Canopy released their September 30, 2021 earnings Friday morning November 5, 2021.  They published financials after their earnings call, much to my chagrin.

We will be tracking this through the year… “Medium-Term Financial Milestones (from December 31, 2020 financials on February 9, 2021 earnings release).

And… as we suggested two quarters ago… guidance was pulled. Let’s reminisce…

“With our new strategy in place, our organizational changes complete, and our operational cost savings program now underway, the Company is in position to establish the following medium-term financial targets:

• Net revenue CAGR of 40%-50% from FY 2022 to FY 2024;
• Positive Adjusted EBITDA during the second half of FY 2022 and 20% Adjusted EBITDA margin for the full year FY 2024; and
• Positive operating cash flow for the full year FY 2023 and positive free cash flow for the full year FY 2024.”

So, what do they have to hit in F2022? Let’s keep track:

• Sales growth of 40% would be $850 million annual F2022 revenue… they are tracking at $534 million or short by 37%.  Last 2 Q’s: I expect them to amend guidance or suggest guidance is more for F2023 and F2024 than F2022. Yep. Yoinked with no replacement.
• +EBITDA to get there they need to mow down a -$94 million Q4 F2021 deficit… they are at -$93 million. They get there via…
• SGA improvement of $45 million which would put Q4 F2022 SGA at $66 million… they are at $119 million Q2 when backing out covid subsidy. Sales and Marketing alone was $65 million for the Q!!!
• GM improvement of $50 million which would put Q4 F2022 GM at $60 million… they are at -$71 million which includes a $7 million covid subsidy, so -$78 million. Reversing the $87 impairment in the Q and they are $9 million.  Without sales increases there is no way they make this number. 

Constellation has until November 1, 2023 to pull trigger on increasing ownership to +50% with an $4.5 billion (88.5 million shares at $50.40) incremental investment.  They will be watching progress eagerly as they will need to raise equity or term debt to fund the payment.  We are predicting a restricting of the agreement, again.

What I said last Q:               

Pluses

• Gross Margin increase… to 20% of which covid subsidy ($7 million) adjusted would be 16%
• SGA (net of covid subsidy of $13 million) decreased QoQ by $22 million and is below sales for first time since I have been spreading since Dec 2016.
• Adj EBITDA (I removed covid subsidy, they did not) improved by $28 million QoQ… to -$73 million
• Other income swung an aggregate of $948 million QoQ to a positive $581 million, which provided the +Net Income of +$390 million

Minuses

• Sales decreased 8% QoQ with every reported segment contracting QoQ.  Second Q in a row of reduced sales.
• Gross Margin in Other revenue segment decreased to 32%, an all-time low.
• Another $89 million in asset impairment… fixed asset impairments over last six Q’s aggregates $1.2 billion

This Q:

Pluses

Growth in International cannabis revenue by $4.2 million or 22%.

Minuses

Yoinked aEBITDA guidance. We had this pegged on March 31, 2021 figures were published.

Sales decreased 3.5% QoQ. Each segment except International Cannabis sales, decreased.

B2B Adult use sales, net of $14 million from Supreme and Ace acquisitions, is lowest on record. Like, since adult use was launched!

$14 million in Supreme and Ace revenue would equal Supreme ONLY revenue in Match 31, 2021 Q.

Gross Margin gets an $87 million impairment and rings in at negative 54%. Without impairment and step-up GM is 14%. Reverse covid subsidy and it is 7%.

How they will get to 30% let alone 40% GM, when Other Revenue has a 32% GM and B2C (Retail) is likely sub 30%, is a work of fiction. They need cannabis GM, which is presently 8% without impairment and step-ups, to exceed 40% when their best adjusted GM on cannabis is 22% over past 6 Qs.

MDA only speaks to comparing quarter to the same quarter the prior year.  Its Ok… we have it covered.

Open the financials and Management Discussion and Analysis and follow along.

Overview of Quarter:

Sales:

For the quarter ending September 30, 2021, CGC evidenced $131 million sales net of excise tax, backtracking from the previous Q of $136 million. This was a 3.6% decrease from the previous quarter. This is their lowest sales figure since $110 million June 30, 2020, six quarters ago.

Table 1: Revenue

Rec sales were $59 million net of excise tax versus $60 million last Q, a decrease of $1.0 million or -2.4%.  B2C, despite having 34 stores for the entire Q, slid $0.6 million or -3.7% to $16.7 million.

