Aphria Earnings release.

The results from this Q really shows why they are buying Tilray. Cannabis Sales growth in Canada has turned into a knife fight and adding sales from Tilray accelerates their business plan. The Ontario store ramp from 40 to 80 new stores a month is the last Canadian catalysts, unless Quebec starts increasing stores, decreases age of use to 18, and allow edibles and vapes.  It also shows how far off Aphria was last year with their revenue guidance.

And it looks like it is US GAAP, maintains Aphria year end, and Tilray is working on TSX listing as we get to merger.

What I said last Q

Minuses

• Net sales increase in 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 +62,000 KGs.  This assumes no destruction of inventory.  Given no impairment to CoGS, no destruction is a fair assumption.  They vaulted +41,000 KGs and the Vault now stands at +133,000 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.

This quarter:

Minuses

• They lost market share as their sales have not grown at same pace as market this Q.
• Net sales increase in adult rec and Canadian medical drops from $11 million to $8 million to $5 million to $2.5 million QoQoQoQ.  This is why they are buying Tilray.
• GM% for cannabis was below their +50% guidance as they had Unabsorbed Overhead of $1 million and $1.5 million in dated inventory sold at a loss.  The Unabsorbed Overhead is why they are buying Tilray.
• Canadian Medical sales fell again, 6 Qs in a row.
• Cash balances decreased $212 million to $188 million but they closed the Sweetwater loan post-closing which increased proforma balance to +$300 million.

Pluses:

• Adult use sales inclusive of excise increased 3%, the 7th successive Q of increases.
• Dried flower grew for the second consecutive Q but slowed to +2.8%.
• Oil and Vape sales increased +18% and +14%, respectively.
• International sales to Israel and Germany appeared for first time at $5 million.  They filled the Israel annual commitment in this Q, as such it will be spotty going forward.
• Distribution revenue rebounded +$9.5 million, but not all the way back to two Q’s ago.
• They sold 65% of this Q’s harvest amount as throttling the grow reduced harvest by +21,000 KGs to 41,432 KGs AND they still reduced cash cost per gram.

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 but NOP stepped backwards with SBC increase tied to SP increases.

Sales

Table 1 Sales Segmentation

Aphria recorded a +10% increase in Net Revenue of $15 million to $161 million. Cannabis revenue have increased each Q under review. With rebound in Distribution revenue, Distribution regains the largest segment by sales.

Before Excise tax…

• Cannabis Revenue increased $4.7 million or 6% to $87 million before excise and increased $5.4 million and +9% after excise.
  • Adult use was up 3.6% by $2.5 million to $72 million.
  • Medical was down 4% by $0.1 million to $7.8 million, marking the sixth Q of givebacks.
  • Wholesale decreased $2.9 million in sales to $1.8 million and
  • International makes its first appearance at $5.3 million.

• Distribution Revenue increased $9.5 million or +12% to $92 million, rebounding somewhat from last Q’s decrease.
• Sweetwater recorded five days of revenue at $0.9 million.
• Other Revenue decreased from $1.0 million to $0 million this Q.  Seems that was an insurance claim.

Table 2 Revenue by Product Segment

Flower growth is slowing with 3% or $1.8 million QoQ.  They indicated they missed out on pre roll demand in Alberta and now have tripled production capacity.

To get to CEO Simon’s 30% market share this will be the biggest hill to climb. 

Oil products saw a nice rebound after two Q’s of decreases with +18% to +$1.5 million.

Vapes maintain trajectory with +18% increase or +$1.5 million the same $ increase as last Q.

Table 3 KGs Sold and Average Selling Price

The 8.7% increase in cannabis sales increase was largely driven by a 28% increase in KGs sold of 5,848 kgs for a total of 26,730 kgs, a new record. 

• The adult rec market decreased 129 kgs or a 1% decrease. Value brands are becoming more dominant.  They did evidence an improvement in ASP by 4% to $4.33/gram. The lack of a pipeline fill compared to last Q is rational given for the decrease in KGs sold.
• The medical market saw a nominal increase of 44 kgs or 4% and a decrease in average selling price of 6%, as they introduced compassionate pricing for those impacted by covid.
• While the wholesale and the newly added international market increased by 5,933 kgs to 8,693 kgs.  Israel annual purchase commitment with Cannadoc has been fulfilled, as such more sales through that channel are at Cannadoc discretion.  As wholesale includes the sale of flower below cost, we see a 49% reduction in average selling price. 

