Canopy Growth (NYSE:
CGC) didn't exactly wow investors with its fiscal 2019
fourth-quarter results last week. The Canadian cannabis
producer reported lower quarter-over-quarter cannabis sales on all
fronts, although overall revenue increased thanks primarily to its
acquisition of German vaporizer device maker Storz & Bickel.
Canopy also posted a huge operating loss of nearly 175 million in
Canadian dollars -- more than triple the size of the company's
operating loss in the prior-year period.
As you might expect, increased spending on sales
and marketing as well as general and administrative functions
played a big role in Canopy's wider operating loss. The company
also spent significantly more on research and development and
incurred higher acquisition-related costs.
But there's another factor that accounted for
well over half of Canopy Growth's operating loss in Q4 and nearly
one-third of its net loss of CA$323.4 million. You might be
surprised what's significantly holding back the company's ability
to turn a profit.
Image source: Getty Images.
Canopy Growth recorded CA$74.7 million in Q4
related to share-based compensation expense. It also reported
another CA$18.5 million for share-based compensation expense
related to acquisition milestones. More than CA$93 million in total
went to Canopy Growth's employees in its last quarter for stock and
options compensation above and beyond their salaries.
The only cost on Canopy Growth's income statement that
was higher than its share-based compensation expenses was the
company's other expense of CA$133.5 million. That expense stemmed
from an accounting fair-value adjustment of Canopy's convertible
senior notes. Because Canopy Growth stock rose, the company had to
increase its expense associated with those notes, which will be
able to be converted into stock in the future.
Canopy Growth's share-based compensation expense
was much higher than analysts expected it would be. It was also
more than share-based compensation reported by the next three
largest Canadian cannabis producers by market cap, Aurora
Cannabis, Cronos Group, and
Bruce Linton, Canopy Growth founder and co-CEO,
defended his company's huge employee stock expense in a phone interview with
MarketWatch last Friday. He said about the share-based
compensation, "I think people should say, 'That's
Linton's idea is that every employee at Canopy
Growth and other cannabis companies with a salary of less than
CA$200,000 should receive 1.5 times their salary in stock options
on the first day on the job. His view is that granting options to
employees makes the overall business stronger.
This perspective makes sense in many ways.
Employees who own stock options have a vested interest in helping
the company succeed. And if the company is successful over the long
run, all shareholders win.
There are downsides, though. Linton acknowledged
that "if we had zero stock-compensation loss, we would have a much
lower loss." Canopy could also have to issue new shares down the
road if employees exercise their options. But Linton told
MarketWatch that Canopy Growth would be "a much worse company"
without the options that it grants to employees.
The reality is that right now, most Canopy Growth
shareholders aren't overly concerned about the company's huge
operating loss or its widening net loss. Most probably aren't
bothered too much by the company's employee stock options, either.
After all, the stock is up more than 40% so far this
Over the long run, the issue about Canopy's
employee stock options could be made irrelevant by the company
continuing to deliver impressive returns to investors. The primary
ways that Canopy can pull this off are by continuing to command a
leading market share in the Canadian adult-use recreational
marijuana market, generating strong growth in international medical
cannabis markets, and expanding into the U.S.
The good news is that Canopy appears to be doing
the right things on all of these counts. Even with a
quarter-over-quarter decline in recreational sales in Q4, Canopy
should be able to rebound as it ramps up production capacity and as
more retail locations open. Increased capacity should also help the
company boost international sales.
Canopy is arguably in the best position of any
Canadian cannabis company to enter the U.S. It's moving forward
with the construction of a large-scale hemp production facility in
New York State. Canopy Growth is also in good shape to be ready to
acquire U.S.-based cannabis
operator Acreage Holdings if federal
marijuana laws are changed in the U.S.
Of course, there won't be a good way to know how
much employee stock options really made a difference for Canopy in
achieving success in the future. But if that success comes (as I
suspect it will), it's likely that no one will care.
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Keith Speights has no
position in any of the stocks mentioned. The Motley Fool has no
position in any of the stocks mentioned. The Motley Fool has a