[OGI will be up tomorrow]
Open up the fins and MDA and follow along.
There a few new moving parts with Q3F2019 with the acquisition of CC Pharma on Jan. 9/19 and the ABP for a whole Q.
Aphria sales increased $52 million wholly on the back of the CC Pharma and ABP acquisitions, as cannabis sales declined 20% pre excise tax from $22.3 million to $17.9 million QoQ. CC and ABP contributed over $1 million a day in sales for the Q.
Both KGs sold in Rec and medical dropped to 1,329kg and 1,274kgs decreases of 32% and 13%, respectively. Rec revenue was further eroded by a drop-in revenue per unit from $6.32/gram to $5.14/gram, a drop of 19%. Medical revenue per unit increased to $8.03 from $7.51/gram, an increase of 7%.
The net impact was a drop in Medical revenue by 7% to $10 million, while Rec revenue dropped 29% to $6.6 million.
The decline in cannabis revenue reflects a lack of product “from a transition in growing methods” [they went from larger pots to smaller pots in late fall and early winter, which affected yield available for sale] coupled with logistical issues in packaging and distribution. The packaging and logistic issues, while temporary, will linger into Q4.
Aphria Phase IV and IV will not be available for sale until Q1F2020 [June 2019], so unless the yield improves on existing facilities, this sales tightness from cannabis could last another Q.
It is important to separate gross margin by revenue stream as we have above. The distribution arms [CC Pharma and ABP] carry a much lower Gross Margin of 14% and make up a greater portion of revenue than does cannabis, which carries a 34% GM on the Q down from 47% last Q. This higher sales mix with lower GM resulted in combined GM of 18%.
Despite the 240% increase in sales GM in absolute terms only increased by $3.1 million to $13.4 million.
Pressure on cannabis gross margin versus historical continues, as the decision to cut production capacity from 30,000 kgs/year to 20,000 kgs/year for mothers to feed PIV and PV continues into Q3F19. Expect continued pressure in Q4 with improvements in Q1F2020 when PIV and PV product is available for sale. However, Q1F2020 will likely be impacted by the “license to sales lag” of Aphria Diamond, assuming it is licensed in the present Q. So full benefit may have to wait until Q2F2020.
GM was also affected by the transition in growing methods and by sharp increases in packaging costs from $0.97/gram to $1.98/gram as Aphria, in order to maintain SKUs at provincial distributors, reduced ¼ ounce containers in favor of pre rolls and 1/8ths, thus occupying more shelf space. Smaller unit packages have more unit costs than for a 1/4 ounce jar.
In the CC the packaging was also addressed. The late arrival of packaging regs required Aphria to order a stockpile of packaging inventory that has multiple layers. They are working through this stockpile and will be using less layered packaging as this supply is exhausted. Automation in the pre roll area will also improve COGS when that comes on line [Not sure if it is in Q4 or Q1F2020.]. They are presently hand filling pre rolls.
Cash cost for dried cannabis increased to $1.48/gram from $1.34 QoQ, whereas all in costs increased to $3.76/gram from $2.60 with the bulk of that consisting of the aforementioned packaging costs.
Gross Margin against the larger peer base is now 3rd from the bottom, ahead of only CGC and Tilray.
Fair Value Increment on inventory sold for the Q was $5.5 million or $2.10/gram sold versus $2.44/gram sold last Q. Gain on Biologicals doubled to $9.5 million from $4.2 million which should lead to more inventory available in Q4. The $9.5 million was similar in $ size to Q1F19 and second highest on record.
[Note: I removed both transaction costs and impairment from Opex to maintain trend and peer analysis.]
SGA & SBC Peer
SGA & SBC Trend
Selling, G&A dropped as percentage of sales due to the increase in the sales denominator from CC Pharma. Comparing QoQ for a trend basis will require a few more Q’s to provide a meaningful trend line.
Selling decreased QoQ in absolute terms to $6.9 million from $8.3 million. The reduction, despite $1.7 million in new selling expenses from Distribution, is a result in the new C-45 regs coming into effect and curtailing allowable advertising spend.
G&A increased from $12.3 million to $22.4 million as CC Pharma added to headcount, officers and directors, prof fees, insurance and travel by $3.1 million. A further $3.3 million was due to the special committee on LATAM acquisition. The balance was the scaling up of operations for packaging and distribution for PIV PV.
Peer Comparisons, while provided, will be less useful due to Aphria’s diversification into distribution.
SBC also jumped dramatically from $2.6 million to $14.3 million and increased as a percentage of sales to 19.4% QoQ from 11%. This was the biggest increase of all the Opex. This was explained in the MDA
- The Company recognized share-based compensation expense of $14,300 for the three months ended February 28, 2019 compared to $5,959 for the prior year. Share-based compensation was valued using the Black-Scholes valuation model and represents a non-cash expense. The increase in share-based compensation is a result of an increase in deferred share units (“DSUs”), stock options vesting, as well as an increase in stock price used in the valuation of DSUs and options issued in the current period. The Company issued 3,516 DSUs and 1,525,000 stock options in the current quarter compared, to nil DSUs and 1,825,000 stock options in the same period of the prior year. Of the stock options granted in the quarter, 1,100,000 vested in the quarter.
I have mentioned this prior… but SBC is lumpy and will rise as more units are distributed or if stock price increases.
Total Opex is rounded out with Amortization of $3.7 million (expect this to jump next Q as PIV and PV are brought on line) and R&D of $0.2 million.
