GoBlue2016 wrote: Q1 F2018 MDA Review… “Setting the table”
Recently I was chided by a CGC investor about “finally” recognizing the need for Operating Expenses (Opex) to sometimes lead sales. I referred to it as a “sales lag”. I do recognize the need, as I have built my own biz from scratch. And when you are in the early days there is a lot of hand to mouth and sleepless nights. But if luck, good fortune, understanding your market and your value proposal, and planning are all good… you just might make it.
I will refer to this Q as “setting the table” which is VERY different than “Front Running”, which I would define as trying to anticipate where the market will be a in a foggy future but building as if you know what the market will be. You can burn a lot of money by front running. You can make a lot too... but only if you are right.
Aphria is definitely not front running. And by not doing so they have focussed on their plan. So far so good.
This is a page flip process though the MDA and stream of consciousness… Not looking for style points.
The important news….
Phase III is on schedule for first revenue from harvest May/18. Why is this important? The rec shelves start getting filled up to 60 days in advance of July 1. That is May.
Level 9 vaults… this is likely the good news GTP was referring to. They were running out of storage room in the vaults. And without storage room you cannot produce any more. This was VERY good news!!
$5.9 million in twelve month trailing EBITDA… this is what lenders look at to determine maximum leverage. This will become important by day 1 of rec after Aphria release their F2018 year ends.
Cash cost and All in cost of gram down AGAIN…Cash cost is down to 0.95 from 1.11 last Q and 1.73 Q3F17. That’s 45% in 6 months. All in Cost [includes amortization and packaging] down to 1.61 from last Q 1.67 and 2.23 in Q2F17. That’s 28% in 6 months!!
The above, coupled with Opex I’ll speak to later, is the table setting required for Q2 F2018. It isn’t the table setting for first day of rec, but for next Q. We actually won’t see much table setting for day 1 of rec as it’ll be more “trial by fire” in that: April/18 first harvest Phase III, Saleable May/18 and on the trucks in May and June.
QoQ Sales is up 7% in $’s and 15% in KGs. EBITDA went down $1.3 million [I’ll talk about these in the MDA page flip order]
How did we make money in Q2??… Investments carried the day.
But it wasn’t LHS which netted $2.4 million loss [despite being worth $60 plus million more than book].
It was Copperstate... ringing in at $33 million total or a $22 million increase in “fair value” in Level 3 investments. The additional investment in Copperstate during the Q allowed Aph to reset the value of the entire investment as it had new/current valuation to work off. As Copperstate is not publically traded it is not revalued every Q end based on its stock price [Like Level 1 Hierarchy], it can be revalued at an event [new investment] like this.
IMO… Copperstate will be Aph contribution to next LHS equity raise to keep ownership in LHS near where they are today. That is at least $33 million contribution which supports an $87 million raise if they hold investment at 38%.
The Copperstate increase was dampened by TBP and Scythian drops of $3 million ish to get a net of $19 gain.
Fair Value Measurements
As in my predictions… I was not foolish… in that Aph kept on course with their strategy of all in costs booked to inventory of bud $3.75/gram, trim at $3/gram and Oil at $0.63/ml.
Now the interesting thing with this is… when you couple it with a declining cost per gram they can pull more profit forward at harvest as the FVI is the variable plug [Booking Value = Fair Value Increment + Cost]. So they are pulling more profit to harvest but they have kept a lid on Booking Value so they don’t have to face a write down on inventory when the rec cost per gram becomes the new measuring stick. I am not a fan of pulling profit forward to harvest, as the goods are not saleable at harvest. But I do like the hard booking cost they are using for modelling purposes.$3.75/ gram is waaay more conservative than $5.40/gram that another LP uses. Especially with rec wholesale to largely be in $4.50-.50/gram range.
The reason I noticed this is the marked decrease in oil cost per ml over the Q. It dropped to 0.23/ml from 0.35/ml. That’s 34% in one Q!!!! Bud is down 27% in COST and trim 14%. That is some more table setting for next Q.
Cost Per Gram
All in 1.61 vs Q4 1.67 and Q3 2.23.
Cash 0.95 v Q4 1.11 and Q3 1.73
I do note they dropped from their MDA the comparison to others LP cost calculations that they did for the first time last Q.
Results of Operations
Revenue.
I had predicted 5%, with “phenomenal” given capacity constrained and VAC headwinds at 8-10%. They achieved 7%... Predictions not yet making me foolish.
Well VAC headwinds were bigger than I expected… the change in VAC Policy [10 grams/ day to 3 grams/day] resulted in $1 million in sales coming off the top line. Without that change we are looking at not the 7% increase achieved but 24%. THAT IS AN ENORMOUS SHIFT if VAC Policy remain unchanged.
