Earnings Call Transcript - ACB Q3 2021

Operator, Operator

Greetings, and welcome to the Aurora Cannabis Inc. Third Quarter 2021 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ananth Krishnan, Vice President, Corporate Development and Investor Relations. Please go ahead.

Ananth Krishnan, Vice President, Corporate Development and Investor Relations

Thank you, Hector, and good afternoon, everyone, and thank you for joining us for the Aurora Cannabis third quarter fiscal 2021 conference call for the 3 months ended March 31, 2021. This is being recorded today, Thursday, May 13, 2021. With me today are Aurora's CEO, Miguel Martin; and CFO, Glen Ibbott. After the close of markets today, Aurora issued a news release announcing our financial results for the fiscal third quarter. This news release and the accompanying financial statements and the MD&A are available on our website or on our SEDAR and EDGAR profiles. In addition, you can find a Q3 supplemental information deck on our IR website. Listeners are reminded that certain matters discussed in today's conference call or answers that may be given to questions could constitute forward-looking statements that are subject to the risks and uncertainties related to Aurora's future financial or business performance. Actual results could differ materially from those anticipated in these forward-looking statements. The risk factors that may affect results are detailed in Aurora's annual Information form and other periodic filings and registration statements. These documents may be accessed via the SEDAR and EDGAR databases. Since we are conducting today's call from our respective remote locations, there may be brief delays or other minor technical issues during this call. We thank you in advance for your patience and understanding. Following prepared remarks by Miguel and Glen, we will conduct a question-and-answer session to ensure we get to as many questions as possible, we ask the analysts to limit themselves to one question each. With that, I would like to turn the call over to Miguel. Please go ahead.

Miguel Martin, CEO

Thank you, Ananth, and good afternoon. I would like to start with some brief thoughts on the quarter, including a discussion of our domestic and international medical businesses, and then I'll address our plans for the near-term challenges in the Canadian adult-use business. Afterwards, Glen will provide his financial review. Finally, I'll talk more broadly about strategy and why we believe that Aurora, as the largest Canadian pure-play cannabis LP in the market, has an incredible opportunity within the global cannabis space. I think it is clear from our results that Aurora benefits greatly from having built a diversified business across domestic medical, international medical and adult-use recreational markets. This provides us with both stability and growth no matter how the global cannabinoids industry evolves. First, let me say by talking about our domestic medical cannabis business, which is on very solid ground. We're number one by revenue in Canada's medical market, which, as you know, is the largest federally regulated medical market in the world. And our estimated market share is nearly double that of our next largest competitor. Notably, our international medical business also thrived during the period, demonstrating sequential growth even as many of our peers experienced declines. It should be mentioned that both of these units exhibit approximately 60% gross margins. The domestic medical business is unique as it represents a direct-to-patient distribution model that is powered by sophisticated technology infrastructure, allowing for an end-to-end patient experience. This infrastructure covers patient clearing, onboarding, medical consultation straight through to prescription fulfillment. We are extremely proud of the investment in technology and infrastructure we've made to service the medical patient base and it provides a tangible barrier to entry to the medical channel. In the adult-use environment, low barriers to entry and provincial middlemen add a layer of cost and complexity; the Canadian medical channel's direct-to-patient model is a welcome, sustainable, high-margin diversification piece to Aurora's business. We believe we offer the most expansive product selection and a carefully curated portfolio to ensure wide coverage of patient conditions at a variety of price points. Under my leadership, Aurora will maintain its focus on providing unparalleled professional counseling and guidance to patients looking for assistance in navigating medical cannabis alternative treatments. This high-touch approach to the medical channel is unique and is not easily replicated in the adult-use retail experience. Further, we continue to exhibit success leveraging these core capabilities from Canadian medical into our growing international medical platform. We sold medical cannabis into 12 countries during this quarter, and the number of countries exploring medical cannabis continues to grow. We've shown that we can take the expertise we gained in Canadian medical and export that internationally. And we continue to believe that this expertise represents a key success factor for Aurora as new countries look at launching medical cannabis regimes. Companies with success operating in federally regulated medical systems like those governed by Health Canada or the German health industry are going to be advantaged when new markets open up to federal regulations, typically first for medical, then for recreational adult use. It should not be overlooked by anyone that on April 20, in response to a question from a journalist, the White House press secretary publicly confirmed that President Biden supports legalizing medical cannabis. In a country like the United States, and their federally regulated system, we would fully expect the FDA to have significant influence in the federal medical cannabis program. And we think Aurora is uniquely advanced when that happens. We view our enviable positioning in medical cannabis as a tailwind that over time will translate into success on a global scale. Taking this point one step further, as of March 31, Aurora was the second largest Canadian LP in terms of global cannabis sales and a leader across multiple markets and segments. We have grown the credibility to pursue incremental M&A opportunities in Canada, the United States and around the world in support of shareholder value creation. Still, consistent with our peers, the Canadian consumer business presented challenges during the quarter. In our view, these challenges were twofold: first, COVID-related lockdowns and key problems have made it more difficult for consumers to access products at retail, despite curbside pickup and online ordering for delivery as available options. Secondly, COVID slowed construction and opening of newly licensed stores. However, it's undeniable that there exists great retailer interest in having a more premium focused assortment, and they are therefore taking a more accretive approach to margin as it pertains to 2.0 products versus just low-cost flower. We anticipate that these expense reductions will not inhibit any of our strategic growth plans across our businesses or our current revenue opportunity, but they will help to reduce our cash burn, solidify our margins and enhance our overall financial flexibility.

