Aphria Earnings release.

Last Q: 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.

This Q: A very good run of Progress Quarters hits the reality that we have been identifying over past few Q’s.  The knife fight for sales has emerged as the sector leader gets hit with their first product returns on cannabis.  The covid lock downs are going to persist into Q4 F21 in all of their markets.  Q1 F22 will have a full Q of integration of Tilray.  It will be bumpy for a while.

As we said last Q, the slowing of sales shows why they bought Tilray. 

What I said last Q

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.

This quarter:

Pluses

• SweetWater added $15 million in sales in their first full Q.
• SweetWater GM is their top segment by % of sales at 41% which includes a inventory step up of $1 million on the purchased inventory that will dissipate over the next 2-3 Q’s as the purchased inventory is sold.
• SGA reductions in absolute terms and remained consistent as a % of sales, despite the full Q of SweetWater SGA.
• Cannabis inventory levels remained consistent, but high, despite sale decrease.
• Adj EBITDA showed a slight increase and increased for eight consecutive Q.

Minuses

• Sales, despite adding SweetWater for the full Q of $15 million, decrease $7 million or -4%.
• Adult use cannabis decreases 17% to $60 million, reversing two Q’s of growth in one Q.
• International sales all but disappeared reducing from $5.3 million to $0.4 million.
• First ever return of $5 million in cannabis from Alberta.
• Gross Margin decreases to lowest level since Q3F20 hit by product return, unabsorbed overhead and inventory step up.
• Free Cash Flow, despite strong improvement QoQ, remains negative at $3.9 million

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 -4% decrease in Net Revenue of $7 million to $154 million. Cannabis revenue (net excise) have decreased for the first time since the May 2020 Q, dropping $16 million or -24%. Distribution revenue continues its rocky covid period decreasing 5% or $4.6 million.  SweetWater has a full Q of sales at $14 million.

Before Excise tax…

• Cannabis Revenue decreased $18 million or 21% to $69 million before excise and decreased $16 million and -24% after excise.
  • Adult use was -17% reducing by $12 million to $60 million, returns of $5 million partially account for decrease.
  • Medical was down 5% by $0.4 million to $7.4 million, marking the seventh Q of givebacks.
  • Wholesale decreased $0.1 million in sales to $1.6 million and
  • International, after its first appearance at $5.3 million last Q, ends up at $0.4 million

• Distribution Revenue decreased $5 million or -5% to $87 million, the second lowest of five Q’s under review
• Sweetwater recorded $14 million in sales.

Table 2 Revenue by Product Segment

Flower growth had been slowing and finally went negative this Q, with -23% or -$15 million QoQ.  This is a function of the lack of International sales in the Q coupled with product returns and reduced inventory demand, as provincial boards reduced inventory ordering in the face of store closures from the pandemic.  

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

Oil products had the second worst month in the five Q review period.

Vapes trajectory backslid strongly at -25%.  Pricing pressure and competition are the reasons.

Table 3 KGs Sold and Average Selling Price

The bulk of the decrease in KGs sold is found in the decrease of 6,983 KGs in wholesale and international and represents 87% of the decrease QoQ. The balance of reduction is largely adult use market at -13%. This is their third highest KGs sold in past five Q’s.

• The adult rec market decreased 1,035 kgs or a 6% decrease. Value brands are becoming more dominant.  They also evidenced a decrease in ASP by -12% to $3.82/gram.  They are moving 16,000 KGs +/- 1,000 KGs over the past three Q’s. In order to get the Aphria cultivation moving at full steam they need to increase this rather dramatically.
• The medical market saw a nominal decrease of 17 kgs or 2% and a decrease in average selling price of 4%, as they introduced compassionate pricing for those impacted by covid in Q2F21 and for the full Q in Q3.
• The wholesale and the newly added international market decreased by 6,983 kgs to 1,980 kgs.  Israel annual purchase commitment with Cannadoc has been fulfilled in Q2, as such more sales through that channel are at Cannadoc discretion.  They sold some product in Q2 at a loss, this the bounce back in Q3 pricing to $1.05/gram +33%.

