Auxly released their Q1 F2021 earnings today.

This will be my fourth pass on Auxly for a Quarter in Pictures. Getting comfortable with them.

Outlook for 2021 from Q4F20 MDA:

“Our overall objectives for 2021, which may be impacted by the COVID-19 pandemic (see further discussion in this MD&A under “COVID-19 Pandemic”), are as follows: 

• Continued leadership and strength in the Cannabis 2.0 Products market;
• Focused expansion of Cannabis 1.0 Products;
• Continue to take measures to improve cash flows and finance the business;
• Leverage the Sunens facility to establish a secure supply of cannabis and reduce reliance on open market purchasing; and
• Explore possible cannabis market entry strategies in regulated international markets, on an asset light basis.”

Much like last year’s objectives, 2021 objectives offer little in the way of “meat on the bone” targets and objectives are all “soft”.

From Last Q:

Of Note: Sunens is in default of the bank debt with BMO, as they missed Q1 revenue target of $3.45 million.  They are working on amending or forbearance.  I have heard rumors of a rift developing between Quiring and Auxly for quite some time.  Could explain why the supply deal has been amended and interest on Auxly provided debt waived. As both parties are on the hook with BMO, I imagine a solution will surface.  They have already had to kick in more equity of $2 million.

This Q:

Sunens still in default.  Bank advanced funds under loan when they did not have to given default. 

Here is disclosure from MDA:

• On April 16, 2021, Sunens received a notice of default from BMO in its capacity as lender, administrative agent and syndication agent under the credit facility with respect to Sunens’ failure to satisfy the Revenue Milestones Requirement. Although the lenders have reserved their rights under the credit agreement, they advanced another $1 million in April 2021 pursuant to a borrowing request made pursuant to the credit facility and BMO granted a one-month payment holiday and term extension of the equipment loan payment due in May 2021 in the amount of approximately $0.2 million which was used to fund day-to-day operations. In addition, Sunens may require additional funding for working capital until production and revenue from sales reach expected levels. In May 2021, the Company has begun further supporting Sunens through purchases of cannabis as production from the Sunens facility increases. Discussions with the lenders with respect to a formal credit amendment and/or forbearance agreement are continuing although there can be no assurance that an agreement with the lenders will be reached. The lenders have retained an accounting firm to provide them advice with respect to the credit facility in the form of a report expected to be completed in the next two months.

• Subject to reaching an acceptable accommodation with the lenders, the joint venture partners are considering additional costs to optimize the processing and storage capabilities of the Sunens facility which may be funded by the joint venture partners and/or lenders, however, a reasonable estimate of any such costs is not determinable at this time. The Company anticipates that it will transition Sunens to become one of its primary suppliers of cannabis inventory over the course of 2021.

If there is tension in the relationship how they fund going forward will give you some insight as to who has who by the short and curlies.  And with the drop in sales at Auxly… how much product can they really offtake?? Launching cultivation in the face of a sales downturn is daunting, to say the least.

Open up the financials and MDA and follow along.

Income Statement Drivers – Trend

Sales:

In Q3F20, Sales increased +57% QoQ to $13.4 million. In Q4F20, they increased another 40% +$5.5 million to $19 million.  In Q1F21, they gave back those previous two Q’s of sales increases and dropped -47% QoQ.

Research revenue increased $0.2 million to $0.8 million and cannabis revenue decreased 50% or -$9.1 million to $9.2 million.  2.0 products accounted for -$4.0 million in declines (reversing one Q of growth) while 1.0 products dropped by -$1.8 million to $1.8 million in sales.

Granted other LP’s saw decline QoQ as covid had provinces adjusting inventory levels,  but nothing of this magnitude.

Income Statement Drivers – Peer

With FIRE and NRTH being bought and us tossing AH out of the peer group due to suspect actions around biomass swaps… our Tier 2 peer base is going to look anemic.

Gross Margin: Trend and Peer

Last Q we harped on GM being an issue.  Took many a slings and nastygrams on social media for our take.  But again… Gross Margin is an issue despite it bouncing almost back to the first three Q’s of last fiscal of 30%. 

They recorded an improvement in GM from 8% to 21%.  Despite the decrease in sales, absolute GM increased $0.5 million QoQ to $2.1 million.  The entirety of the improvement, and then some, was a reduction in inventory impairment QoQ to $0.2 million from $1.8 million.  CoGS on cannabis improved from 75% last Q to 68% this Q, which without impairment would give them a 32% GM. 

GM from research was $0 after being negative $0.8 million last Q.

Gross Margin needs to be around 40% AND sales need to rebound to Q4F20 levels for them to have even a fighting chance at breaking even.

To put it in stark terms: Gross Margin is $2 million, and Interest Expense is $4.6 million. Granted some of the interest is paid in shares ($2.9 million), but that does not give them a pass except on saving them cash. Plus netting the non-cash interest gives them a cash interest expense of $1.6 million versus this Q GM $2.0 million and last Q GM of $1.5 million.

