Supreme Cannabis Q1 F21 September 30, 2020 “Quarter In Pictures”
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Here is Supreme’s Earnings Release.
What we said last Q:
- Sales going backwards, but Adult rec saw a nice +27% +$1.5 million increase QoQ. Only 4 more Q’s of +27% and they will almost reach previous sales record (Stripping wholesale completely)
- GM negative two Q’s in a row
- Interest greater than unimpaired GM, which should improve with $65 million convertible early conversion.
Supreme has a problem many other LP’s have. They need enough 2.0 sales to absorb trim or else that byproduct will be written off. They do not break out their Adult rec sales, but given how tight they shave their nugs they need a good chunk of 2.0 sales to absorb trim.
- Rec sales stalled with a +3% increase
- GM records another cost-based impairment of $8.3 million after $10.6 million impairment last Q
- Not only did they impair cost-based inventory by $8.3 million they took a chainsaw to the IFRS premium embedded in inventory. Did they finally clean out the inflated values? This will be an interesting watch next Q. As if they did, they might be able to pull a decent Gross Margin from a less inflated inventory base.
- G&A expenses dropped by $2.2 million. No narrative QoQ. Something to watch next Q
- Way cute… negative GM but a positive Adj EBITDA as impairment was backed out. They still have large quarterly interest cost which will improve next Q with Debentures reduced for the entire Q.
- Cash is down to $20 million and new debt will not be an option for a while. Do they have enough cash to get to a sales increase of a meaningful amount?
Income Statement Drivers and Implied Breakeven – Trend
Sales finally broke the sub $10 million mark after three Q’s. Sales for the period was $11.9 million, representing $2.3 million growth QoQ or +25%.
Rec sales were $7.5 million up 3% from last Q. Dried flower sales fell -8% to $5.2 million while extract sales increased +44% to $2.3 million from $1.6 million. Will the extract sales keep increasing or will the sales channel pressurization fizzle?
Wholesale to Israel was $4.4 million an increase of 93% QoQ from $2.3 million last Q. This is where they are getting their sales increases.
They had $30 million in Finished Goods to start the Q, so no excuse of lack of product impacting sales.
Fire recently started disclosing average selling price: $4.15/gram adult rec flower a decrease of 19% as they repriced their offering and $1.95/gram W/S +14%. They do not give a revenue per gram for extracts.
Imputed KGs sold was
- Wholesale They sold 2,248 KGs internationally an increase from 1,330 KGs last Q.
- Direct Adult Use: dry flower sales dropped to 1,261 KGs from 1,449 KGs QoQ
- Total KGs sold (not including extracts) was up to 3,509 KGs from 2,779 KGs last Q.
Income Statement Drivers and Implied Breakeven – Peers
FIRE is really struggling to generate more rec sales. A story we are hearing in the majority of Cdn LPs.
Gross Margin: Trend and Peers
GM% improved from negative 87% to negative 18% as a result of an impairment of $8.4 million on the cost side versus $10.6 million last Q. Without the impairment GM would have been $6.2 million or 53% versus GM net impairment last Q of $2.3 million and 24%.
With the impairment GM was -$2.2 million versus -$8.2 million last Q.
They indicate they transferred 3,609 KGs to inventory from biological assets during the Q, which is only 100 KGs more than they sold without including extracts. They might have this in balance.
A look at production costs show
- wages and benefits decreasing as a % of sales to 65% from 40%
- facilities and supplies decreasing to 34% from 41% QoQ.
- Purchased cannabis decreasing to 27% from 56% last Q
GM net of impairment of $6.2 million versus interest expense of $4.3 million for the Q.
IFRS voodoo is interesting this Q as Fair Value increment on biological assets was $3.9 million versus always being negative for the three years prior. They really whacked the premium they had embedded in here.
And FVI in Cost of Goods Sold was negative after never being negative before. Negative $13 million this Q versus +$13 million last Q. Again, a cleaning out of previous inflated fluffery. It will be interesting to watch this next Q.
Gross Margin: Peers – larger group
The basement is getting crowded with +50% in the basement.
SGA and SBC- Trend
Note: Restructuring charges has been moved to Other Expenses to maintain peer comparisons.
Selling expenses increased by $0.1 million to $0.8 million. Tough to increase sales while keeping a foot on the neck of selling expense.