Revenue per gram increased from $3.25/gram to $3.69/gram, a reduction in wholesale and international is the reason.

Adult Recreational Cannabis Revenue: Trend and Peer

First step back from Aphria on Rec in since the first full Q of adult rec.  Canopy has $20 million in retail store level sales.    

Medical Cannabis Revenue: Trend and Peer

Medical, which now includes international sales, decreased to pre Q2F21 levels.

Wholesale Cannabis Revenue: Trend and Peer

Wholesale of $1.6 million.  Last Q 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 $87 million in Distribution and $14 million beer sales.

Gross Margin Before IFRS Voodoo:

Overall gross margin decreased to 25% vs 27% QoQ and decreased to $38 million this Q in absolute terms from $44 million, for a decrease of $6 million in absolute Gross Margin:

• -$3 million in GM was the return of the $5 million in product from Alberta
• -$2 million was result of lower annual yield in the Q3 quarter due to sunlight reductions.
• -$1 million in unabsorbed overhead from operating below capacity.
• +$5.5 million in GM from SweetWater which itself has a $1 million inventory step up charge from the inventory at date of purchase. 

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

Cannabis GM% fell from 46% to 39% as they took a $3.0 million loss on returned inventory $1.0 million in unabsorbed overhead an improvement of $1 million QoQ.  Without the inventory returned at loss GM would have been 44%, still below the +50% guidance given on Q2F20 CC.

Gross margin was flat in Distribution at 13%.  Net GM decreased as sales decreases of 5% took its toll.

GM for SweetWater was 41% and adjusted for acquired inventory was 49%.  They mentioned that keg sales have a larger GM% and that with opening of more venues post pandemic in US that improvement should flow through.

Cash cost of cannabis sold increased 14% or $0.11/gram QoQ to $0.90/gram the second highest in the period of review.  The full decrease was attributable to the reduced yield in the Q3 Q which is seasonal.

With SweetWater in the mix, Cannabis GM was 54% of total GM versus 70% last Q

All in GM was $38 million versus $44 million last Q. this is the second lowest absolute GM in the five Q’s reviewed.

Gross Margin Cannabis Trend and Peer

Aphria leads the peer group with a 39% cannabis GM versus the next closest Hexo at 34%.

Fair Value Increment on inventory sold increased QoQ to $45 million from $30 million, which is odd given KGs sold dropped. The only material FVI in inventory now is on cannabis as trim has $0 FVI and oil and vapes are $0.01/ml only. 

Gain on Biologicals increased by to $39 million from $26 million but well below the record pre-throttle of $59 million in Q1F21. They have increased the grow, likely in anticipation of Tilray acquisition and shutting the Tilray London grow and likely throttling the Tilray Nanaimo grow until BCC can refurbish.

Given this is the last Q under IFRS, Carl has gotten them through IFRS without an inventory impairment.  But one could be looming next Q and it might include costs.

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:

SGA & SBC as % of Sales: Trend Analysis

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

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 $1.7 million to $26.1 million, which is rather good seeing SweetWater added $2.7 million in the Q. G&A as percentage of sales was 17%, stable QoQ.  Decreases in consulting fees of $1.1 million and executive compensation (not including SBC) of $1.0 million.  Office and General was also down $0.7 million.    

Selling expenses was flat at $7.6 million while marketing and promotion decreased by $1.3 million to $4.0 million. Selling and Marketing as a percentage of sales was flat QoQ at 8% of sales.

SBC, which is cyclical, blew out by $23 million to $36 million or 15% of sales, as the stock price increase is the reason, as it is the reason for the convertible debenture loss below.

Rounding out Opex is:

• R&D of $0.2 million vs $0.3 million last Q
• Amortization of non-production assets of $14 million versus $5.6 million last Q as SweetWater definite term assets are amortized.

Overall Opex increased to $88 million from $60 million QoQ with SBC and depreciation 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 48% with TLRY next at 52%.  Again, Aphria has a low margin high revenue Distribution business that drives the lower figure.

Net Operating Profit Before IFRS Voodoo:

NOP was negative $50 million versus negative $16 million last Q.  Decrease in GM of $6 million coupled with SBC and depreciation increases are the reason.

