Aphria Earnings release.

What I said last Q

Minuses:

• They are harvesting at annual rate of 208,972 KGs versus a projected capacity of 255,000 KGs.  Problem is they are selling at a rate of 50,228 KGs.
• Impairment $64 million on Columbia, Jamaica and Lesotho
• Inventory build with cannabis inventory reaching $206 million
• Dried flower sales decreased in the Q by 6% inclusive of excise
• $4 million improvement forecasted from last Q in Selling and Marketing did not materialize this Q.
• $10 million loss on capital asset… Cannot determine which asset.
• Still holding $4.4 million in sleeved product at MDA date that is scheduled to be sold in Q1 F21.

Pluses:

• Adult rec increases almost fully replaced last Q wholesale revenue from Biomass swap
• Market share in Ontario, Alberta, Quebec and BC reportedly increase 27% from last Q.  Unsure of the % last Q.
• Nice increase in Distribution revenue, albeit at low margin.
• Gross Margin % increase in Cannabis to 53%, Peer Group leading
• Significant reduction in Fair Value Increments for Inventory and Bio Assets, reducing likelihood of writedowns on FVI in future
• G&A decreased in $ amount despite increase in sales.

This quarter:

Minuses

• Net sales increase to Adult Rec and medical drops from $11 million, to $8 million to $5 million QoQoQ
• GM% for cannabis fell, but the value brand launch will do that.
• They removed Harvest per Q from MDA (likely because of the negative focal point it has become) but never fear… I imputed it at 57,365 KGs.  This assumes no destruction of inventory.  Given no impairment to CoGS, no destruction is a fair assumption.  They vaulted 36,483 KGs and the Vault now stands at 128,531 KGs versus 20,882 KGs sold for the Q.
• Inventory has likely not peaked.
• Medical sales fell again, 5 Qs in a row
• Distribution revenue decreased $17 million or -17%, covid related
• Cash balances decreased $97 million to $400 million
• Cannabis inventory is 4.2X cannabis sales.

Pluses:

• Adult use sales inclusive of excise increased 23%, the 6th successive Q of increases.
• Dried flower net of wholesale increased by 5,734 KGs, all BINGO at 6,340 KGs.  Otherwise flower net of wholesale would have decreased by 606 KGs QoQ.
• Apparently, there is a wholesale market for saleable flower as they wholesaled $4.7 million.
• They have throttled grow which impacts the September 2020 harvest and beyond.  No comment on extent of throttle but the least efficient areas of Aphria1 were taken offline.
• They indicate cannabis GM will remain at 50-54% despite throttle AND launch of large formats.
• Distribution GM$, despite drop of 17% in sales, decreased under $0.2 million.
• Trim inventory, while doubled to $6 million, remains controlled at this point on a $ basis.

Now, open up the financials and MDA and let’s get to it, shall we.

Income Statement Drivers and Breakeven Sales Levels – Trend

Trend lines are developing.

Sales

Table 1 Sales Segmentation and KGs Sold Table

Table 2 Revenue by Segment

Aphria recorded a -4% decrease in Net Revenue of $6.5 million to $146 million. Cannabis revenue have increased each Q under review and is now greater than Distribution Revenue.

Before Excise tax…

• Cannabis Revenue increased $17 million or 26% to $82 million before excise and increased $9.4 million and +18% after excise.
  • Adult use was up 23% by $13 million to $70 million
  • Medical was down 6% by $0.5 million to $7.9 million, marking the fifth Q of givebacks
  • And Wholesale increased $4.4 million in sales to $4.7 million.

• Distribution Revenue decreased $17 million or 17% to $82 million, its lowest for the period under review.  Reduction in doctors’ visits resulting from COVID was the reason given.
• Other Revenue increased to $1.0 million from $0 million last Q.  Seems that was an insurance claim.

The cannabis sales increase was largely driven by a 66% decrease in KGs sold of 8,325 kgs for a total of 20,882 kgs. 

