Organigram released their earnings today. I missed the earnings call.  I’ll read the transcript and add any thoughts in an EDIT.

This Q is not pretty but this…

MDA

• Sales volumes of dried flower in grams declined 24% to 2,986 kg in Q3 Fiscal 2020 compared to the prior year comparative quarter, primarily as a result of significant volumes of product shipped during Q3 Fiscal 2019 to address orders to fill pipelines and product shortages in the adult-recreational market.

That is Excusifying 101.  When you do not beat the prior year’s Q and you blame it in on the pipeline fill in the May 2019 Q.  Dang, the store count has skyrocketed and the adult use sales over the last 12 months are up 142%.  The pipe is much bigger now that in was last year.  We have been commenting on the lack of brand stickiness for quite some time, and today their SVP of Marketing walked or should I say “left to pursue other interests”.

What were our conclusions last Q??

Plus side

• Rec sales finally increased

Minus side:

• Out of covenant with bank – likely get availability trimmed as trade off for leeway on covenants
• Used full ATM last Q
• Sales slid and flower slid
• GM% slid
• SGA increased
• EBITDA turned negative
• Inventory, inventory and inventory.

After writing down inventory Gain on Biological by another $20 million in the Q (that is $44 million in three Qs), OGI has $113 million in inventory.  If we just look at Rec and Medical sales, given that the Aphria purchases will have ended and other companies wholesale revenue are in the ditch, at $17 million … OGI has seven Quarters of inventory available and another record harvest underway at a projected yield of 22,735 KGs.

And the issues with inventory are now far from over.  From their MDA

• “… adjustments to the net realizable value of inventory of $(20,390) (February 28, 2019 – $(856)). The significant increase in adjustment to the net realizable value of inventory relates primarily to a write-down of the Company’s inventory of flower and trim available for extraction, for which the Company has no immediate need given the sufficient inventories of concentrated extract already on hand.”

“Sufficient inventories” is an understatement.

This Q:

Plus side

• Back in covenant with their bank but… see minus side
• Rec sales were up 2% net of provisions, Vapes were up 33%.
• Medical sales were up 14%, but that’s $98 thousand
• Aggregate SGA reduced by $4 million

Minus side:

• Bank requires all equity raises post Dec. 31, 2020 be used to pay down loans
• Used full ATM previous Q and used full new ATM by June 2020.
• Sales slid and flower slid
• GM% was bombed by writedowns
• EBITDA got ugly
• Four Q’s in a row where they wrote down the IFRS side of inventory. $70 million and counting
• Inventory, inventory and inventory.

Two Q’s ago we said that they needed to generate sufficient 2.0 sales over the next two Q’s to replace the wholesale revenue of $9 million from the November 2019 Q.  They generated $4.8 million.

And the issue with inventory does not appear to be over. From earnings release:

• The Company expects an improvement to gross margins before fair value changes to biological assets and inventories sold in Q4 2020 due to fewer inventory write-offs and provisions as compared to Q3 2020. A negative non-cash adjustment to cost of sales for unabsorbed fixed overhead costs are anticipated to persist as Organigram intends to cultivate at less than the target cultivation capacity for the foreseeable future. Further, as indicated in previous quarters, the Company expects some production inefficiencies to persist in the near term and impact gross margin while it continues to launch new Rec 2.0 products and optimize production.

Open the Financials and the MDA and let’s get to it.

Income Statement Drivers and Breakeven Sales:

Sales:

Table 1: Sales Delta’s

In the past 5 q’s, revenue has dropped in four of five Q’s including this Q.  Sales were down $5.2 million and remain below all but one Q in the past five Q’s.

Adult Recreational Sales: Trend and Peer

Adult Rec sales were up 2% or $0.3 million to $15.3 million. As per table above, Rec flower continues its descent with an all-time low of $10.7 million, rec oil has been discontinued and recorded a 51% drop.  2.0 products increased $1.8 million to $4.8 million which offset the 1.0 decrease of $1.5 million.

Vapes accounted for $3.4 million of 2.0 revenue, with edibles at $1.4 million, increases of 40.8 million and $1.0 million, respectively.

Provisions and returns of $3 million, up $2 million QoQ, are very high as a percentage of sales. Over the last four Q’s they have provisioned $9 million. That is 13% of adult use revenue.

Medical Sales: Trend and Peer

Medical sales increased 14% to $2.5 million. Oil is 2/3rds of the Medical mix.

Wholesale Sales: Trend and Peer

Wholesale followed industry trend to $0 from $5.6 million last Q.

Income Statement Drivers and Breakeven Sales: Peers

OGI is the smallest in sales in the above peer group. 

Gross Margin

Gross Margin % Peer Base

Gross Margin headed into the basement this Q at negative $26 million.