Glen Ibbott, CFO

Thanks, Miguel, and good afternoon, everyone. Please note that the figures I'll be reviewing are all in Canadian dollars and can be found in the press release we issued this afternoon or in the Q3 MD&A and financial statements filed today on SEDAR and EDGAR. I also want to highlight that our Q3 financial results represent the best measure of the company's transformation and improved performance. Where appropriate, I will also note sequential period comparatives. For context regarding our Q3 financial results, I would like to take a moment to remind you of the plan we outlined to you in December 2020 and February of this year. Last quarter, we discussed a number of initiatives as part of our transformation of our consumer business. We talked about a focus on higher quality, higher-margin products. So we reduced Sky production to 25% of its previous run rate to allow for process and cultivation changes to strengthen the flower standards there. A bit later, Miguel will speak to the success at Sky so far. But for now, I'll say that we are greatly encouraged by the significant improvement in quality performance at Sky and across all of our operations. The reduced run rate has resulted in under-absorption of certain overhead costs at Sky, which then flow through to impact our cost of goods and gross margin in the quarter. So although it hurts our gross margin in the short term, it's clearly the right long-term shareholder value creation decision. As the improved quality results we're seeing from Sky should allow that facility to truly perform as a gem in this industry. In addition to allowing for the transformation of Sky into a higher quality cannabis facility, we noted that the significant reduction in production volumes at Sky would allow us to align our overall production levels with demand. And we expected our sales to production ratio in Q3 to be in the 90% range. In fact, in Q3, despite the challenges of the consumer business, we sold 93% of what we produced. We did this, replacing older, lower potency flowers and pre-rolls with the new standards that Miguel will explain, including San Raf brands that deliver higher THC potency and a very terpene profile without exception. Although the product swaps resulted in a returns provision of $3.2 million, which impacted our Q3 net revenue and margin numbers, the actions we took aimed to provide a sturdy foundation to support higher margins and accelerating cash flows in the coming quarters. So now to actual Q3 results, and I'll start with a few high-level comments. Q3 2021 revenue demonstrated the importance of Aurora's diversified cannabis business. While the Canadian consumer business was being repositioned to a higher standard, our leading medical businesses in Canada and Europe continued to perform exceptionally well, delivering growth in high-margin revenues. Our Q3 net revenue was $58.4 million, excluding the product return provisions of $3.2 million. Our medical cannabis segment continued to accelerate, generating $36.4 million in sales, and our consumer cannabis business delivered $21.3 million in net revenue prior to the return provisions. Adjusted gross margin for cannabis net revenue remained strong at 44% compared to 43% in the comparative quarter. Excluding short-term impacts of unabsorbed overheads at Sky and return provisions, our normalized Q3 adjusted gross margin was 54%. We continue to operate at our targeted low $40 million range for SG&A. Pulling all of this together, we generated an adjusted EBITDA loss of $16.7 million, excluding revenue provisions for restructuring, which represents a continued improvement from the $44.6 million adjusted EBITDA loss in the prior year comparative.