• The adult rec market absorbed an additional 5,949 kgs (similar KG increase to last Q) or a 55% increase with Bingo pipeline fill of 6,340 KGs being the reason given.  Without Bingo the KGs sold would have decreased by 391 KGs.  Bingo accounted for 30% of all KGS sold and 38% of Rec KGs sold.
• The medical market saw a decrease of 202 kgs or 16%
• While the wholesale market increased by 2,577 kgs to 3,030 kgs. No biomass swap noted and reportedly flower sales.

Revenue per gram decreased to $3.94/gram from $5.21/gram largely due to lower priced Bingo pipeline fill and the return of wholesale.

• Adult Rec decreased 21% to $4.15/gram from $5.23/gram, giving back the previous Q’s gain. This was largely due to more mix of their large formats of Good Supply and Bingo, in the sales mix. 
  • Vape revenue was $5.96/gram, up from $5.85/gram or +2%
  • Vape revenue increased to $10.6 million from $9.0 million QoQ or +17%
  • Flower sales increased 38% to $63 million from $46 million last Q or +38%.  Expect this to increase next Q with a full Q of large format offerings.
  • Oil sales decreased 23% or $2.4 million to $8.1 million
• Medical increased 11% to $7.38/gram the highest since $8.16/gram in Nov 2019 Q.
• Wholesale increased 115% to $1.55/gram from $0.72/gram. Must have sold flower versus trim this Q.

The strong increase in Adult Rec sales revenue is all that more impressive when other companies were reporting soft increases or decreases.  Adult rec will be the growth engine going forward. So, it is comforting to see Aphria getting the sell through.

Excerpts from MDA:

Headset data, while not all encompassing of retail sales in Canada, covers a large portion of the retail market. The most recent publication by Headset highlights the Company’s brands for the current quarter as follows:

• 48.4% growth in the quarter, 55% better than the industry average in Canada;
• #1 LP in Canada with market share of 14%, more than 20% higher than the next closest LP;
• #1 LP in Ontario and Alberta, #3 in British Colombia, #4 in Quebec and 60% higher share in Ontario than the next closest LP and 4% higher share in Alberta than next closest LP; and
• In the month of August, Aphria vape cartridges maintained the highest market share, scoring a 12.6 share, 30% higher than the next closest LP, our brands held the #1 pre-rolled share and our brands held the #2 dried flower and oil shares in Canada.

Aphria has some brand stickiness and they are starting to include more of the above clips in their MDA.

Adult Recreational Cannabis Revenue: Trend and Peer

Aphria is the present “leader in the clubhouse” in Adult rec market in Canada.  Aphria is the only LP that has seen increases in Adult Rec revenue in each full quarter of Adult Rec.

Medical Cannabis Revenue: Trend and Peer

Medical decrease remains disappointing, the increase they expected from covid did not sustain over the Q. They indicate that …

• The decline is a result of the decline in registered medical patients and decline in patients registering due to the COVID-19 pandemic as discussed above. This factor was partially offset by…  Increase in the average gross retail selling price to medical patients during the quarter from $6.63 to $7.38, a 11.3% increase from the prior quarter.

Wholesale Cannabis Revenue: Trend and Peer

Wholesale revenue reappears at $1.55/gram over 3,030 KGs for $4.7 million in sales. Aphria believes the extract grade and trim market is overs supplied, whereas the saleable flower market offers an opportunity for sales.

Income Statement Drivers and Breakeven Sales Levels – Peer

Note: Sundial, ACB and OGI breakeven could not be calculated due to negative GM%. 

Aphria is the largest company by sales in the peer set.  Sales do include $82 million in Distribution.

Gross Margin Before IFRS Voodoo:

Overall gross margin increased to 30% vs 26% QoQ and increased to $43 million this Q in absolute terms from $40 million, for an increase of $3 million in absolute Gross Margin.

No segmentation exists nor disclosure on the remaining flower purchased from a third party or CBD oil.

Table 3: Gross Profit per Segment and Cost Per Gram Table

Cannabis GM% fell from 53% to 49% despite the large push of Bingo and Wholesale revenue. Gross margin increased in Distribution by 2% to 14% as CC Pharma focused on higher margin items.  Despite the decrease in of 17% in Distribution sales, GM$ in distribution fell by less than $0.2 million.  

