Time to look at Aurora Cannabis quarterly earnings release for September 30, 2020.

Earnings Release

What we said last Q:

Hold my beer while I have a chuckle at this from their MDA:

• During the year ended June 30, 2020, the Company’s wholesale bulk cannabis net revenue decreased by $9.5 million as compared to the prior year. The Company generates revenue from wholesale bulk cannabis from time-to-time when opportunities exist, and pricing and terms are appropriate.

RTI had to declare Aurora a “Related Party” and disclosed the size of the Biomass Boomerang to be $25 million.  They manufactured their wholesale and provided non industry standard extended terms to RTI, so I am not sure “opportunities exist and pricing and terms” will ever be defined as “appropriate” in anyone but ACB’s CFO’s mind.

When a company does something like a Biomass Boomerang and does not disclose it is usually out of desperation and portends a rocky road.  And the 4 Q’s since same has been just that. 

Add the Alcanna investment to the above Garage Sale with proceeds of $27.6 million gross proceeds. Total proceeds from Garage Sale were $33.7 million. BMO term debt was paid down by $24 million from the Garage Sale or 70% of proceeds.

To think that they can go from Sept 2020 decline in sales to an amount of sales required to hit their newly minted >$4 million EBITDA covenant with the bank at Dec/20 is fantasy.  Expect another amendment, likely with a significant paydown of bank debt before they declare +EBITDA flag plant 4.0.

But what investors should be most concerned about is the hard drop in their Adult Rec Gross Margin even when impairments are netted out. (Given I do my own GM calculation I have not really paid attention to their “Adjusted Gross Margin”.  But they back out depreciation, which is lunacy, as we are not looking for cash based Gross Margin.) This Q Adult GM was 22% netted for impairment. This is a decrease from 34% last Q. Part of this is them reallocating management production salaries from SGA to CoGS.

This Q:

Not one analyst question on “How are you going to increase EBITDA $15 million next Q in order to make the bank covenant of >$4 million next Q?”.  Adult Rec cannabis would need to increase $55 million in one Q by +162% at present 27% GM on adult rec to get there.

I can only imagine a pay down in bank debt to get the covenant moved yet again is in the works.

Flat sales and stagnant GM.  Things are not looking up for Aurora.

Now let’s get to the Q at hand.  Open the Fins and MDA and follow along.

Overview: Income Statement Drivers and Breakeven Sales: Trend

Table 1 Sales, Delta and Mix

Above is a summary and below are the various components after Excise Tax.

Sales decreased 6% or $4.3 million to $68 million QoQ.  Adult use dropped 2.6% or $0.9 to $34.3 million.  Medical sales increased 3.9% or $1.2 million to $33.5 million. The entirety of medial increase was international which grew $1.8 million to offset the $0.6 million decrease in Cdn sales.

Other sales decreased $4.7 million and disappeared as the operations were discontinued.

Adult Dried sales dropped 16% as Aurora shifted focus away from value to try and restore their higher margin brands.  2.0 sales increased 31% QoQ, which put them roughly at $8 million.  Of the $2.8 million increase in adult oil sales Relieva accounted for $1.7 million in sales, up from $0.6 million last Q. Provisions for returns improved by $1 million to -$0.8 million

Canadian Recreational Sales: Trend and Peer:

Adult Use decreased by $0.9 million -2.6% to $34 million.   

Medical Sales: Trend and Peer

All in Medical increased $1.2 million to $33.5 million. Cdn Medical decrease was $0.6 million due to switching all medical users to a single platform. International medical offset that decrease by posting a $1.8 million increase. 

Bulk Wholesale: Trend & Peer

The bulk wholesale baby that Cam Battley trumpeted on the June 30, 2019 CC remains at $0.  I imagine us exposing the ACB RTI Biomass Boomerang might have something to do with that.  Along with the wholesale bulk market collapsing. 

Table 2: Segmented Revenue

Looking at the individual components of Medical shows Cdn Dried cannabis exported to International being the growth areas.  Domestic Medical Oil retreated.

