Canopy Growth hit with millions in product return charges, $375M net loss in Q2

Canopy Growth (WEED.TO)(CGC) reported a $374.6 million dollar net loss in its fiscal second quarter, more than double Wall Street’s expectations, after the company was hit with millions in unexpected charges related to product returns and price changes.

The Smiths Falls, Ont.-based pot giant announced a $32.7 million charge for returns, return provisions and pricing allowances for its line of softgels and oils on Thursday, as well as a $15.9 million charge for a new retail pricing, packaging and marketing strategy for those hard-to-sell products. The combined charges amount to $48.6 million.

“It really is a one-time event. We had to make decisions about our production and our SKUs, and anticipate demand for these products before the market existed,” chief executive officer Mark Zekulin told Yahoo Finance Canada in a phone interview on Thursday. “We obviously overshot the market.”

Shares fell 16.7 per cent to $20.35 in Toronto at 12:00 p.m. ET. New York-listed shares dropped 16.59 per cent to $15.43.

Canopy said the larger-than-expected quarterly loss amounted to $1.08 per share. The company reported $76.6 million in sales for the three months ended Sept. 30, and adjusted EBITDA of negative $155.7 million.

Analysts had expected a net loss of $155 million or $0.39 per share on revenue of $102.3 million and adjusted EBITDA of negative $96.1 million, according to Bloomberg estimates.

"The last two quarters have been challenging for the Canadian cannabis sector as provinces have reduced purchases to lower inventory levels, retail store openings have fallen short of expectations, and Cannabis 2.0 products are yet to come to market," Zekulin stated in a news release before markets opened on Thursday.

"We took the necessary steps to address inventory levels on our oils and softgels. Looking beyond this, the fundamentals are strong.”

Canopy Growth first noted an oversupply of oils and softgels in certain provinces in August. Retailers said they were not selling, resulting in a glut of inventory. Zekulin said the launch of edible products slated for mid-December will help the oil and capsule category gain traction.

Chief financial officer Mike Lee said the company will now focus on a “smaller portfolio of products at more competitive price points” within the oil and softgel category.

The company is reviewing which products will be returned, which will be subject to “buy downs,” and which will be unaffected.

“Recreational oil and softgel pricing adjustments of $10.3 million are required to establish our new pricing architecture,” Lee said on the call. “To date, we have taken actual returns of $20.5 million from the provinces, and we expect another $6.4 million to be returned in the coming weeks.”

Gross margins were impacted by $40.4 million due to the write-downs and returns announced on Thursday. Canopy Growth reported a negative gross margin of 13 per cent.

The world’s largest cannabis company previously said it would achieve sales of $250 million its fourth fiscal quarter of 2020, with a gross margin of 40 per cent. Those goals have been deemed “increasingly unlikely,” given the slower-than-expected roll out of retail stores.

Lee said store openings in Canada are six to 12 months behind where he thought they would be. The company’s current demand projections assume 40 new stores per month opening in Ontario beginning in January, in line with the pace of store openings seen in Alberta.

Asked if the 40-store-per-month target was aggressive given the province’s slow track record, Zekulin said, “I regret using those numbers. It was meant to be an illustrative case. But to be honest, I think it will come to pass though, as long as the Ontario government turns on the tapes for the private sector.”

Zekulin sees the challenges at the world’s largest cannabis company by market value as mainly short-term, touting sales growth at retail stores and strengthening Canadian and international medical cannabis revenue.

Canopy sold 10,913 kilograms of cannabis products in its second quarter, up three per cent from the prior period. Sales in Canada fell seven per cent from the last quarter to $76.6 million.

“In a supply-constrained environment, the provinces accumulated inventory. Now that they have more comfort, they want to hold less inventory, which is a normal thing to do,” he added. 

Zekulin has had a busy second quarter at the helm of the cannabis giant, following his counterpart Bruce Linton’s firing in July. 

The company recently struck a partnership with Canadian hip hop star Drake.

Last month, Canopy Growth unveiled suite of cannabis-infused beverages and drinks at an event at its Smiths Falls headquarters, revealing a Tweed line of “distilled cannabis,” as well as ready-to-drink formats under its Tweed, House Plant and Deep Space banners. It also debuted sparkling CBD-infused drinks and an infused line of chocolates.

This is likely to be Zekulin’s last quarter as CEO. The company is expected to announce new leadership by the end of the year. He said the search for a new leader has been narrowed to a “handful of extraordinary candidates.”

Cantor Fitzgerald analyst Pablo Zuanic said there are bright spots in the “mostly bad news” quarter.

“The few positives would include recreational pricing fell ‘only’ 10 per cent [before allowances], revenue volume fell only five per cent, cannabis export doubled, although from a small base,” he wrote in a note to clients on Thursday. “But management seems encouraged about the outlook and its own restructuring adjustments.”

Canaccord Genuity analyst Matt Bottomley sees Canopy Growth’s costly inventory changes as an indicator that more challenging sales to provincial retailers will impact the broader sector.

“We believe this represents a red flag for the company and the industry as a whole as inventory balances held with provincial distributors have grown to a level that will likely continue to stymie near-term wholesale purchases,” he wrote in a research note. 

Canopy Growth said it had $2.74 billion in cash, equivalents, and marketable securities at the end of its second quarter. The company has been investing heavily in its beverage facility and chocolate factory at its Smiths Falls headquarters, spending $404.7 million in cash in the quarter.

“We are coming off a major phase of investment in Canada, and we are literally in the final stages of that and paying the bills for the last part of it,” Lee said. “And then our next wave of investment will be in the U.S., but it’s a much smaller wave initially. So our capital spending will be muted over the next 12 to 18 months relative to the last 12 to 18 months you’ve seen.”

Canopy Growth expects to launch CBD products in the U.S. by the end of this fiscal year.

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