So they were digging out from a $1 million hole from VAC and got $1.4 million of that back. How did they get there?
17% or 142 kgs of KGs sold in Q were to new patients on boarded in Q versus 146 kgs in Q4. I would hope that this grows considerably next Q. The fact that it slid 4 kgs QoQ is a little disappointing.
And the big one was 22% or 191 kgs were wholesaled versus 10 kg last Q.
GOOD NEWS folks… VAC changes are now in the past. These substantial headwinds from Q3 F17 and this Q are done!!! No more digging out!!
Oil staying at 32% of revenue versus my prediction of 40% was foolish. The change in oil strategy hopefully gooses the number.
Gross Profit Margin
Hey look new Gross Margin presentation… Not looking foolish here either!!
GM did fall from its record of 85% in Q4 to 78% in Q1. As comparison Q3 F17 was 77% and 78% for F2017 full year. The decrease is due to increase production costs. But still a modest improvement over F2017.
Now this is how they describe it in the MDA [Ipanema and Monte… if you can help decipher this please do. Or let me know if I am correct in my evaluation]… page 12 MDA 3 para from bottom.
“The increase in production costs is primarily attributable to decreased over-absorption of overhead costs in the quarter, which represents period costs as described above. The reduction to incremental over-absorption of overhead costs was primarily a function of increased production yields.”
OK… what I think this means is there was more production costs as they brought Phase II through a grow and had expenses to cover from the new building BUT their per unit costs went down because of increased yields. This is what I predicted in my “foolish” post.
This % gross margin compression should bounce back next Q as the sales lag disappears. This compression only took a modest bite out of EBITDA of $128 k.
SGA Cost
SGA Increased substantially by $2.7 million to $6.5 million. Of this increase $1.8 million is share based compensation [non EBITDA] which seems to ebb and flow on a 6 month cycle [it was $688 k last Q and $1.3 million Q before].
The remaining $900 k of SGA increase
$472k was G&A and largely investor relations and public company expenses [meaning they are out explaining to institutions and hedge funds what is going on in the company and why they should invest] and $97k of the $472 in exec salaries.
$279k was Selling, Marketing and promotion… getting those 11 clinics Vic mentioned signed up at last Q interviews with 20 or so on the way.
As a % of sales QoQ G&A went up 6% to 28% [for comparison Q3 was 24% Q4 22% so the trend is up but it is also linked to now being on TSX and reporting requirements] and Selling went up 4% to 32% [for comparison Q3 was 36% and Q4 28% so Q1 splits the middle].
Non-Operating items [all non EBITDA related] that changed materially:
· Fx loss swung $560 in the wrong direction from last Q to a loss of $150
The marketable security portfolio was minus $1.7 million from approx. $200k last Q (these should bounce back with uptick in market]
· LHS and Copperstate and the rest of investments make the balance of the plus $17 million to the good number
EBITDA
Well I looked foolish here… Last Q was 49% at $2.8 million and for the year it was 30%. For Q1 it dropped QoQ to $1.5 million or down $1.3 million. So that’s 25% EBITDA. I was hoping for 40%. The change is largely in SGA [not including Share based compensation which is non EBITDA] increase noted above of $840k and about $200k in reduced gross margin.
EBITDA should improve next Q as sales lag disappears.
They also do another EBITDA calculation bringing LHS portion of negative EBITDA into the equation. That is negative $675 K. I wouldn’t concern myself with this portion. LHS will be self funding.
Liquidity:
They have $119 million in cash and securities on hand and the commercial commitments to finish phase III and IV is $44 million… $75 million in cash reserves well positions Aph to handle Pharmacy payment terms [120 days] and rec payment terms [anticipated 60 days] with some spending money left over. That float is $60 million ish at Phase IV sales.
So, dear reader [as Stephen King would refer to you]… If you are still here…
A lot of expected items hit in this Q that dampened sales [VAC], added COGS cost [Phase II sales lag], and Opex increases mainly in SGA. But despite this Aph produced 25% positive EBITDA. Again, I use EBITDA and not Net Income as my basic measure as it removes accounting voodoo and the whims of the stock market.
The investment increases are nice, and given Aphria has made a conscious effort to act like an investor I probably should give them more due consideration. But some of them were strategic and meant more about getting something outside of the actual investment for Aphria’s future benefit. But it is hard to give them due consideration when LHS is worth $60 million more than booked value and that is not fully rolled in.
The table is set and in Q2 we eat!!
GoBlue