IFRS impact is negligible.

Gross Margin- Peer Group

On a larger peer basis, Auxly’s 21% GM ranks fifth overall.

Operating Expenses:

Selling, General and Administrative Expenses as % of Sales: Trend

NOTE: I moved interest expense to other expenses to maintain peer comparability.

Selling expenses were $1.3 million or 13% of sales versus $1.8 million and 9% last Q.

G&A expenses came in at $7.9 million or 79% of sales versus $7.6 million and 40% of sales last Q.  The wage decrease last Q of $2.0 million may have been a year end true up, as wages increased to $4.3 million or +$1.0 million QoQ.  All other expense categories aggregated a $0.8 million decline QoQ.

What I said last Q:

I have been harping on their SGA for quite some time.  SGA is $9.4 million versus GM of $1.5 million or $3.3 million without the inventory impairment.

This Q:

I am going to continue to harp on SGA expenses.  They are 92% of sales at $9.2 million per Q. If we used their record sales last Q of $19 million at a 30% GM (which they have never exceeded) they would still have a $3.5 million deficit to SGA, and that is before we get to all the other expenses.

Folks, we are in year 2 of 2.0 formats.  This company was set up for 2.0.  This is not acceptable.

Depreciation of $2.5 million, versus $2.3 million last Q, rounds off Opex.  I note that a good portion of this depreciation really should be in CoGS as it pertains to the production assets. So, their weak GM is inflated by not domiciling the depreciation where it should be.

Selling, General and Administrative Expenses as % of Sales: Peer

Breakeven Sales Required to post +Net Operating Profit: Canadian peer Group

At current GM% and OPEX$’s Auxly needs an incremental 473% increase in quarterly sales to cover Opex and return a +NOP.

NOP without IFRS was -$9.8 million this Q versus -$10.6 million last Q.  The bump in GM$’s was offset by a decrease in Opex.

Other Expenses:

Other expenses aggregated negative $1.0 million versus expenses of $16.8 million last Q.  Of note:

Net Income was -$11 million versus -$27 million last Q.

Adjusted EBITDA: Trend and Peer

Auxly EBITDA slid QoQ by $1.0 million to negative $6.9 million, their worst showing since Q2F20.  But with interest expense of $4.6 million they have quite a way to go to cover that expense.

Opex Burn for the Q was $4.3 million versus $6.4 million last Q.

Breakeven Sales Required to post +Adj EBITDA: Canadian peer Group

At current GM% and cash OPEX$’s Auxly needs an incremental 330% increase in quarterly sales to cover Opex and return a +NOP.

Balance Sheet items of Note:

• Going concern note
• Cash was $20 million a decrease of $0.8 million QoQ, despite a raise in the Q of $19 million. The operating burn of $4.3 million coupled with the investing in non-cash working capital of $14.4 million sucked that up.  They have an open $30 million At The Market offering as well that has not been drawn. They also completed an offering post Q for $8 million.  Cash is in reasonable shape.
• Deposits increased $3.3 million to $11 million.  Looks like $2.5 million of the increase is what they sent to Sunens for future inventory.

• Speaking of inventory… It increased $7.6 million to $51 million.  $3.7 million of that increase was packaging and supplies.  They have more packaging and supplies than one q of sales.  Granted there are many supply chain concerns across numerous industries, but this is excessive. They have $36 million in products in various stages of inventory.  This does not bode well for possible future impairments with in excess of five quarters held in inventory.

• Accounts Receivable of $8,500 is large compared to $10 million in Q sales that usually carry 60-day terms.  They have $1.5 million greater than 61 days from billing with a provision of $0.9 million against that.

• Accounts Payable and Accrued liabilities were paid down by $5.8 million in the Q to $21 million.

• Share capital and Reserves are up $20 million QoQ largely from the equity raise in Q.

In conclusion:

Two steps backwards this Q.  It could take them two more Q’s to reach Q4F20 sales levels.  The impressive sales increase last Q coupled with the hope of GM improvement AT THAT SALES LEVEL… went poof.

Gross Margin, while improved QoQ, remains a problem given SGA and interest costs.  Over the past four quarters GM was $10.7 million against interest expenses of $15.5 million.

Sunens remains in default and Auxly might have to shovel more cash into it.  It looks like they have pre-purchased inventory, and they already have five quarters of inventory on hand.

This company, despite strong market share in 2.0, is not showing directional improvement in operating metrics. 

Sales cures a lot of ills, but they would need a tripling of sales with their cost structure.  And the Canadian retail market space is not being very accommodative despite the deluge of stores opening in Ontario.

I expect if they cannot correct course, they will announce a “strategic review” by Q3 reporting.  They might be acquired, but that price just took a substantial haircut.

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 Auxly and will not start one in the next five days.