Aphria has guided Cannabis GM to 50-54% range despite increase in large format offering, 

Cash cost of cannabis sold decreased 1% QoQ to $0.87/gram the lowest in the period of review. A decrease in all in costs per gram from $1.69 to $1.41 gram is attributable largely to reduction in packaging and distribution costs per gram which dropped in aggregate from 12.9% of sales to 8%.  Large formats require less packaging at the 14 and 28 ounce offering and wholesale requires none.

Despite throttling grow, Aphria anticipates cash costs to remain under $1/gram.

As the cannabis sales mix increases, so does the cannabis contribution to GM which remains +70% of GM or $31 million up from $28 million QoQ.

All in GM was $43 million versus $40 million last Q.

Gross Margin Cannabis Trend and Peer

Whew.  This is an ugly peer group.  Aphria leads the peer group with a 49% cannabis GM versus the next closest CGC at 6%.

Fair Value Increment on inventory sold increased QoQ to $27 million from $21 million, largely reflective of the increase in KGs sold. 

Gain on Biologicals doubled to $59 million from $28 million. More Fair Value Increments on inventory were changed during the Q. Here are some of the notable decreases in FVI (all per gram):

• Harvested Trim had cost cut as well as FVI.  Cost reduced $3.04 to $0.19 and FVI from $0.24 to $0. They might have a lot of trim at 32,487 KGs (16,395 KGs more than last Q) but its value has been reduced to $6 million or 2.3% of total cannabis inventory.
• Oil from $0.06 to $0.01
• Soft Gels from $0.09 to $0.07
• Even Vapes from $0.09 to $0.04

Carl has tidied the inventory up nicely.  We will see if the chattering masses notice.

FVI is the pull forward in accounting profit allowed under IFRS.  By doing this Aphria is reducing the likelihood of FVI related inventory impairments going forward.  This does not change the possible slow-moving inventory writedowns.

Gross Margin Large Peer Group

With a large chunk of revenue delivered from lower margin Distribution, Aphria ranks to the lower end of the positive peer set.

Operating Expenses:

Note: I strip Transaction Costs from Opex to provide a more consistent peer comparison.

SGA & SBC as % of Sales: Trend Analysis

From MDA of Feb 2020: In the current quarter, the Company reclassified marketing salaries and wages from selling marketing and promotion to general and administrative costs to be consistent in its recording of all corporate overhead.

G&A increased by $0.9 million to $28.4 million.  Decreases in Professional Fees and Consulting fees of $1.5 million were offset by $1.7 million increase in salaries and travel. Salaries and Travel bounced back to the previous Q level. G&A increased by 1.4% as percent of sales to 19.5%.

Selling expenses decreased by $1.1 million to $7.2 million while marketing and promotion increased by $2.2 million to $6.1 million as the functions resumed operations after a reduction during COVID. Selling and Marketing as a percentage of sales increased 1% to 9%.

SBC, which is cyclical, decrease by $0.6 million to $4.3 million or 3% of sales, consistent with the prior Q. 

Rounding out Opex is:

• R&D of $0.1 million vs $0.6 million last Q
• Amortization of non-production assets of $5.4 million versus $5.4 million last Q

Overall Opex increased to $51 million from $50 million QoQ.

SGA & SBC as % of Sales: Peer Comparison

Compared to Peers, Aphria is the lowest in combined SGA & SBC at 29% with Sundial next at 41%.  Again, Aphria has a low margin high revenue Distribution business that drives the lower figure.

Net Operating Profit Before IFRS Voodoo:

NOP was negative $8 million versus negative $11 million last Q.  The increase in $3 million GM$ was partially offset by the slight increase of Opex.

NOP becoming positive will be a welcome step.

+NOP Breakeven Sales

Aphria is highest in this ranking. Aphria improved from needing an incremental sales increase of 27% last Q to 19% this Q.  Meaning, they require incremental sales of 19% to achieve +NOP at present GM% and OPEX$’s.