Revenue per gram decreased from $3.94/gram to $3.25/gram largely due to lower priced Bingo and the return of wholesale.

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:

• #1 licensed producer in Canada with market share of 13%;
• #1 licensed producer in Ontario and Alberta, #3 in British Columbia, #3 in Saskatchewan and #4 in Quebec; and,
• In the three months ended October 2020, Aphria vape cartridges maintained the highest market share, scoring a 19.2 share, our brands held the #1 dried flower share with a 13.2 share, #2 pre-rolled share with a 12.6 share and #2 oil shares, with a 20.5 share 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, which now includes international sales, increased fully on the back of the international sales, as Cdn medical continues to contract.

Wholesale Cannabis Revenue: Trend and Peer

Wholesale of $1.8 million.  This was sold below cost with a hit of $1.5 million to Gross Margin.

Income Statement Drivers and Breakeven Sales Levels – Peer

Note: Sundial 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 $92 million in Distribution.

Gross Margin Before IFRS Voodoo:

Overall gross margin increased to 27% vs 30% QoQ and increased to $44 million this Q in absolute terms from $43 million, for an increase of $1 million in absolute Gross Margin.

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

Cannabis GM% fell from 49% to 46% as they took a $1.5 million loss on inventory sold below cost and $1.0 million in unabsorbed overhead.  Without the inventory sold at loss GM would have been 48%, still below the +50% guidance given on last CC.

Gross margin decreased in Distribution by 1% to 13% as product mix shifted.  Net GM went up modestly as sales increases offset the lower GM%.

Cash cost of cannabis sold decreased 9% QoQ to $0.79/gram the lowest in the period of review. A decrease in all in costs per gram from $1.41 to $1.30 gram or -8% and is attributable largely to reduction in packaging costs per gram which dropped in aggregate from 3.9% of sales to 2.3% or -$0.09/gram.  Large formats require less packaging at the 14 and 28 ounce offering and wholesale requires none.

I am quite surprised they maintained those cost per gram despite a hard throttle of cultivation last Q by -34%.

As the cannabis sales mix increases, so does the cannabis contribution to GM which remains +70% of GM or $31.2 million up from $30.5 million QoQ.

All in GM was $43.8 million versus $43.3 million last Q.

Gross Margin Cannabis Trend and Peer

Whew.  This is an ugly peer group.  Aphria leads the peer group with a 46% cannabis GM versus the next closest Hexo at 41%.

Fair Value Increment on inventory sold increased QoQ to $30 million from $27 million, largely reflective of the increase in KGs sold. 

Gain on Biologicals decreased by more than half to $26 million from $59 million. More Fair Value Increments on inventory were changed during the Q. Here are some of the notable decreases in FVI (all per gram):

• Cannabis flower had cost cuts per gram from $1.32 to $1.24 and FVI cuts from $1.50 to $1.23.
• Harvested Trim had cost cut by 5% to $0.18/gram and FVI remains at $0.  They might have a lot of trim at 39,744 KGs (7,257 KGs more than last Q) but its value was $7 million or 2.7% of total cannabis inventory.
• Oil unchanged
• Vapes cost dropped $0.01 to $0.22/ml. FVI unchanged.

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. But with the move to US GAAP, likely at year end, FVI will disappear.

Gross Margin Large Peer Group

With a large chunk of revenue delivered from lower margin Distribution, Aphria ranks in the middle 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 decreased by $0.6 million to $27.8 million.  Decreases in Salaries and Wages of $0.6 million was the biggest decrease in the group, with insurance, travel and office expenses declining $0.6 million in aggregate.  The largest increase was $0.6 million in executive compensation.

Selling expenses increased by $0.3 million to $7.5 million while marketing and promotion decreased by $0.8 million to $5.2 million. Selling and Marketing as a percentage of sales increased 1% to 8% in line with two Q’s ago.

SBC, which is cyclical, increase by $9.3 million to $13.6 million or 9% of sales, as the stock price increase pushed this higher.

