Despite all of the great news for Canopy Growth Corporation (NYSE: CGC) over the last few months, the big marijuana grower appears to be headed in the wrong direction when it comes to financial performance. Canopy announced results for its fiscal 2019 second quarter before the market opened on Wednesday. Revenue in Q2 was lower than the previous quarter. And Canopy posted the biggest loss in the company's history.
Canopy Growth's Q2 revenue of 23.3 million in Canadian dollars was about what the company expected, though, and still reflected a 33% year-over-year increase. But what about that net loss of CA$330.6 million, or roughly US$250 million? There are three reasons Canopy reported such a massive loss in the second quarter.
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1. Spending like crazy
One of the biggest reasons behind Canopy Growth's all-time worst net loss was the company's increased spending. And we're not talking about spending just a little more.
Canopy's sales and marketing expenses of more than CA$39 million more than quadrupled from the prior-year period. Its general and administrative (G&A) costs skyrocketed 342% year over year to CA$37.1 million. Research and development spending of more than CA$1.9 million nearly quadrupled from the second quarter of last year.
Sales and marketing costs by themselves were 67% higher than Canopy's total revenue during the quarter. Where did all of this money go? Canopy launched a national media campaign with digital ads across Canada, brand launches, building up its retail operations, and more. It also developed branding and educational campaigns as well as new recreational product packaging.
The company's big jump in G&A expenses came from increased legal and professional services fees related to what Canopy called "investments in governance," domestic and international operational expansion, and business development. Canopy Growth also boosted its information technology spending, including implementing a new ERP system.
2. Going shopping
Another major factor behind Canopy Growth's huge Q2 loss was its acquisition activity. The company made three significant acquisitions in the second quarter: Hiku Brands, BC Tweed, and Canopy Health Innovations.
But weren't all three of these deals stock-based transactions? Yep. However, there were some acquisition-related expenses totaling CA$5.1 million. This amount reflected a significant increase from the CA$1.7 million spent on acquisition-related expenses in the prior-year period.
More importantly, there were milestone payments associated with the acquisitions. Canopy treated these milestone payments as stock compensation expense rather than allocating them to the purchase price of the deals. As a result, the company reported CA$50.7 million in share-based compensation expense related to acquisition milestones, up from less than CA$1.2 million in the second quarter of 2017.
3. Paying the price of success
Speaking of stock compensation expense, Canopy Growth had a lot of it in the second quarter that wasn't related to acquisitions. All of Canopy's employees receive stock options as part of their overall compensation package. That's not unusual -- many companies do the same thing. What was out of the ordinary, though, was the huge jump in Canopy's stock compensation expense.
The company reported share-based compensation expense in Q2 of a little more than CA$45 million. In the prior-year period, Canopy's share-based compensation expenses totaled only CA$5.9 million. What happened? Canopy's share price soared roughly 63% during the second quarter of fiscal year 2019. As a result, the company had to adjust its stock compensation expense related to all of those stock options given to employees.
And there was an even greater price of success that Canopy had to pay. The company reported other expenses of CA$115.7 million in Q2 compared to CA$71 million in other income in the prior-year period. This drastic difference resulted in large part from adjustments to the fair value of senior convertible notes. As Canopy stock soared, so did the fair value of these notes.
Sometimes bad is good
At first glance, Canopy Growth posting its worst loss in its history might sound like really bad news. But the reality is that the reasons behind this big net loss were all good things for the company.
Canopy Growth's Q2 spending increases made sense as the company ramped up in anticipation of the opening of Canada's recreational marijuana market. Its acquisitions appear to be smart strategic moves. No one should be overly concerned about higher stock compensation expenses and other expenses related to the valuation of senior convertible notes when those expenses are higher due to Canopy stock's great performance.
And thanks to the major investment by Constellation Brands, Canopy Growth has plenty of cash to absorb even a relatively large loss like the company had in the second quarter. The bottom line here is that the bottom line for Canopy Growth in Q2 isn't really all that bad.
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