quarters, the low margin CC Pharma revenue has wiped out the sales increases from cannabis. The headlines from the financial press is always on sales and net income, despite the operational progress made between those lines. That CC Pharma had less than a $0.2 million decrease in Gross Margin despite a $17 million decrease in revenue proves that the financial press is not looking at more important metrics.
The preceding is the opinion of the author and is in no way intended to be a recommendation to buy or sell any security or derivative. The author has a position in Aphria and will not start one or divest in the next five days. The author has no position in any of the other mentioned companies and will not start one or divest in the next five days.