NOP becoming + will require stock price to settle down and a return of sales and GM.

+NOP Breakeven Sales

Aphria is fourth highest in this ranking. Aphria requires an incremental sales increase of 133% to reach +NOP at present GM% and OPEX$’s.  But with SBC settling down this might reverse a good degree next Q.  

Other Income & Expenses of Note:

• Finance Expense:
  • Interest Expenses was $10.4 million versus last Q $6.5 million. This increased with a full Q of the SweetWater term loan.
  • Finance income was +$0.4 million level with last Q.

• Other Expenses and Income:
  • Transaction costs of $12 million related to Sweetwater and Tilray.  I would expect another $20 million or so next Q as Tilray closes.
  • Unrealized loss on Convertible Debentures of $265 million versus a loss last Q of $6.5 million.  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 after three years from issue. 
  • F/X loss of $4.9 million as CAD appreciated QoQ versus last Q loss of $4.2 million.
  • Loss on Long Term investments of $3.3 million this Q and last Q -$0.5 million.
  • Other expenses were -$3.5 million versus income of $2.5 million last Q. No narrative provided.

Total Other Income was negative $299 million after negative $118 million last Q.

Income Before Tax was negative $355 millionversus negative $139 million last Q.

Taxes were $6 million.

Net Income after tax was -$360 million versus -$122 million last Q. The big swing is $264 million in FV loss on debenture, $12 million transaction costs, $6 million reduction in GM, and increases in SBC and Depreciation aggregating $30 million.

I do note that Non-Controlling Interest, largely Diamond, was $18 million for the Q.  So, the Diamond boys are making good money being a farmer in this relationship. Diamond has revenue of $139 million YTD and Net Comprehensive Income of $97 million. The Diamond boys get $47 million of that.  I will be asking Carl if that money actually leaks out of the JV or if it will be used to pay down debt within the JV.

+Adjusted EBITDA Breakeven Sales

Aphria is positive Adj EBITDA.  At current GM% and Cash OPEX they could run at 67% of existing sales and be +EBITDA.

EBITDA: Trend and Peer

With EBITDA of $12.7 million we now have eight successive Q’s of +EBITDA with sequential QoQ increases in each Q for the past seven Q’s. 

• Cannabis operations evidenced a $7.6 million EBITDA vs $12.9 million last Q a very notable decrease. The sales decrease, returns and unabsorbed overhead are the reasons.
• Distribution evidenced a $1.2 million EBITDA versus $2.6 million EBITDA last Q. Half of that impact is from the reduction in sales and resultant GM.  
• SweetWater evidenced $5.0 million EBITDA.
• Businesses under development had a negative $1.5 million versus negative $3.2 million. This is the lowest in +2 years.

We were expecting an increase in EBITDA with the accretive SweetWater being added.  The reduction in the cannabis business EBITDA might take a few quarters to rectify.

Operating Expense Burn: Trend

Cash generated from Operations was $1.5 million versus $3.4 million last Q. Cash provided by financing activities was $100 million (the SweetWater term loan) versus $122 million last Q.

Cash used in investing activities was -$11 million versus -$348 million last quarter when they purchased SweetWater.

Opex was a source of cash (versus burn) during the Q of +$7.6 million versus -$16 million last Q. They missed being Free Cash Flow positive with $5 million in investment in capital and intangible assets offsetting the Opex Source.

Carl is guiding to positive Free Cash Flow in the back half of F2021.  He has one more Q to get there.

Operating Expense Burn: Peers

Balance Sheet Items of Note:

• Cash increased $79 million to $267 million as SweetWater loan closed after Q end.   
• A/R reduced $14 million to $82 million. Lack of wholesale and international coupled with decrease in adult rec are the reasons.
• Inventory saw its first decrease since Aug 2017, with a decrease of $7.7 million.

Cash versus Debt Service

• Annual debt service is $69 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 $83 million annually to cover same (although P amortization is not included). They are at $51 million in annualized EBITDA. This will change with Tilray, and not to the good.  However, the Aphria or Tilray Convertible Debentures could be flipped to equity, which changes the look of the company significantly. I fully expect an equity raise in very close proximity to the Tilray closing.  +$500 million would not surprise.