Cdn Medical has been flat all for five Q’s at $13-14 million. Slight decrease QoQ -2.9%.

International medical cannabis sales were the only improved segment sales wise.  QoQ increase was $4.2 million +22 % to $23.7 million, the second lowest in past five Qs. “Other” was the bigger gainer at +$3.7 million, while C3 was $0.5 million +4.0%.

Global cannabis sales net of excise tax increased +2.6% to $95 million from $93 million QoQ.

Other Sales were down $7.2 million or -17% to $36 million, the lowest figure since June 30, 2020.

• Storz & Bickel -$9.6 million -40% to $15 million. This is the lowest sales in the 6 quarters they have been disclosing this item,
• This Works +$2.5 million +39% to $9.1 million, the second highest in past six Qs.
• Biosteel gets its own revenue line last Q… $7.5 million up +$0.9 million +13% QoQ.  Biosteel net loss for the Q appears to be -$16 million a slide from -$13 million last Q.
• The balance includes CBD US business and clinic partners was $5 million a decrease of $1.0 million or -17% QoQ. 

Table 2: Revenue by Form

I put a flag on this as the Revenue by Form also consists of all the product CGC sell through their Tokyo Smoke stores. This includes double counting TWD and any other branded sales PLUS what they sell of other LP products.

Sales mix for Rec continue to shift from pre 2.0 mix of 90-10 Dry-Oil to 80-8-13 Dry-Oil-2.0, respectively.  Provisions were not stated this Q or were $0.

• Rec dried saw a decrease of $9.2 million -14% or $56.8 million the lowest since June 30, 2020.
• Rec Oil evidenced a decrease of $0.2 million and was $5.5 million, lowest in past six Q’s
• 2.0 formats were stable + $9.2 million.
• Rec Provisions $0 disclosed versus last Q $3.0 million.
• NOTE: These improvements are not solely CGC product sales as they include products sold at CGC stores.

All in Rec was down post excise by $1.4 million (which includes a $3.0 million reduction in provisions) -2.4%.

Medical.  Mix 25-57-22% split with flower-oil-2.0

• Medical Dried saw a moderate decrease at $0.5 million -5.3% to $9.1 million.
• Medical Oil saw a $0.3 million increase or +1% to $20.8 million.  
• Medical 2.0 formats saw a $4.0 million increase or +97% to $8.2 million

Gross medical revenue was $36.7 million post-excise, an increase $3.8 million or +12% QoQ, the third best results in last four Qs.

Other Revenue was $36.1 million down $7.6 million QoQ or -17%, the lowest since June 30, 2020.

• S&B was down $10 million, accounting for the entire decrease. 
• This Works was + $2.5 million,
• Bio Steel +$0.8 million and
• Other -$1.0 million.

Sales by Geographic Region:

CGC just started providing the above.  Canada, USA and Germany were down QoQ and “Other” was the only region that increased. I imagine Other includes UK revenue.

Given they have been trumpeting their US CBD strategy, it is odd to see USA actually went down 8%. Given BioSteel went up $0.8 million, assuming that is largely USA, that would mean their Martha Stewart brand might not be doing that well after load in.

Adult Use Revenue: Peer and Trend

Provisions are included in the above. 

Recreational sales were assisted by $14 million in Supreme and Ace acquisitions.  Were it not for these two contributors, which they acquired in the prior Q, recreational sales would have been at an all-time low.

Medical Revenue: Peer and Trend

Canadian medical has stabilized in the $13-14 million sales range at $13.1 million this Q, no change QoQ. ACB remains the market leader followed by Canopy.

International medical sales were $24 million a 22% increase or +$4.2 million for the Q.  

 Gross Margin:

WE HAVE SEGMENTATION.  The above is simply cannabis GM%.

Table 3: Gross Margin Adjusted for Non-Producing Assets Inventory Step Ups

I usually only show five quarters in this type of chart, but this is truly remarkable. 

Actual GM has been so bad for so long, despite all the promises to get to the mythical 40%.  Over twelve quarters spanning Adult use launch (Sept 2018 is last Q of medical and is provided as reference) they have once been over 30% (33.8% in Dec 2019, which then was wacked by impairments the next Q). 

They have an adjusted GM of 14.5%.  This includes a $6.9 million covid subsidy. Without the covid subsidy the Adjusted GM is 8%.

No mention of unabsorbed overhead.

Table 4: Gross Margin Segmentation

Gross margin is the crux of their problem, followed by SGA spend.