G&A decreased $2.1 million to $5.9 million and now register at 49% of sales. Somehow their G&A line item decreased $2.2 million to $0.6 million QoQ whereas wages and benefits barely budged. I am not sure what happened here and if it is sustainable. The narrative from MDA only relates to Sept 2019 and indicates it was covid related. (Edit: I went to the transcript of the CC and found the answer. From this past Q: “the inclusion of a CAD 2.2 million bad debt write-off recorded in Q4 2020.” And from previous Q CC, “These reductions though, were offset in part by a 93% increase in G&A expenses, driven by a non-recurring $2.2 million write-off related to an accounts receivable balance that the company deemed as uncollectible during the period. Now, this was related to a legacy B2B customer for a transaction that occurred over a year ago.”)
SBC has gone negative -$1.5 million from +$4.7 million last Q, as options were forfeited. This is a swing of $6.3 million.
OPEX decreased from $14.7 million to $6.4 million QoQ an improvement of $8.4million ($6.3 million is SBC), good for 54% of sales versus 154% last Q.
SGA and SBC- Peer
There are some dregs in here.
Implied Breakeven Net Operating Profit divided by Current Q Sales
NOP before IFRS voodoo came in at -$8.5 million an improvement from -$23 million last Q.
We cannot calculate Breakevens with FIRE at a negative GM%.
Other Income and expenses:
- Finance cost of $4.3 million for debt servicing versus $5.2 million last Q as debentures were paid down
- Restructuring costs of $0.2 million versus $1.2 million last Q
- Gain on retiring convertible debentures of $42 million versus nil last Q
- Gain on settlement of contract of $6.8 million versus nil last Q. This was termination of the KKE contract which was settled for $0.15 million versus what they initially reserved.
Taxes were approx. $3.5 million to deferred.
Net Income for the Q was $30 million versus negative $32 million last Q.
Adj EBITDA: Peer and Trend
Adj EBITDA improved to +$0.3 million from -$4.2 million last Q as GM net of impairment improved $3.9 million and cash Opex improved $2.1 million.
It is pretty cute having a negative gross margin yet a positive adjusted EBITDA.
And they had to service $4.8 million in interest this Q. Getting to +EBITDA is a goal but not the destination.
Implied Breakeven Adj EBITDA divided by Current Q Sales
With a negative GM% this metric cannot be calculated.
What I said last Q:
From MDA Dec/2019 Q:
- “The Company expects fluctuations in Adjusted EBITDA on a quarterly basis and to be Adjusted EBITDA positive within 12 months.”
I bet they don’t get there. They need to conjure sales without the wholesale trim market helping them.
Well… I guess they got there.
I am not sure if it is sustainable, given the odd reduction in G&A QoQ.
Cash vs Debt Service:
Cash decreased to $20 million from $28 million QoQ.
“Gas in the Tank”
Modest increase in sales delta and a decrease in FG of $8.1 million likely a function of the cost-based impairment. They have PLENTY of FG at $22 million especially given the purging of a lot of IFRS fluffing this Q.
Accounts Receivable decreased by $2.0 million to $11.0 million QoQ. All trade A/R with reasonable aging.
Debt maturities for Bank deal are three years out and the convertible debenture matures October 2021. They reduced the coverts by $67 million by Q end. So, if they can stay onside with bank covenants the repayment of the debt is not yet a concern.
The bank EBITDA covenant was extended in the previous Q.
What I said Last Q:
Sales are stagnant overall but the increase in adult rec of 27% was a bright spot. The problem is they will need four more Q’s of +27% to get them back to $20 million per Q in sales (assuming no wholesale).
GM is weak and they are harvesting considerably more than their sales. SGA have been crunched and I do not know how much farther they have to go. The interest burden has been lightened with the conversion of $63.5 million of debt into shares.
Cash seems sufficient for several Q’s.
This company is treading water operationally and has been for sometime. At their present unimpaired 38% GM, which will come under pressure for impairment if they are indeed selling 30% of harvest, they need $10.5 million more in sales to be +EBITDA. If that does indeed take four quarters to get there that cash pile will look much smaller.
Sales increased but not much in adult use. The large portion of sales increase was international to Israel. Expect a lot of incoming competition to Israel as they cozy up to cannabis.
While negative GM this Q, I am slightly optimistic with the purging of a lot of IFRS fluffery on the biological assets and inventory that they might show a positive GM next Q.
That G&A reduction has really got me puzzled. It was large and not explained in MDA or presser. But answer was found in CC.
The cash position at $20 million is not great but is adequate for the near term. They still have an open ATM if needed and their capex program appears to have run its course.
FIRE has cleaned up a number of lingering issues in inventory which has impacted GM, and in interest expense with the pay down of convertible debentures this Q. The question becomes can they grow the business in adult use as more competition will come in the international arena.
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 FIRE and will not start one in the next five days.
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