Earnings release: Higher cost of sales in Q3 2020 was primarily due to:

• Write-offs of excess and unsaleable inventories of $19.3 million, of which $11.9 million related to excess trim and concentrate;
• $2.7 million in inventory write-downs to net realizable value to reflect declining prices; and
• $7.9 million in charges related to a reduced workforce due to COVID-19 comprised of $5.0 million in plant culling, $2.0 million in unabsorbed fixed overhead as a result of lower production volumes, and $0.9 million mostly related to lump-sum payments paid to temporarily laid-off workers.

That is $30 million. Had it been reversed Gross Margin would have been $3.5 million or 19% of sales.  Yikes!!!

That unabsorbed fixed overhead is what yield drops can do to a gross margin.  Sundial’s next Q will be a case study in that.

Gross Margin is going to be in for a rough ride.

And I am calling bullshit on covid as reason for plant culling.  Last Q they had a projected yield of 22,735 KGs incoming and this Q they harvested 6,830 KGs. So, they culled 16,000 KGs.  They have stopped announcing KGs sold in each of the last two Q’s.  But considering their previous highest sale level was Nov/2019 of 5,501 KGs, which included $9 million in wholesale revenue, they needed to throttle the grow.  Covid is more Excusifying 101.

This Q they have quit harvesting trim and have a projected yield of 7,309 KGs which is likely still 150% to 200% of their Q sales.

We have been calling the write downs on extract for awhile now: Medipharm, Valens, Hexo and now OGI.

And another data point was lost this Q: Cultivation Cost per Gram goes into the disclosure graveyard. The previous Q (from last Rundown) All in Cultivation Cost per gram decreased to $0.75/gram from $0.87/gram.   They need to sell the product though to take advantage of same.

That was prescient.

Fair Value increment from inventory sold was $7.5 million down from $9.4 million, likely a caused by the drop in sales overall and the ongoing reversal of FVI.  Gain on Biologicals for the Q was $9 million a significant decrease from $34 million last Q due to the culling.

What I said last Q:  If they don’t sell those harvests this will go bad fast.

It has gone bad.

They also had an Adjustment to Net Realizable Value of $26 million for the Q that makes $70 million over the last four Q’s. They have been chasing this for a while.  Have they finally got ahead of the price decreases?

Gross Margin % Larger Cdn Peer

OGI is the lowest in the growing smoke circle in the basement. Seven positive and six negatives.  Gads! Quite the peer group.

SGA & SBC Trend Analysis

NOTE: I moved impairment of the Moncton campus to Other Expenses to maintain consistency amongst peers.

Opex decreased $4 million QoQ to $11 million.

G&A decreased $2.5 million to $6.0 million level with two Q’s ago. Almost all expense category decreased with wages and benefits decreasing $1.3 million and professional fees decreasing $0.7 million. G&A decreased to 33% of sales from 37% last Q. From previous Q MDA:

• G&A from MDA: “Part of the increase during Q2 Fiscal 2020 relates to expenses that are expected to decline or not recur in future periods, including certain consulting costs and professional fees related to the project-specific work such as the launch of Rec 2.0 products during the period.”

Selling expenses also decreased by $1.2 million to $4.3 million, as the support campaigns for 2.0 products were did not reoccur this Q. Selling expenses were 24% of sales, same as last Q.

SBC was level at $2.4 million but increase from 10% of sales to 13% due to sales decrease.

Opex returned to the same level as two Q’s ago at $11.4 million.

SGA & SBC Peer Comparison

Aggregate SGA had OGI as #2 in Peer group trailing APHA, which is also the case in SGA + SBC.  Aphria does have a large Distribution business that improves these figures against a pure cannabis company like OGI.

Net Operating Profit before IFRS voodoo:

NOP was negative $38 million before IFRS voodoo versus negative $8 million last Q. Decrease in GM in $ and in absolute terms and expense increases were the reasons.

Other expenses include:

• $38 million writedown of Moncton campus
• Financing costs were $2.2 million for the Q up $0.2 million QoQ 
• Impairment of Investment sent me to Note 14 which should actually be Note 13 and shows that “An impairment loss of $1,600 and $3,000 has been included in the statement of (loss) income and comprehensive (loss) income for the three and nine months ended May 31, 2020, respectively.”  Eviana is fully written down.

A tax credit in deferred taxes of $10 million rounds off other items of note.

Leading to a net Income of negative $90 million versus negative $7 million last Q.

Net Operating Profit Breakeven divided by Current Q Sales

With a negative GM% I cannot calculate a breakeven.

Adj EBITDA: Trend and Peer

EBITDA took a bad turn.  The extra writedowns in cost of sales is the biggest culprit, although not replacing the wholesale revenue did also contribute.

My figure is different than their figure in the MDA.

• Included in COVID-19 related charges (net) are $5,048 of plant waste due to insufficient staff to harvest plants as a result of COVID-19, lump sum payments paid to temporarily laid off employees, a temporary pay premium paid to Moncton employees, and the employee portion of health and dental benefits paid for by the Company, less government subsidies income of $3,237.