They want to get to a 40% GM. 

• Their Other Revenue segment has settled in below the 40% at 32% for the last three Qs.  This means they need to generate +40% on cannabis GM to get to 40% all in. Revenue in Other is $36 million.
• But the cannabis revenue also consists of B2C (retail stores) that are likely generating a GM of 25-30%. This means they need to generate +40% on non-retail cannabis revenue to get to 40% all in. Revenue is $17 million in B2C.

The above is $53 million of their $131 million in revenue, or 40% of overall revenue that is below 40% GM. I estimate GM from these segments to be $16 million. To get these segments to 40% they need a GM of $21 million. While its only $5 million difference in GM, the cultivation and processing side of the business have to make that $5 million up.  The problem is I have their cannabis business including retail B2C, reversing impairment and covid subsidy, is generating -$3 million in GM.  If I deduct the retail B2C GM of $4 million, cultivation and processing is now -$7 million GM.

A GM of 40% in cannabis would be $38 million and it is presently negative without impairment and covid subsidy. But they need cannabis GM to be greater than 40% to achieve 40% all in GM. YIKES!!

Back to the above table…

Cannabis GM, not adjusted for $6.9 million covid subsidy (they did not indicate if the subsidies were only in Canada or on which segment), slid to -87% from 14% QoQ or to -$83 million.  Without the $87 million impairment they are at +$4 million. Add a step up on inventory of $3 million less the covid subsidy removed they are at $0.6 million.

Other segment showed its lowest GM% in six quarters at 32% or $11.5 million.

To get to the mythical 40% GM level they will need both cannabis and Other to ratchet up substantially. I honestly do not see a path to the mythical 40%.

Gross Margin: Larger Peer Group

CGC is second of last place in the peer group. Without impairment they would be tied with Hexo whose GM includes an impairment.

Gross Margin: North American Peer Group

I do note that Tilray has a substantial portion of non-cannabis lower GM% business in their sales mix.

Operating Expenses:

SGA & SBC as % of Sales: Trend

Note: Asset impairments and the like have been moved to Other Income/Expenses to maintain peer comparability.

We have added back $10.6 million to G&A for Covid subsidy in September 2021 and $12.7 million in June 2021.

They ramped Martha Stewart Gummies and Biosteel in the prior Q.  Let’s see how they contributed in the selling expense side. 

Selling expenses increased to $65 million from $51 million. That is quite the increase.  Martha Stewart and Biosteel partnership deals and promotion the bigger items. They need to get sales follow through or this will be more spent money not an “investment”. And with USA going backwards in revenue in the Q, I am not sure how well it is going.

G&A expenses were stable at $46 million QoQ. This is lowest they have been since December 2018 and four Qs in a row of $ reductions.

Transaction and acquisition related expenses was $2.4 million versus $5.8 million last Q.

SBC increased to $16 million from $13 million.   

SGA and SBC total 84% of sales, an increase from 71% last Q.

R&D increased QoQ to $8.8 million from $8.3 million. Winding up R&D at some closed facilities and less product development underway the last two Qs.

Depreciation of non-production facilities were stable at $14 million QoQ.   

Total Opex was $142 million versus $126 million last Q. This represents 108% of sales. The prior Q was the first time it was lower than sales.  Short lived.

SGA & SBC as % of Sales: Peer

CGC is highest in selling expense, second best in G&A (given scale, that makes sense), and second worst in aggregate.

Net Operating Profit was negative $212 million versus negative $98 million last quarter, despite aided partially by $17.5 million in covid subsidies. The GM going negative and selling expenses increasing are the reasons.

+NOP Breakeven: Canadian Peer Group

At current negative GM% breakeven cannot be calculated.

+NOP Breakeven: North American Peer Group

Other Income and Expenses:

This was +$193 million versus the last Q +$491 million.

• Asset impairment of $2.5 million versus $89 million last Q. Seven Qs in a row with impairment.
• Other gain (below) of +$195 million versus $581 million last Q. Price decreases in Acreage and TerrAscend the main contributors, as is the decrease in CGC stock price which decrease value of STZ warrants.

Other Income Table

Interest expense ramped to $27 million from $23 million. That is the USD 750 million loan that has not been put into action.

Add a tax credit of $3.2 million in tax and you get a Net Income of -$16 millionversus + $390 million last Q, which was mostly achieved by Other Income and stock prices falling.

Non-Controlling Interests:

NCI was -$5.3 million.