Other Income & Expenses of Note:

• Finance Expense:
  • Interest Expenses was $7.6 million versus last Q $4.8 million.
  • And Finance income was +$0.4 million an unexplained negative $4 million.
  • Net: $7.2 million expense -$1.5 million from last Q

• Other Expenses and Income:
  • Transaction Costs of $3 million versus $2 million last Q.
  • Unrealized gain on Convertible Debentures of +$0.4 million versus a $27 million loss last Q
  • F/X loss of $20 million as CAD appreciated QoQ.
  • Loss on Long Term investments of $1.3 million

Total Other Income was negative $27 million after negative $98 million last Q, which was largely impairment driven.

Income Before Tax was negative $4 millionversus negative $99 million last Q.

+Adjusted EBITDA Breakeven Sales

Aphria is positive Adj EBITDA.  At current GM% and Cash OPEX they could run at 77% of existing sales and be +EBITDA.

EBITDA: Trend and Peer

With EBITDA of $10 million we now have a six successive Q’s of +EBITDA with sequential QoQ in each Q for the past five Q’s. 

• Cannabis operations evidenced a $10.3 million EBITDA vs $9.4 million last Q an improvement attributable to GM% improvement.
• Distribution evidenced a $2.4 million EBITDA versus $1.9 million EBITDA last Q.  Some good expense control given GM was down slightly.
• Businesses under development had a negative $2.8 million versus negative $2.7 million. This is the first time this deficit has increased in the last six Q’s.

The improvement in GM$ was offset by increase in SGA expense to drive the overall improvement in EBITDA.

Operating Expense Burn: Trend

Opex burn returned during the Q to -$12 million from + $2.7 million last Q.

Carl is guiding to positive Free Cash Flow in Q3 F2021.

Operating Expense Burn: Peers

Balance Sheet Items of Note:

• Cash and securities decreased $97 million to $400 million.   
• They announced a USD $100 million ATM last Q.  They indicate it will be used for acquisitions that require a cash component or debt retirement. They have not drawn it.   

Cash versus Debt Service

• Annual debt service is $42 million (P due in 12 months + 4 times this past Q’s interest expense).  In order to get to a 1.20: EBITDA to Debt Service Coverage (a familiar covenant for traditional debt lending) Aphria would need EBITDA of $51 million annually to cover same. They are at $40 million in annualized EBITDA.  

• A/R increased by $26 million in the Q to $82 million as a delay in receiving HST payments from Revenue Canada and a large shipment of Bingo in August were the reasons given.   
• Biological Assets decreased $6 million to $22 million after a similar reduction last Q.  Reduction in FVI is likely the cause. Expect this to dip next Q as they throttle the grow.
• Inventory increased $57 million to $321 million; FG and WIP remain unsegmented, much to my chagrin.
  • $41 million is Distribution inventory an increase of $6 million.  They indicate they will work this down this Q as they match to a lower sales level.
  • $21 million are Other Inventory items (packaging and vape hardware) a $1.3 million reduction QoQ
  • FVI reductions mentioned above kept the $ of inventory from increasing pro rata to the unsold harvest for the Q. FVI accounted $36 million of the increase.
  • Cannabis inventory at cost increased $16 million with Harvested cannabis at cost accounting for $17 million. Harvested cannabis at cost is $98 million versus total cannabis cost-based inventory of $144 million. The second largest cost component of cannabis inventory is oil at $32 million.
  • 74,996 kgs flower up 27,678 KGS… this is concerning as they sold 17,303 KGs of flower in the Q, which is an improvement.  Next Q with a full Q of large formats should slow the growth of this figure.
  • Purchased cannabis and cannabis oil has been merged with respective inventory.
  • Trim inventory of $6 million up from $3 million last Q. Under good control but an outlet is needed.
  • Litres equivalents in oils increased to 120,420 l from 106,371 l.
    • That is 20,942 KG equivalents from the oil. They sold 1,792 KGs of Oil in the Q.  Some wholesaling of oil inventory or launch of more 2.0 formats would be welcome.
  • Vape Oil 5,189 KGs up from 3,775 KGs last Q. They sold 1,787 KGs of vapes in the Q.
  • Soft gel kg equivalents 104 kg down 290 kgs… giving you an idea where Aphria is prioritizing, and it isn’t soft gels.
  • It is important to remember that inventory from harvest takes 5-7 weeks to hit retailer shelf.