Miguel Martin, CEO

Thanks, Glen. As I referenced earlier, Aurora's underlying strength is that we are a diversified business that can be broken down into 4 parts. First, the Canadian Medical business; second, an international medical business; third, a U.S. CBD business; and fourth, finally, our Canadian adult rec-use business. The latter is clearly facing some near-term COVID-related headwinds, but we're confident that when these conditions abate, we will have a strong business across all 4 key platforms. Although we are already the number one medical cannabis company in Canada by revenue, we still believe that we have significant growth ahead. First, I'd like to highlight that the top 5 LPs in the Canadian medical channel represent less than 40% of the market, with Aurora being roughly half of that. This means that there are plenty of LPs out there that make up 60% of the medical market, representing a lot of potential for us to grow into. Second, there are further opportunities to leverage technology and improve patient intake and user experience to lower wait times while increasing service levels and product choices. We have made the requisite investments in infrastructure and have the necessary regulatory experience and compliance systems that effectively create a barrier around our business, supporting key patient groups, while enabling us to sustain approximately 60% gross margins for the foreseeable future. Our international medical segment generates revenue across 12 countries and has been a consistent winner. We have a leading position in Germany in dry flower, but are also optimistic about the large and growing oil market there. Additionally, we have made inroads in Israel through a strategic supply agreement with Cantek. We are also involved in the French medical cannabis tender program with our partner, Ethypharm, where we won 3 of the 9 tenders, representing all of the dried flower tenders awarded to supply the French medical pilot program. As you know, Senator Chuck Schumer said on the Senate floor, that 4/20 is the unofficial American marijuana holiday, and that he now supports legalizing cannabis on a national level. On that same day, the White House press secretary acknowledged the President's support for medical cannabis legalization. I feel confident about Aurora's chances for success within a federally regulated medical framework. The timing for this legalization remains uncertain, but our expertise operating within a highly regulated framework, supported by our commitment to science, testing, labeling and EU GMP compliant cultivation puts us in a strong position for potential opportunities. Let me end by highlighting our commitment to improving operations while leveraging our extensive knowledge and impact across the industry. Thank you for your interest.

Operator, Operator

Thank you. At this time, we will be conducting a question-and-answer session. Your first question comes from the line of Vivien Azer with Cowen. Please proceed with your question.

Vivien Azer, Analyst

Hi, how are you?

Miguel Martin, CEO

Good afternoon, Vivien.

Vivien Azer, Analyst

Good afternoon. So my question has to do with the competitive dynamic in the adult-use market in Canada. Although COVID shutdowns and delays in store openings have been challenging for you and your peers, I am curious to understand your perspective on the competitive landscape. It appears that smaller operators are picking up market share, and I wonder how you view the balance of benefits of being the first mover versus competing against these smaller second movers.

Miguel Martin, CEO

Great question. Let me address the macro issues that everybody faces because COVID is the top line answer. But we have to consider that the provinces, which act as wholesalers, made massive cuts to their days on hand in reaction to current events. That's a significant factor. Market share in isolation is not a good indicator, as smaller companies are now picking up market share primarily through value products and discount offerings, which have lower margins than premium products. If we look at the last 12 months, while flower sales might be up, more innovations in concentrates, vapes, and premium products have been growing at a greater rate. Competitive dynamics are likely temporary, as we are noticing that the provinces are becoming concerned about price compression and are beginning to implement price floors on key products. Our market share is under pressure, which is frustrating, but we have made major changes in the quality of our products, and I'm optimistic about the changes we are implementing.

Pablo Zuanic, Analyst

Miguel, may I ask about the relationships between Aurora and the provincial boards, as well as retailers and consumers? I'm curious about how those relationships have been affected by the competitive dynamics, especially considering the ongoing struggle with market share.