Total Opex increased to $48 million from $26 million yet decreased due to the sales increase to 65% of sales versus 118% last Q.
Net Operating Profit B4 IFRS Voodoo
NOP fell to negative $34 million from negative $20 million last Q. The $3 million uptick in GM was not sufficient to balance out the $22 million increase in Opex.
As mentioned above, I pulled the impairment of LATAM assest of $50 million and transaction costs of $0.9 million into this section. Other expenses totaled $89 million. Of which the Impairment of $58 million, includes Latam assets, and loss of $30 million on LT Investments.
Impairment from MDA…
- During the quarter and at the request of the Ontario Securities Commission, the Company completed an annual impairment test on its LATAM assets. As a result of this impairment test conducted by the Company, it determined that a $50 million non-cash impairment charge to the carrying value of the LATAM assets was required. The basis for this impairment arises from the Company’s reassessment of the discount rate and the financial forecasts for these entities as a result of new financial information received from independent third party’s review of the LATAM transaction. This new financial information consisted of lower gross margins and EBITDA margins used by the financial advisor for the Special Committee and recent financial information from the LATAM entities that showed higher than expected expenses. As a result of this new information, Aphria determined that the discount rate should be adjusted which resulted in the non-cash impairment charge to the carrying value of the LATAM assets. Also included in impairment is £4,600 GBP ($8,039 CAD) related to uncollectible notes receivable.
This would have likely been conducted in Q4 during the audit but the OSC had requested and the review. The assumptions were adjusted as was capitalization rate which pulled value down by $50 million on Latam. Where the pound sterling uncollected note receivable is from… I didn’t dig into it. I would guess it was CC Pharma.
The $29 million was described as follows…
- For the three months ended February 28, 2019, the Company recognized a loss on long-term investment of $29,968. The loss in the period relates to the loss realized in the divestiture of equity investment in passive US assets of $10,577, the unrealized loss on the Company’s portfolio of long-term investments of $19,391 due to change in the fair value as at quarter-end. The unrealized loss on long-term investments for the three months ended February 28, 2019 is largely comprised of the loss on the remaining U.S. legalization options of $15,037 and losses recognized in the Company’s investment portfolio.
Adjusted EBITDA continued to slide with a decrease to negative $13.8 million from $6.1 million for Cdn Assets, whereas Aphria International improved from negative $3.5 million to negative $0.6 million. So, the burn from the International assets has slowed and is trending to positive. We will see if the award of German licenses produces some drag next Q and going forward.
Breakeven Sales required to +NOP increase dramatically. This is a function of the decrease in GM% and the increase in Opex. They need approximately $188 million in more sales at present GM% and Opex $’s to get to +NOP.
To get to +Adj EBITDA they will need $79 million more in sales. They should get $40 million in Sales from holding CC Pharma for a full Q, BUT that also increase SGA.
The biggest “knob” that Aphria can turn to reduce Breakeven Gaps [3 knobs to improve breakeven: Sales increase $’s, Opex decrease $’s, GM % increase] is to improve Gross Margin, which will not likely be until Q1F2020.
As a good chunk of Opex was non cash in Q3 [SBC] the Breakeven Sales for + Adj EBITDA is less of a climb when divided by current sales.
Balance Sheet Items of Note:
- Cash and marketable securities decreased $50 million to $134 million. With additional $89 million from divestment of GGB assets, cash is looking less concerning than last Q. Also, there remains ability to get Term Debt with PIV and PV licensed and Diamond soon to be.
- A/R increased substantially. With the decrease in Rec cannabis sales this is likely all CC Pharma
- Bio Assets increased modestly to %7.3 million from $6.1million. Look for this to increase substantially next Q.
- Inventory increased $46 million QoQ to $86 million but… $44 million of that is CC Pharma nd packaging related.
- Lets look at cannabis related inventory… And
Carl will get a message from me on the lack of breakdown. [I suggested he looks at OGI which does a
VERY good job of breaking down saleable and non saleable inventory]
- KGs in inventory went up 26% or $8 million. The bulk of that increase is in dry Cannabis which went up $3.7 million and Cannabis Oil which went up $3.4 million.
Gas in tank Peers
Gas in Tank Trend
- As Aphria doesn’t break out WIP and FG I have put it all CANNABIS inventory into WIP and in the latter Trend chart I have shown just the Cannabis Inventory Delta.
- Cannabis Inventory is greater than last Q Cannabis Sales, but we have no insight as to sales ready. On the CC I believe they indicated Cannabis sales would remain in same ballpark for Q4.
- Capital assets increased by $52 million to $66 million as new construction in progress wa sup $40 million. The balance is Land $5.2 million, $5.4 million equipment and $4.6 million production facility.
- Intangibles were written down with the LATAM impairment
- Note Receivable dropped $67 million and LT Investments dropped $38 million
- Goodwill increased $18 million to $674 million
- A/P increased $76 million…likely due to CC Pharma and construction related events.
All in all… a tough Q for Aphria. Cannabis sales have retrenched and look to be in same neighborhood until new product from PIV and PV is available on shelves in June/19. With rooting chambers processing clones, the 10,000 kg reduction for Mothers and Nursery may be alleviated somewhat.
Gross Margin will likely be depressed through Q4F19, as more lower margin Distribution will be on the books for the full Q and no significant rebound in higher margin cannabis until Q1F20.
The LATAM write down was probably a Q in advance of when it would normally be. It’ll be interesting to see if peers with upcoming Q4’s have similar write-downs.
That’s all I got.
The writer has a position in Aphria.