Over Half of Canopy Growth's Huge Q4 Operating Loss Resulted From This Surprising Reason

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.

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Spreading the wealth

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 Tilray combined. 

Awesome?

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 awesome.'" 

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.