Rounding out Opex is:

• R&D of $0.3 million vs $0.1 million last Q
• Amortization of non-production assets of $5.6 million versus $5.4 million last Q

Overall Opex increased to $60 million from $51 million QoQ with SBC accounting for all of the increase.

SGA & SBC as % of Sales: Peer Comparison

Compared to Peers, Aphria is the lowest in combined SGA & SBC at 34% with Hexo next at 57%.  Again, Aphria has a low margin high revenue Distribution business that drives the lower figure.

Net Operating Profit Before IFRS Voodoo:

NOP was negative $16 million versus negative $8 million last Q.  The increase in $1 million GM$ was offset by the SBC increase.

NOP becoming positive will be a welcome step but with stock price up even higher, this might have to wait.

+NOP Breakeven Sales

Aphria is highest in this ranking. Aphria improved from needing an incremental sales increase of 19% last Q to 37% this Q.  Meaning, they require incremental sales of 37% to achieve +NOP at present GM% and OPEX$’s.

Other Income & Expenses of Note:

• Finance Expense:
  • Interest Expenses was $6.4 million versus last Q $7.6 million. This will increase next Q with SweetWater loan.
  • And Finance income was +$0.4 million level with last Q.

• Other Expenses and Income:
  • Transaction expenses for SweetWater were $23 million.  I shudder to think what Tilray will be. Last Q transaction costs were $3 million.
  • Unrealized loss on Convertible Debentures of $87 million versus a small gain of $0.4 million loss last Q.  Shareholders that complain about this seem to be happy with the share price (sarcasm). The Aphria convertible debenture price of USD 9.38/share with ability to force convert at 130% for 20 days. BUT with merger the Lenders have right to convert immediately at USD 9.38/share.  And there our valued subscriber is part of the “arbitrage” you are seeing.
  • F/X loss of $4 million as CAD appreciated QoQ versus last Q loss of $20 million.
  • Loss on Long Term investments of $1.3 million last Q and this Q -$0.5 million.

Total Other Income was negative $118 million after negative $98 million last Q, which was largely impairment driven.

Income Before Tax was negative $139 millionversus negative $4 million last Q.

Taxes had a recovery of $18 million.

Net Income after tax was -$122 million versus -$3 million last Q. The big swing is $88 million in FV loss on debenture, $23 million transaction costs and $18 million tax recovery, offset by a $16 million reduction in FX loss.

+Adjusted EBITDA Breakeven Sales

Aphria is positive Adj EBITDA.  At current GM% and Cash OPEX they could run at 72% of existing sales and be +EBITDA.

EBITDA: Trend and Peer

With EBITDA of $12.2 million we now have a seven successive Q’s of +EBITDA with sequential QoQ in each Q for the past five Q’s. 

• Cannabis operations evidenced a $12.9 million EBITDA vs $10.4 million last Q an improvement attributable to GM% improvement and cash Opex improvement.
• Distribution evidenced a $2.6 million EBITDA versus $2.4 million EBITDA last Q.   
• SweetWater evidenced $0.3 million EBITDA for five days.
• Businesses under development had a negative $2.6 million versus negative $2.4 million reversing the only increase in this expense in the past seven Q’s last Q.

The improvement in GM$ was and cash expense control were the reasons for the improvement.

Operating Expense Burn: Trend

Cash generated from Operations was $3 million versus -$69 million last Q.

Cash provided by financing activities was $122 million versus $8 million last Q.

Cash used in investing activities was -$38 million, largely SweetWater, versus -$17 million last quarter.

Opex burn during the Q was -$17 million versus -$12 million last Q. The difference between Adj EBITDA and Opex Burn is largely transaction costs and interest.

Carl is guiding to positive Free Cash Flow in the back half of F2021.

Operating Expense Burn: Peers

Balance Sheet Items of Note:

• Cash and securities decreased $212 million to $188 million but will be +$300 million from SweetWater loan closed after Q end.   

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 (although P amortization is not included). They are at $49 million in annualized EBITDA and it should bump next Q with SweetWater for the full Q.   This will change with Tilray, and not to the good.  However, the Aphria Convertible Debentures could be flipped to equity, which changes the look of the company significantly.