 “Gas in the Tank”: Trend Analysis

Inventory in $ decreased for the first time since 2017.

• Biological Assets decreased $1.9 million to $27 million. Reduction in FVI is likely the cause.
• Inventory was -$7.7 million to last Q at to $314 million; FG and WIP remain unsegmented, much to my chagrin.
  • $28 million is Distribution inventory a decrease of $10 million.  
  • $28 million are Other Inventory items (packaging and vape hardware) and likely some SweetWater inventory, a $5.3 million increase QoQ.
  • FVI decreased a $4.3 million in the Q to $102 million.
  • Cannabis inventory at cost increased $2 million with Harvested cannabis at cost accounting for the entirety of increase. Harvested cannabis at cost is $112 million versus total cannabis cost-based inventory of $251 million. The second largest cost component of cannabis inventory is oil at $23 million down $2.6 million QoQ.
    • 86,981 kgs flower up 1,557 KGS… they sold 14,462 KGs of flower in the Q. 
  • Trim inventory of $7 million level with last Q. Under good control but an outlet is needed as there is 46,000 KGs in inventory up 6,400 KGs.
  • Litres equivalents in oils increased from 97,311 l to 106,383 l.
    • That is 18,501 KG equivalents from the oil. They sold 2,270 KGs of Oil in the Q.  Some wholesaling of oil inventory or launch of more 2.0 formats would be welcome.
  • Vape Oil 6,013 KGs down from 6,330 KGs last Q. They sold 1,962 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

• Implied Harvests decreased by 13,530 KGs to 27,902 KGs from 41,432 KGs, as Phase IV was taken offline in Q2 but is reportedly being replanted.
• The delta for this quarter on Harvest Versus Sold of 9,207 KGs was a decrease from 14,702 KGs last Q. 

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

Waterfall: Peer

ACB out harvested Aphria in the latest Q.

Harvest vs Sold KGs and Sales versus Inventory

Inventory to Sales:

• Aphria inventory turnover slowed to 4.71 Qs from 3.61 Qs last quarter.  They are in dangerous territory.  With Tilray expected to close in this Q I would not be surprised with an inventory impairment next Q.

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

• PPE decreased by $10 million to $645 million with PPE increasing $5 million against increased depreciation of $15 million for the Q. They are signaling Capex for the second half of the fiscal will be minimal and will be selective.

• Goodwill and Intangibles decreased $23 million. Looks to be amortizing of SweetWater and other G/I as no impairments for the Q.

• A/P decreased $86 million to $168 million

• Long Term debt increased by $110 million mostly due to the USD 100 million term loan.

• Convertible debentures by $265 million to $623 million.  Stock price increases.

• $76 million is contingent consideration from SweetWater acquisition.

What we said last 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.

This Q:

We have gone from Progress quarters to progress quarter to a solid step back this Q, one which might take more than a quarter to remount.

COVID has taken a toll.  But COVID has been here for a year.  The downturn in Adult use sales for Aphria is the main concern as is the Gross Margin taking a hit.  SGA controls were quite good given they went down despite onboarding SweetWater for the entire Q. 

The throttling of the grow in Q2 is seeing its affects in both inventory levels and unabsorbed overhead.

It is going to be bumpy for at least the next 2-3 quarters as Tilray is absorbed and integrated, dilution is likely but will also likely improve the balance sheet with a likely debt pay down of incoming Tilray convertible debentures (that are waaaaay out of strike price) and some higher priced term loans.

This quarter was very predictable if you have been a subscriber and have been following our takes on Canadian recreational sales increases slowing.  Aphria went on a very admirable streak of increased rec sales that have spanned eight quarters.  They will have to look to restart that streak with Tilray next Q and for the full Q in Q1F22.  The Q to keep an eye on will be Q2F22 (and for our subscribers we will be doing our best to dissect the onboarded sales via Tilray versus any organic growth for the next two Q’s).  Will they start adding to sales or will the knife fight continue?

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.