Miguel Martin, CEO

Thank you for the question. Our relationship with the provincial boards is evolving as this market matures. We have a good relationship, and they are becoming more sophisticated, making sure to focus on quality. We're providing a strong value proposition with our product portfolio, and we are hearing concerns about price compression from the provincial boards. Regarding retailers, we have a somewhat fragmented retail environment, but our investments in retail infrastructure through Great North Distributors will help us better manage our relationships and improve overall efficiencies. For consumers, we've enhanced our product quality while also understanding the shifts in consumer preferences, which leads to more innovative offerings tailored to their needs.

Frederico Yokota Choucair Gomes, Analyst

We've seen M&A activity ramp up in Canada recently. How do you view the current environment, and do you have any plans for M&A in Canada?

Miguel Martin, CEO

Frederico, that's an interesting question. At the moment, we do not see any immediate acquisitions in Canada that we absolutely must have. Given the dynamic nature of market share buying, we're being careful not to chase companies just to rent market share. That said, if an opportunity arises that provides value to us, such as technology or a strong management team, we would certainly consider it. Overall, we're focused on securing opportunities that align well with our current business strategy.

Michael Lavery, Analyst

Regarding the cost savings initiatives you've laid out, can you clarify how you expect those savings to impact your financial performance, specifically in terms of net versus gross savings?

Miguel Martin, CEO

Michael, I believe we can deliver the projected $60 million to $80 million in savings. We have made significant strides in identifying redundancies and inefficiencies across operations. The need for reinvestment into those improvements is minimal, which allows us to expect more direct flow-through to our financial metrics without being unduly reliant on revenue growth. It's our goal to achieve breakeven EBITDA soon.

Heather Balsky, Analyst

Can you talk about your balance sheet, cash position, and the timeline for achieving positive cash flow?

Glen Ibbott, CFO

Certainly, Heather. Regarding cash flow, our operational cost savings play a significant role in improving our cash position. We need to remember that our EBITDA loss was only slightly higher than the previous quarter, which indicates that our savings initiatives are performing as expected. Long-term growth in cash flow is contingent upon maintaining our strong cash position and balancing it against working capital as we continue to invest in our growth plans.

Matthew McGinley, Analyst

Can you provide insight into the expected financial performance in the upcoming fourth quarter compared to the third quarter?

Miguel Martin, CEO

It's difficult to provide specific guidance for the fourth quarter as numerous market factors are in play. While I expect stabilization in some segments, we also need to acknowledge that it may take additional time for some of the initiatives to fully materialize into tangible results. We will keep you updated on overall business trends as we progress.

Tamy Chen, Analyst

Can you explain the consistency at which the Sky facility can produce high-quality cannabis and how that might impact inventory and possible impairments going forward?

Miguel Martin, CEO

Sky has required a significant operational pivot to meet the growing demand for high-potency products. While production has seen a temporary reduction rate, we are beginning to see positive results in quality. The other facilities have maintained good quality, which gives us flexibility in inventory management. Therefore, while the transition can create short-term challenges, we believe that we'll achieve consistency in high-quality product flow over time.

John Zamparo, Analyst

Miguel, can you provide more details on the current percentage of retail distribution and how that has changed over the last year or so?

Miguel Martin, CEO

While I can't disclose exact figures, we monitor our distribution and stock levels closely. We are actively enhancing our store presence and have partnered with Great North Distributors to increase our brand visibility. Our outreach strategy focuses on maximizing shelf space and maintaining stock levels to optimize product distribution.

John Chu, Analyst

Can you discuss your thoughts on the Canadian medical and European markets?

Miguel Martin, CEO

The Canadian medical market currently represents about 1% of the total population, and our share is significant. There's a huge potential in the European medical market as well—Germany's penetration is vastly unexplored, meaning there remains a considerable growth opportunity. Our strength in medical provides not only stable revenues but also synergies with our recreational growth plans.

Operator, Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I'd like to turn the call back to Mr. Miguel Martin for closing remarks.

Miguel Martin, CEO

On behalf of all of us, I want to thank you for your interest in Aurora. We look forward to executing on our plans and hope you and your families stay safe. Thank you.

Operator, Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.