Medical platform is the strength of this company. Assuming ACB survives in one piece, this will be a strong platform, albeit not likely a huge growth platform in Canada, to support other areas of the business.

Adult sales dropped in dried by $4.8 million with adult oil increasing by $2.8 million, respectively.  Provisions and Returns also improved by $1.1 million.

Table 3: Price per Gram and KGs Sold

KGs sold in Medical and Adult backtracked to 16,189 KGs for the Q, a 609 KG reduction pretty evenly split between Medical and Adult.

Average net selling price per gram increased 3% to $3.72/gram largely a result less focus on their value brand and improved

Aurora does not break out Average Selling Price between Adult and Medical.  I imputed same.  Average net price per medical gram increase by 10.6% to $8.93/gram as increase in higher value international cannabis is likely the reason.  Average Selling Price for rec remained constant at $2.77/gram.

Table 4 Gross Margin by Segment

A lot in the table to digest.  Good news was no impairments.  Bad news is Adult Rec margin remains stubbornly low and at a GM per gram sold of $0.74/gram. They have to sell a whole lot of grams to close the $15 million EBITDA to get to bank covenant next Q.

• Medical GM% decreased 11% to 46% largely a result of ramping Denmark which accounted for $2.6 million in extra costs this Q.   Of $25 million in GM medical generates $15 million
• Adult rec GM increased from 22% to 27% but remains low.   Overall Adult GM was $9 million.
• Wholesale remains zeroed out
• Other Revenue disappeared as operations were closed and sold.

It is interesting the CoGS on medical that are largely shipped directly to patients has a $2.81/gram cost structure greater than mass shipped adult rec attached to it.

Cash cost to produce a gram has been removed from their MDA. 

You will note I added a “Cultivation Level” line to this.  Why you might ask?  Well cultivation level is what drives a lower CoGS, impacting GM.  Should an LP pull back on amount harvested this will impact the cost of new product going into inventory, which (assuming selling price remains constant) pressures GM% down. They produced 46,874 KGs this Q and that is projected to reduce to 36,310 KGs next Q.  Adding more headwind to their objective of meeting their EBITDA covenant.

Absolute GM was $25 million for the Q, a $100 million improvement QoQ as there were no impairments. Previous Cannabis GM without impairments was $26 million. Wrong direction.

Gross Margin Peer and Trend

Aurora surfaces from last Q’s impairments with a +GM (which is 100% cannabis now) of 36%, trailing Aphria’s cannabis GM of 49%.  The problem is the engine for growth is on the 27% Adult Rec GM and not the higher medical GM%.

Fair Value Increment on inventory sold in the Q was $3 million a decrease from $43 million last Q.  FVI per gram sold drops to $0.20/gram from $2.58/gram QoQ.  They are taking a very different approach than the past GoB fluffing based on this Q’s result.

Unrealized gain on bios remained increased dramatically by $7 million to $5 million while projected yield decreased by 13% to 36,310 KGs.

Gross Margin: larger Cdn Peer Base

Aurora moves into second place behind Aleafia with a 36% GM (Aleafia have hallmarks of Biomass Swap in their last few sets of financials). 

Gross Margin: North American Peer

The larger North American Peer base for GM% is dominated by the vertically integrated US MSO’s with them occupying the top 7 spots.  Aurora is highest Cdn player in the peer group.

Operating Expenses:

SGA & SBC as % of Sales: Trend

Second Q in a row with Aggregate SGA and SBC below sales at 75%. Given GM was $25 million against SGA and SBC of $51 million… you have some work left to do.

Selling expense decreased by $1.8 million to $15 million as savings are becoming harder to squeeze out. If they are going to reinvigorate premium brands, I would expect this to start to increase.  This Q was reduced as they decreased promotion of Daily Special and 2.0 products.

G&A decreased by $14 million to $29 million as some expenses would have fallen into discontinued operations.  There are $4.1 million in restructuring and severance costs in G&A which should help next Q.    