• A/R increased by $13 million in the Q to $96 million. Part of this could be the SweetWater acquisition.   

 “Gas in the Tank”: Trend Analysis

Inventory in $ was level with prior Q.

• Biological Assets increased $6 million to $29 million. Reduction in FVI is likely the cause and the throttled grow.
• Inventory was level to last Q at to $321 million; FG and WIP remain unsegmented, much to my chagrin.
  • $38 million is Distribution inventory a decrease of $3 million.   
  • $23 million are Other Inventory items (packaging and vape hardware) and likely some SweetWater inventory, a $1.7 million increase QoQ.
  • FVI decreased a $8.5 million in the Q to $106 million.
  • Cannabis inventory at cost increased $3 million with Harvested cannabis at cost accounting for $7 million of the increase. Harvested cannabis at cost is $106 million versus total cannabis cost-based inventory of $147 million. The second largest cost component of cannabis inventory is oil at $25 million.
    • 85,424 kgs flower up 10,428 KGS… they sold 22,347 KGs of flower in the Q, which is an improvement but includes the inventory of trim sold below cost. 
  • Trim inventory of $7 million up from $6 million last Q. Under good control but an outlet is needed as there is 40,000 KGs in inventory up 7,000 KGs.
  • Litres equivalents in oils decreased to 97,311 l from 120,420 l.
    • That is 16,923 KG equivalents from the oil. They sold 2,057 KGs of Oil in the Q.  Some wholesaling of oil inventory or launch of more 2.0 formats would be welcome.
  • Vape Oil 6,330 KGs up from 5,189 KGs last Q. They sold 2,279 KGs of vapes in the Q.
  • It is important to remember that inventory from harvest takes 5-7 weeks to hit retailer shelf.

“Gas in the Tank”: Peer Comparison

Aphria has the second most inventory AND CGC is US GAAP with no FVI component.

“Waterfall” – Trend Analysis

• Harvests decreased by 21,122 KGs to 41,432 KGs from 62,554 KGs, as Phase IV was taken offline but is reportedly being replanted.
• The delta for this quarter on Harvest Versus Sold of 14,702 KGs was a decrease from 41,672 KGs last Q. 
• What we said last Q: With the grow throttled and large formats out for a full Q, hopefully the delta will decrease QoQ going forward.

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

Same the last two Q’s.

Waterfall: Peer

ACB out harvested Aphria in the latest Q.

Harvest vs Sold KGs and Sales versus Inventory

Inventory to Sales:

• Aphria improved inventory turnover to 3.61 Qs from 4.02 Qs last quarter.  Again, this has the benefit of the sale of trim below cost.

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

• PPE increased by $61 million to $655 million, SweetWater would have been a $56 million of that and it looks like $40 million were Right of Use Assets that are leased. 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.

• Goodwill and Intangibles grew $134 million and $324 million, respectively with the onboarding of SweetWater. Of the $496 million total consideration $468 million was G/I.

• A/P increased $129 million to $254 million, $76 million is contingent consideration which I presume is new this Q as last Q did not have a breakdown.

What we said last 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.

This Q:

I would consider this a small “p” progress quarter.  Adult rec sales are slowing and further catalyst, beyond Ontario increasing store ramp from 40 to 80/month is the last “big” one unless Quebec does something. The bounce back in Distribution is comforting as is the appearance of international sales. 

The need to purchase Tilray is evident.  Sales increases are going to be a knife fight and incremental.  The onboarding of Tilray sales with a phase in of Aphria cultivation will also allow a higher capacity out of Aphria1 and Diamond to reverse the growth of Unabsorbed Overhead, plus a better GM at Tilray operations.

The throttled grow had little QoQ impact on GM or on cash cost per gram sold, which is a nice surprise. However, being below the 50% cannabis GM guidance is disappointing.

While the combined debt of Aphria and Tilray is worrisome, there is a chance of Aphria Debenture Lenders request payout of the Convertible Debentures and/or if the stock price stays above USD 12.19 Aphria can force the conversion.  This impacts $358 million in debt.  Without this debt the debt serviceability of the combined entity is much better, although it comes with dilution. Again, we think this is driving part of the “arbitrage” we see right now in the conversion price differential.

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.