• Biosteel (CGC owns 72%) For the Q2 had Negative Income of -$16.3 million versus its loss from last Q -$13.4 million. Biosteel has a cumulative loss of $58 million since acquisition.

• Vert Mirabel (CGC owns 55% increasing): For the Q4 had negative Net Income of $1.6 million versus + $2.9 million last Q.

Adjusted EBITDA:

EBITDA Trend and Peer

I backed the $17.5 million in covid subsidies from EBITDA, and I added back the entire inventory impairment of $87 million which they did not reverse. 

EBITDA went from -$73 million to -$93 million this Q a slide of $20 million and in line with Q4F21.   The slide in Adjusted GM and increase in Selling expense the culprits.

Keep in mind they had interest expense of $26 million.  Getting to $0 EBITDA is still a long way off but covering interest is even further.

At the 40% MYTHICAL GM, with current SGA & R&D, they would need Q sales increase of $167 million to cover it, over double current sales and more than the quarterly target of $250 million needed to get to +EBITDA.

+EBITDA Breakeven Canadian Larger Peer Group:

At current negative GM% breakeven cannot be calculated.

+EBITDA Breakeven North American Larger Peer Group:

Cash Flow Statement:

Cashflow from Operations: Trend

Quarterly

• Cash used in operating activities $86 million (net of above figures)
• Cash Used (generated) in investing activities $328 million.
• Cash provided by (Source) in financing activities $2 million
• Net increase (decrease) in cash and equivalents -$247 million.   

Balance Sheet Items of Note:

• Cash and marketable securities total $1,958 million a decrease of $92 million.
• Annualized interest and P payments $115 million.

Gas in the Tank: Trend

• Total inventory is an industry leading $353 million -$59 million for the Q.  They indicate they outsold their harvest in the Q4 F21. Yet they impair inventory by $87 million this Q.   They must be sleeving a considerable amount of inventory.
• Finished Goods is $143 million an increase of $64 million from last Q. FG will include retail inventory at their stores. That is quite the increase in the face of an $87 million impairment. This is the highest finished goods inventory that I can find, and that includes IFRS days. They have very little excuse for not feeding sales in Q3F22.
• WIP was $149 million down $110 million. This is where the bulk of the impairment must have come from.
• Raw Materials was up $11 million to $60 million.

Sold vs Inventory and Production Costs vs Inventory:

As we said last Q: Getting close to that 4.0 figure where we have seen impairments.

Impairments of $87 million.  On a GAAP basis CGC has 3.0 Q’s of inventory a slide QoQ due to the impairment of $87 million.  

Cannabis $ Inventory to $ Sales; Peer and Trend

• Canopy, Cronos and Tilray are reporting as per GAAP, so no IFRS fluffing.  

• PPE decreases $19 million to $1,123 million.  They shuttered Niagara cultivation after Q end.

• Other Financial Assets decreased $282 million to $509 million as their investments in Acreage and TER decreased with share price.

• Long term Debt $1.5 billion down $27 million QoQ.

• Acreage liability decreases $288 million to $162 million with Acreage decrease in CGC stock price.  

• Warrant derivative liability decreased $194 million to $105 million. Constellation Warrants. decreasing due to CGC stock price increase.

What I said last Q:

Another step backwards on sales and management signaling “two quarters out” we will see improvements in sales and GM.

• Sales decrease in each segment
• GM remains in a bad place
• SGA decrease is a glimmer of hope but is is still 92% of sales.  
• EBITDA improvements but still -$73 million and a $25 million quarterly interest bill

The hill to meet their Q4F22 guidance got even steeper this Q.  Klein has been in drivers’ seat for over a year.  This is now his vehicle and it feels like it is up to the door handles in mud.  If Klein could get the mud down to the rocker boards it would be an improvement.  The market has been told to “wait” yet again.

This Q:

Wow.  This was a bad Q.  Flat to declining sales in almost all segments.  GM is negative. Inventory impaired again.  Selling costs increased and sell though in USA decreased. Closed another facility. EBITDA decreased.

They pulled guidance for +EBITDA by Q4F22. This should have been pulled in March 31, 2021 Q reporting.

They have a whack of cash at $2 billion but they also have $1.5 billion in Long Term Debt.

Canopy without the addition of Supreme and Ace Valley would have had the lowest recreational sales on record.  That, unto itself, speaks volumes.

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 does not have a position in CGC and will not start one in the next five days.