Canopy released their September 30, 2020 earnings yesterday.
What I said last Q:
This is only a “progress quarter” as it relates to Selling expense.
- Cash and Marketable Securities increased $60 million to $2.0 Billion as Constellation exercised +$245 million in the money warrants.
- Rec Oil and 2.0 increased $8.4 million QoQ
- Other Revenue increased +8% or $2.4 million
- Opex improved $118 million QoQ, but Q4F20 had many one-time costs associated with restructuring from last Q. Notable $36 million in SGA and SBC acceleration last Q of $33 million.
- Sales increased 2% QoQ, whereas market is increasing +20%
- Dry Rec dropped 18% QoQ to lowest amount in last 5 Q’s under review.
- GM was 6%, an improvement from -85% last Q, but far from the 40% target.
- The Elephant in the Room – Canopy and their non-live production facilities” for further clarification on this issue.
- Opex remains 150% of sales
- Asset impairment of $13 million
- Goodwill and intangibles dropped another $57 million
- They invested another $35 million in Acreage
- Progress on revenue with cannabis sales up 18%
- Dry flower rebounds with a +59% increase to $64 million QoQ
- Gross Margin has a $28 million “under absorption of fixed costs”. I said this last time, but this is their biggest headwind for foreseeable future.
- Opex backslid increasing $3 million to $169 million
- SGA + R&D is four times GM.
- Impairments of $46 million on PPE and $95 million on expected credit loss on PharmHouse
- EBITDA while improved $7.5 million it remains the worst in industry by double any other LP at -$86 million.
Open the financials and Management Discussion and Analysis and follow along.
Overview of Quarter:
For the quarter ending September 30, 2020 CGC evidenced $135 million sales net of excise tax, surpassing the previous record of $123 million in Dec 2019 Q. This was a 23% increase from the previous quarter or + $25 million.
Table 1: Revenue
Rec sales were $75 million before excise tax versus $52 million last Q, an increase of $23 million or +46%. B2C bounced back from covid closures and the opening of nine more stores in Alberta with 100% sequential growth$9.3 million, while B2B evidenced a $14 million +34% increase. Expect the new stores opened by CGC in the Q to help deliver greater sales next Q.
Medical retreated to $33 million or -$2.7 million with Cdn sales flat and international decreasing by -$2.7 million.
Cannabis sales net of excise tax increased 18% to $92 million.
Other Sales were up $11 million or +27% to $43 million. Despite this segment generating an increasing amount of revenue no segmentation is available despite analysts asking for same on CC and being rebuffed.
Table 2: Revenue by Form
Sales mix for Rec continue to shift from pre 2.0 mix of 90-10 Dry-Oil to 81-9-10 Dry-Oil-2.0, respectively. Provisions remained consistent at $3.8 million in the Q.
- Rec dried saw an increase of $24 million reaching its highest level since Dec 2019.
- Oil evidenced a sizeable $3.6 million increase two Q’s ago and is holding well at $7.0 million. There is a push to sell out 1.0 Oil by year end when new packaging requirements are required on 1.0 Oil. This could be part of that push.
- 2.0 formats increased +10% to $8.0 million from $7.1 million.
- Rec Provisions increased to $3.8 million QoQ from $3.4 million.
All in Rec was up pre excise deduction by $24 million.
Medical is consistent at 27-73% split with flower-oil with international sales the slight majority
- Medical Dried saw a decrease of $1.3 million or -12% to $8.9 million.
- Whereas Oil saw a $2.0 million decrease or -8% to $23 million.
Gross medical was $33 million pre excise, a reduction of 8% QoQ or $2.8 million.
Other Revenue was $43 million up $11 million QoQ or 34%.
Overall cannabis sales net of excise increased from $78 million to $92 million reversing two Q’s of stagnation.
Adult Use Revenue: Peer and Trend
Provisions are included in the above.
Canopy’s ceded top position atop of the Rec sales ladder to Aphria two Q’s ago.
On the cc they indicated beverage production is doubling in July and should in August as well. They have registered many “stock outs” on their beverages. This is a good sign, but they do not give a $ amount that beverages are contributing.