I backed out the subsidy from the government from Adj EBITDA but did not addback the covid costs.  They had too much inventory, as seen by the inventory writedowns for each of the last four Q’s. Organigram adding back that cost is not reasonable in my opinion.

+Adjusted EBITDA Breakeven

With a negative GM% I cannot calculate a breakeven.  If the 19% GM adjusted for writedowns is a proxy, they would need sales of $58 million to breakeven.

Cash Flow from Operations:

If you are on our subReddit much, there used to be debate about negative Cash Flows from Operations being “very bad”.  My counter is it depends on what is going on in that figure.  It could be bad.

But here is the perfect example of a positive cash flow from operations of $8.5 million masking the very problems I highlighted when discussing this item.  Opex burn was negative $57 million for the Q.  Cash generated from working capital items (decrease in A/R, Bio Assets and Inventory and Increase in A/P) generated $65 million in cash.  Organigram is not very healthy operationally this Q are they??

Balance Sheet Items of note:

• Cash and marketable securities total $45 million up from $41 million QoQ
  • What we said two Q’s ago: OGI also filed a $175 million Shelf Prospectus and can stealthily raise cash. At date of MDA they have raised $22.4 million and with the spike in stock price following earnings expect them to raise more.
  • They then launched another ATM this past Q for $49 million, filled $30 million and filled the reminder in June 2020 with $18 million more in proceeds subsequent to Q end.
  • With their bank restricting any equity raises post Dec 31, 2020 to repay their debt you can pretty well count on another ATM or equity offering this year.

• Bio assets decreased $21 million to $6 million.  Culling related.
• Inventory decreased $18 million to $95 million. Are they done writing down inventory???
  • What we said last Q: They have too much resin related inventory at $14 million available for extraction and $50 million in various other forms.
  • And they wrote down that by $12 million in trim and concentrate.
  • WIP Flower increased to $26 million or by $16 million.  Could be the layoffs they do not have the resources to process.
  • Flower available for packaging decreased by $6 million to $18 million
  • Flower Finished goods totaled $5 million a decrease of $1.7 million
  • Available for extraction decreased by $11 million to $3.2 million.  This is where not harvesting trim and the writedown are evident as well as in…
  • WIP Concentrate for extract decreased $15 million to $28 million. Still very high relative to sales.
  • Bottled oil increased $0.4 million to $3 million.  I believe this is their discontinued product.  They might take another writedown here if they cannot repurpose it

Gas in the Tank: Trend Analysis

Negative delta of $5.2 million in Sales and a negative delta of $8.1 million in Finished Goods inventory. 

What we said last Q:

• With $41 million in FG inventory, there are very few excuses for next Q on the availability standpoint.  And now do you see why they laid off 45% of work force??

And that is why I didn’t back out the covid adjustment to EBITDA.

Gas in the Tank: Peer Comparison

• CGC has the most FG in sector, followed by Aurora and Tilray and then OGI.

Waterfall – Trend Analysis

OGI pulled reporting KGs sold two Q’s ago.   

Projected Yield of Bio Assets is 7,309 KGs.  They have never sold over 5,000 kgs and that included wholesale revenue of $9 million.   

Waterfall – Peer Analysis

• PPE is down $29 million to $250 million. Capex is minimal going forward.
• Investment in Associates is down $1.6 million as mentioned above.

Liability and Equity Side:

• $78 million in Current Portion of Long Term Debt reverted to Long Term Debt with the second amendment to bank facility.
• Deferred tax liability decreased by $10 million, as per income statement.
• Share capital is up by $30 million thanks to the ATM.

Sales vs Harvest & Sales vs Inventory

With the writedown in inventory in the Q and $70 million over three Q’s, Inventory levels have finally started to decrease.  Unfortunately, so have sales.   

In conclusion:

What we said last Q:

This a bad quarter, following a bad Q.    Much of what we predicted last Q on the temporary reprieve that wholesale revenue gave them last Q dwindled this Q.  Will 2.0 grow more than Wholesale drops next Q is a VERY big question for OGI and their investors next Q.

The stickiness of their brands continues to be a problem.  Flower sales were down again this past Q.

If their bank deal gets trimmed, expect another ATM to be launched.

This Q:

Followed by another bad Q.

The story remains the same with Organigram. Lack of brand stickiness.  Flower dropping to an all-time low for recreational sales is stunning but on trend.

Their Gross Margin will be taking a hit for the near term as the previous “industry leading” cash cultivation costs has been shelved because they couldn’t sell it, rendering it meaningless.  They will have to carry unabsorbed overhead and we will see if trim continues to be discontinued. Gross Margin was once a strength.  Not sure about this anymore.

They have very good SGA with a floor of $10-12 million.  The problem is they need a 60% Gross Margin to cover on $20 million in sales.  They fell short of both this Q.

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 Organigram and will not start one in the next five days.