R&D was $2.6 million versus $7.6 million last Q.  As per MDA: “The decrease is primarily driven by (i) a $1.2 million decrease in UFC sponsorship fees as a result of the mutual partnership termination; (ii) a $0.8 million contract termination fee for R&D services in the prior quarter; and (iii) $1.1 million overall decrease as a result of the restructuring and business transformation plan”

Acquisition and evaluation costs were $2.2 million a decrease from $1.3 million the previous Q.

Depreciation was $14 million consistent with last Q.

Share Based Compensation increased QoQ from $6.0 million to $6.9 million.   

All in Opex came in at $69 million versus $91 million last Q a $22 million improvement.   

SGA & SBC as % of Sales: Peer

ACB is a strong second to CGC for highest in peer, whom I will have to wait for SEDAR filings to complete their SGA and SBC for the Q.

Net Operating Income before IFRS voodoo was negative $44 million an improvement from negative $171 million last Q. The improvement largely stems from lack of impairments to CoGS and improvements in Opex control.

+Net Operating Profit: Cdn Peer

With current GM% and Opex$’s Aurora needs a 215% increase in sales quarterly to evidence a +NOP.

Rounding out the income statement:

Other expenses from MDA:

• For the three months ended September 30, 2020, other expense was $64.2 million and consisted of (i) $43.3 million of legal settlement and contract termination fees; (ii) $14.7 million finance and other costs; (iii) $8.4 million of fair value losses on derivative investments; (iv) $3.4 million impairment of software intangible assets; (v) $1.4 million loss on the deemed disposal of an equity investment; and (vi) a $0.9 million loss on disposal of assets held for sale and property, plant and equipment; offset by (vii) a $7.4 million gain in foreign exchange; and (viii) a $1.7 million fair value gain on the derivative liability related to the $345 million U.S. dollar denominated convertible senior notes.

The big delta was cancelling the UFC contract which lead to the majority of the $43 million legal settlement. 

Finance and interest expenses of $15 million is stark in comparison to a GM of $25 million.

Net Income loss was $107 million after $1,864 million last Q.  The lack of inventory impairments and much reduced impairments on PPE and goodwill and intangible are the driving factors.

+Net Operating Profit: North America Peer

EBITDA Peer – Large Cap

They report an adjusted EBITDA of negative $58 million but adjusted for their bank covenants they get to remove the legal settlement on UFC and it comes in at negative $10 million. 

This is an improvement of -$21 million QoQ, wholly on the backs of expense reduction in SGA and R&D.

To get to that bank covenant of >$4 million in one Q looks impossible.  They have had a sales increase in Rec twice of $15 million QoQ.  They need that in EBITDA!!!

+EBITDA: Cdn Larger Peer Group

With current GM% and Opex$’s Aurora needs a 41% increase in sales quarterly to evidence a +EBITDA, but their Adult GM is only 27% and is the growth driver.

+EBITDA: North American Peer Group

CashFlow Statement:

Cashflow from Operations – Trend

Opex burn is essentially negative EBITDA plus the legal settlement and interest expense.  Inventory was the big growth item in working capital items at +$34 million.

Cashflow from Operations – Peer

Aurora’s Opex Burn is considerable.

Balance Sheet Items of Note:

• Cash vs Debt

• Cash was down by $29 million to $134 million despite drawing the ATM to $114 million.  They hit the ATM pinata pretty hard since Q end and drew down the remaining $127 million.  They filed a new shelf with capacity for $500 million in new shares.

• Accounts receivable are $74 million an increase of $20 million, $15 million is an increase in trade A/R.  If this is do to ramping sales in the last month of the Q it could have positive implications for next Q.
  • Non-government wholesale is $1.6 million… RTI??  They didn’t wholesale the last two Qs, so the RTI financing continues.
• Bio Assets decreased from $6 million to $29 million
  • Projected yield is down 13% to +36,000 KGs
• Inventory increased $34 million to $156 million or 2.3x sales
  • WIP is up $34 million to $108 million
    • Flower is $75 million up from $57 million
    • Oil is $32 million up from $27 million.  Maybe RTI will see some sales next Q.
  • FG went is down by $1 million to $30 million.  PLENTY of FG inventory on hand.
    • $15 million in flower up from $13 million
    • $15 million in oil down from $17 million

Gas in Tank: Trend

Inventories increase $34 million QoQ.