It is interesting that they repeated several times in the CC that they have improved “Customer Order Fill” from 56% last Q to 87% this Q, yet sales were only up 3.3% in a market that saw +20%. They may be filling smaller orders.
Despite the beverages doubling in July and August output the sales increased by $0.9 million or 10% to $8.0 million.
Order fill rates have increased to 90%.
Medical Revenue: Peer and Trend
Canadian medical has stabilized in the $14-15 million sales range at $15.3 million this Q, no change QoQ. ACB remains the market leader followed by Canopy.
International medical sales shrunk by -$2.7 million to $17.5 million. This is the first back to back contractions in the five Q’s under review. More competition on Dronabinol and in German Flower market were the stated reasons.
Gross Margin improved from 6% of sales to 19% of sales, for a total of $26 million. Consider ACB had 50% the sales of CGC and GM of $25 million, which was not that good, and you have a picture of a steep climb to the projected 40% MYTHICAL GM. GM did improve by $20 million QoQ.
They do not provide any GM breakdown by segment. But think of it this way… if their unsegmented “Other Revenue” has a GM of 40% that would be $17 million in GM. Does that mean cannabis is only $8 million in GM or 9% of sales?
What I said last Q:
They removed average selling price, so I can no longer do that math. It was pretty ugly and with value offering contributing more to the sales mix it would not get any better.
Gross Margin was negatively impacted by the following:
- $18 million CoGS charge for “under absorption of fixed costs”.
- $11 million CoGS charge for crop that did not meet THC threshold
- $5 million CoGS charge for inventory holding policy provisions
Here are the quotes from the CC for additional color:
- The biggest driver was an estimated $18 million impact related to under-absorption of fixed costs resulting from lower production output, stemming from reduced demand and our SKU rationalization activities.
- Q1 margins were also negatively impacted by an estimated $11 million charge related to manufacturing variances which included out-of-spec production that did not meet new targeted THC ranges.
- In the quarter, we also recognized an inventory provision of $5 million based on revised forecasts relative to our inventory holding policies.
The latter two were not reversed from Adjust EBITDA, whereas last Q they would have been.
That “under absorption of fixed costs” is DESPITE reducing cultivation capacity in Q4 F20. That is with the current capacity of Smith Falls, TWEED Niagara, Newfoundland, Vert JV, and some other small facilities. Unless they increase usage drastically (via more sales) this figure will be like dragging a boat anchor. To put in perspective, they indicate that Canadian facilities could support sales of $2.5-3.0 billion per year without much more capex. They are running at under $350 million annually. That is a 10% capacity utilization. That is a big problem unless they can conjure sales, and over the last year Q sales have increased 9% despite the market more than doubling in size.
They expect GM to be under 20% next Q.
Unless they increase usage drastically (via more sales) this figure will be like dragging a boat anchor. That was $18 million anchor last Q is $28 million this Q. From MDA:
- In the second quarter of fiscal 2021, our gross margin percentage was primarily impacted by operating costs relating to facilities not yet cultivating or producing cannabis, not yet producing cannabis-related products or having under-utilized capacity. In the second quarter of fiscal 2021, these costs amounted to $28.2 million and primarily related to (i) start-up costs associated with our indoor cultivation facility in Newfoundland and our gummy production facility in Smiths Falls; and (ii) under-utilized capacity associated with our chocolate factory and vape production facilities in Smiths Falls.
A break down between (i) and (ii) would have been helpful, as would a timeframe to deal with the issues. At a 40% MYTHICAL GM they would need $70 million in incremental Q sales to absorb the above.
With GM at 19% of sales it was as guided.
SGA + R&D is $112 million or 4 times Gross Margin.
Table 3: Gross Margin Adjusted for
Non-Producing Assets Inventory Step Ups
What I said
three four Q’s ago:
- Imagine General Motors in 2008-09 during the bailout saying, “if only we ran our facilities at 100% capacity, we would be profitable.”
What I said
two three four Q’s ago:
The projected 40% GM seems to have been pushed off until they get beverages up and running.
This 40% GM target might see further headwind if they start taking full facilities offline.