 “Gas in the Tank”: Trend Analysis

Aphria had a harvest record for themselves and the industry in the Q, imputed at 57,365 KGs.  They continue to slash FVI on a number of inventory components as well as cash components.

They indicated they started to throttle the grow during the Q, but as cannabis has a 12 week grow cycle the impacts to harvest will not be evidenced until September 2020, the first month of the next upcoming Q.

“Gas in the Tank”: Peer Comparison

“Waterfall” – Trend Analysis

• Harvests increased by 5,122 KGs to 57,365 KGs from 52,243 KGs.
• Aphria now has the largest harvests in the industry… better sell them as we have seen what happens when others don’t. 
• The delta for this quarter on Harvest Versus Sold of 36,483 KGs a decrease from 39,686 KGs last Q. 
• With the grow throttled and large formats out for a full Q, hopefully this will decrease QoQ going forward.

What I said last Q; In 2018 I thought CGC had too much inventory.  That is how I am feeling about Aphria now.

Same this Q.

Waterfall: Peer

Harvest vs Sold KGs and Sales versus Inventory

• Cannabis Inventory is MORE THAN sufficient to support a sales increase next Q, with oil and flower well positioned.

• PPE decreased by $6.4 million to $594 million. Germany should be complete in Q2 or Q3 F2021.  They are signaling Capex for the second half of the fiscal will be minimal and will be selective.

• A/P decreased $28 million to $124 million.  Looks like Germany contractors got paid.

What we said last Q

Operationally a very good Q again.  However, the impairments under “COVID cover” took any wind from the sales. 

Impairing Columbia and halting construction removed $40 million in capex from upcoming spend.  They believe they can export to Columbia from Canada to make up the sales volumes they cultivation in Columbia would have generated. I am skeptical until they show some export sales.   Jamaica and Lesotho likely would have been rounding errors but taking $25 million “non cash” is not without consequences as they issued shares to pay for the assets, which will dampen EPS.

Adult sales increases were substantial and on CC they indicated they were muted by inventory reductions at provincial distributors resulting from 1) letting inventory rundown, 2) store openings on hold and 3) stores closed. If this holds true, the first Q of F21 might have some wind in sails as June covid restrictions were relaxed and further relaxed in July.

Gross Margin improved with less wholesale and more sales of their own products. BUT this GM only holds at present levels when the yields are taken into consideration.   Inventory is dangerously high relative to sales and susceptible to an impairment for slow moving.

Adjusted EBITDA also improved, but again it is dependent on GM generation from the inventory on hand.

I really wished they gave some idea of strategy on the cultivation side.  How will they look to get into equilibrium before writedowns occur?   They did not even mention it and no analyst brought it up.

This Q:

A “progress quarter”.

Another good cannabis sales Q on adult rec increase muted by the decrease in Distribution revenue. Cannabis brands appear sticky.

It was comforting to see cannabis GM hovering near 50% despite the rather large shipment of Bingo in the Q.  They are guiding to Cannabis GM in the 50-54% range is very good relative to peers, especially when value brands are incorporated.

The launch of the large formats, the return of wholesale flower sales and the throttling of the grow bode well for next Q inventory management to start to turn the corner.  Trim is low at $6 million and provides little risk at present. Cannabis Inventory is still high and is 4.2X cannabis sales in $ terms.

It would be nice to see them wholesale some oil inventory.

The lack of drawdown of ATM is both frustrating (as it is a drag on Stock Price) and encouraging (as they indicated it would be used strategically). 

Next quarter things will start to get a little more interesting.

That’s all I got.

GoBlue

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.