Gas in Tank: Peer

Aurora has the third most inventory and FG inventory of the peer set, but CGC are US GAAP versus IFRS.

Waterfall Trend

• Harvest increased 2,468 KGs to 46,874 KGs
• Sales decreased 609 KKS to 16,139 KGs
• +30,000 KGs went into inventory despite sales of +16,000 KGs.  This delta increased QoQ by 3,077 KGs in a declining sales environment for Aurora.

Waterfall Peer

Deltas of Harvest to Sales across the board except for Tilray. OGI and CGC pulled KGs sold from MDA in past two Qs.

Sold vs Harvest & Sales vs Inventory:

• What we said last Q: And the ramp of inventory has taken a quarter off with the impairment. Expect it to trend upwards next Q…. This Q: Yup, that happened.  They are reducing the IFRS component of what they are booking to inventory, this should keep the upward slope less steep than in past.

Inventory to Sales:

• The inventory to sales ratio with ACB 2.3:1 having crept upward from last Q’s impairments. 

• Loans and Borrowings -$20 to $184 million
  • They made a $16 million payment in the Q against the bank group loans from the Garage Sale.  Bank term loan now stands at $98 million with leased liabilities $87 million.

What I said last Q:

Aurora had a Progress Quarter… the previous Q.  This Q was anything but a progress Q.

• Sales down and expected down next Q.
• GM% get hammered by impairment this Q, but more worrisome is the 22% adult rec GM.  If adult rec is to get them out of this hole, they need this GM to improve dramatically.  If they have done some witchcraft by over writing down inventory, we will see that next Q.
• SGA hit their target range but $5 million was moved from SGA to CoGS to do it.

I have to admit I am puzzled by the bank group changing the EBITDA covenant to Dec/20 from Sept/20 when there is no clear way for Aurora to close the gap without a more than doubling of Adult Rec sales at a 35% GM (versus the 22% this Q).  Banks do not like to amend a loan agreement, let alone amend every Q.

My gut is telling me that Aurora will make a payment on the term debt from proceeds raised by the ATM to get a shot at moving the covenant one more time. The quid pro quo is a reduction in bank exposure for a new timeframe and covenant amount. The lesser term debt would be welcomed by the bank group. As the bank group is already pregnant with the term debt, they are not in a hurry to demand due to failure to meet covenants.  Every Q they get a little more repaid.  Working down the term debt is their goal.  Shareholders might not like the consequences of the dilution to get there but there is very little other options.

I had though selling their medical might be an option, but the SGA that would have to also depart with 70% of their GM would likely have to be substantial to make it worthwhile.  Adult rec GM of less than $8 million does not pay a lot of bills.

This Q:

• Cannabis sales were flat as guided. Adult Use heading in reverse is not what they need.
• GM is worrisome, as medical takes a dip with launching of Denmark and Adult use is low at 27%. 
• SGA saw another decrease, but the fat is well trimmed.  They might have some more juice with severances largely out of the way but this is going to hit a wall eventually.
• Interest expense of 60% of GM is a big problem still.
• Cash is still being burned at steady clip and the ATM is the only source given the Garage Sale is pretty well wound down, unless someone wants to buy cultivation assets in an oversupplied Canada.

Aurora will stay standing as long as they can tap the equity markets.  I would expect another ATM to be launched soon. 

If Aurora fails to conjure sales with a respectable GM, the wealth transfer from shareholders to lenders will continue unabated.

That’s all I got.

GoBlue

The preceding is the opinion of the author and is in no way intended to be a recommendation to buy or sell any security or derivative. The author does not have a position in ACB and will not start one in the next five days.