What I said
last two three Q’s ago:
Still not breakout of GM% by segment. They did indicate that a 40% GM will not likely occur for the next few Q’s. This along with the drop in sales does not bode well for next few Q’s.
They have changed how they account for their adjustment to Gross Margin. It is no longer “non live production facilities” (which is indicated in MDA to be a charge of $8.7 million for Denmark, SF gummy line and Newfoundland facility) but “Charges related to flow-through of inventory step-up on business combinations”.
Last Q this item was titled “Q4 2020 excludes (i) restructuring and other charges of $132.1 million related to the impact of restructuring actions; and (ii) $4.7 million related to the flow-through of inventory step-up associated with fiscal 2020 business combinations.”.
I am quite surprised that no longer include the non-live production facilities. Maybe they have tossed out the crutch, as I have suggested.
They finally went and put this silly metric in the Metric Dustbin. Good riddance!
Gross Margin: Larger Peer Group
CGC is the lowest of the +GM% companies at 7%.
Gross Margin: North American Peer Group
I do note that Tilray and Aphria have a substantial portion of non-cannabis lower GM% business in their sales mix.
SGA & SBC as % of Sales: Trend
Note: Asset impairments and the like have been moved to Other Income/Expenses to maintain peer comparability.
What I said last Q:
Selling expenses decreased considerably to $38 million from $75 million. A decrease of $37 million. They slashed their marketing department last Q. Given their lackluster sales… it was about time.
G&A expenses decreased to $65 million from $87 million. A decrease of $22 million. But this is only $3 million less than Dec 31, 2019 Q. Most of the previous Q’s expenses were one-time in nature. This is the expense category to keep an eye on.
SBC also saw a sizeable decrease to $31 million from $78 million. They accelerated $33 million in SBC the previous Q. They have indicated that SBC will likely rise next Q.
Selling expenses increased to $43 million from $38 million, an increase of $5 million. They slashed their marketing department two Q’s ago and with covid restrictions improving they appear back out and marketing.
G&A expenses increased to $70 million from $65 million. An increase of $5 million. This is an increase over Dec 31, 2019 Q which was $67 million. No SGA schedule is provided nor any QoQ narrative in the MDA.
SBC also saw a sizeable decrease to $22 million from $31 million. They were guiding this to an increase in the Q, but a number of options were forfeited.
SGA and SBC total 100% of sales a good decrease from 120% last Q.
R&D remained stable QoQ at $14 million. Continued work on yet to be launched beverages and vapes.
Total Opex was $169 million versus $166 million last Q. This represents 125% of sales.
SGA & SBC as % of Sales: Peer
CGC is second to ACB in Selling and Aggregate SGA but is the leader in SGA SBC aggregate.
Net Operating Profit was negative $143 million versus negative $160 million last quarter, for a $17 million improvement. $20 million improvement in GM offset by Operating expenses increasing by $3 million.
+NOP Breakeven: Canadian Peer Group
At current GM% and OPEX$’s CGC needs 549% increase in sales to hit +NOP.
+NOP Breakeven: North American Peer Group
Other Income and Expenses:
This was +$47 million versus the last Q +$28 million.
- Asset impairment of $46 million versus $13 million last Q. Facility closure losses, leaving South Africa and Lesotho, and severances and restructuring
- Expected credit loss on financial asset of $95 million, a new expense. PharmHouse related. Investment, DIP, and other advances.
- -$33 million loss on equity method investment versus -$7 million last Q
- Other Income (below) of $221 million offsets the above.
Other Income Table:
- Other Income and Expenses were +$221 million for the Q versus +$48 million last Q.
- Fair Value Changes were +$226 million for various investments (Acreage, Terrascend), convertible notes, warrants and contingent consideration
- $3 million interest income
- $1.5 million interest expense
- -$5 million FX loss
- Other income -$1.3 million
Add $0.5 million in tax recovery and you get a Net Income of negative $97 millionversus negative $128 million last Q. Progress… I guess?
EBITDA Trend and Peer
What I said last Q:
OK… colour me suspicious. Why didn’t they deduct the $11 million in inventory that did not make the THC threshold and the $5 million in inventory that was provisioned for inventory holding policies? Could they be looking to drop a “Hey, we improved adj EBITDA by $16 million!” next Q just by not having these issues next Q?
EBITDA improved from -$93 million to -$86 million this Q. This is the best adj EBITDA since the Q ended December 31, 2018.
GM was the driver at +$20 million offset by cash Opex increases of $13 million.
At the 40% MYTHICAL GM, with current SGA & R&D, they would need Q sales increase of $145 million to cover it.
+EBITDA Breakeven Canadian Larger Peer Group:
Using current GM% and cash OPEX$’s, CGC would need an incremental increase of 330% in sales to post +EBITDA.
+EBITDA Breakeven North American Larger Peer Group:
Cash Flow Statement:
Cashflow from Operations: Trend
- Cash used in operating activities $162 million
- Cash Used (generated) in investing activities $142 million.
- Cash provided by (Source) in financing activities $4 million
- Net increase (decrease) in cash and equivalents ($302 million). That is 5.7 Q’s of cash at current usage level.
Opex Burn increased as -NOP and losses from PharmHouse drew cash via DIP financing.
Cashflow from Operations: Peer
Still the largest of peers, in a bad way.
Balance Sheet Items of Note:
- Cash and marketable securities total $1.7 billion a decrease of $315 million.
- Below is Gas in the Tank… CGC still has an oil tanker.
Gas in the Tank: Trend
- Total inventory is an industry leading $398 million +$8 million for the Q, and that is without IFRS Gain on Biologicals
- Finished Goods is $79 million similar to last Q.
- WIP was $256 million down $4 million.
CGC deleted the last vestige of their KG Harvest and Sold this Q. With Harvest going into the metric dustbin.
- Harvests dropped 2,890 kgs -11% to 22,990 KGs
Given inventory increased, they likely still have to throttle harvests.
Sold vs Inventory and Production Costs vs Inventory:
On a GAAP basis CGC has 3.9 Q’s of inventory. Given the $28 million of CoGS tied into unabsorbed overhead this figure might be underestimated.
Cannabis $ Inventory to $ Sales; Peer and Trend
- Canopy and Cronos are reporting as per GAAP so no IFRS fluffing.
- I said this
two threefour Q’s ago: “Despite Canopy adjust GM for underutilized facilities, I believe they need to sell some of their cultivation facilities.” And I believe it still holds true, although this Q might have me re thinking that of they grow again next Q.
- Other Financial assets take a $108 million decrease largely on the PharmHouse CCAA issues
- Liability from Acreage agreement decreases $138 million on the restructure
What I said last Q:
Sales were expected to be flat and GM was expected to be low. They were.
SGA were expected to better. Selling was. G&A is pretty much where it was two Q’s ago.
Klein has put his stamp on the organization and now it’s time to see if a focus on flower quality and customer experience pay off.
Beverages, while growing, still represent a fraction of revenue. The reviews are good on Houseplant’s seltzer-like product, mixed on the Houndstooth sweetened drinks, and Deep Space has “taste issues”. Hopefully, they defy other established cannabis markets and bring in new non cannabis consumers.
I am concerned that their GM% will continue to suffer as they are very much selling less than capacity. And unless they shake off six quarters of very meh sales… their sales will continue to underperform the market. Their B2B sales are 20% off their peak of December 31, 2019 Q. Flower Rec sales are 35% off their June 30, 2019 peak.
I expect an improvement in EBITDA next Q as $16 million in provisions hopefully do not re-occur. But I am unsure of other material improvements.
This tear down needs more than a coat of paint.
A progress quarter in that their main sales driver, dried cannabis, shows some good signs of life. 2.0 products are growing but remain below $10 million Q contribution. The growth in Other revenue was particularly impressive.
With Martha Stewart rolled out and CGC promising US wide Biosteel distribution in early 2021 there are a number of new ventures to follow. Unfortunately, without any metrics or segmentation you will have to take C-suite word for any improvement.
Gross margin will be a concern until they can work out from under the $28 million in unabsorbed overhead. Not one analyst asked them about this on the call.
Despite progress EBITDA remains the worst in the industry at -$86 million.
That’s all I got.
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 does not have a position in CGC and will not start one in the next five days.