Aurora Cannabis Inc. (ACB) Q3 2019 Earnings Call Transcript

Then the last two key performance indicators I want you to focus on are kilograms produced and SG&A because they really tell the story of our pathway to profitability. We doubled our production. It's up 99% quarter over quarter to over 15,000 kilograms. The other critical key performance indicator is our SG&A, up only 1%. This is further to the commitment that we made in January that we were shifting gears and focusing on disciplined execution and cost management to ensure that that pathway to profitability comes to reality.

So, I'm happy to say that we are still tracking for positive EBITDA in this quarter. So, the snapshot here before we move on to the formal comments is industry-leading production and production efficiency, industry-leading gross margins, industry-leading product quality, yield, and no crop loss, industry-leading global footprint and unparalleled technology. In this phase of the sector's development, I would absolutely that the number one critical success factor is the ability to produce and sell an enormous volume of cannabis and we have got that in spades.

Now, on to the formal comments. Looking back at the first three quarters of our financial year, we're very pleased at the progress we've made. We've consistently executed on our growth and expansion strategy, resulting in continued revenue growth, while improving efficiencies and scale to drive margin improvement. We're proud of this progress and very pleased that while many in this sector are still trying to decide how to build their cannabis business, we have already successfully built a strong and thriving business with solid fundamentals positioned as a global leader.

Let's look at our achievements in the third quarter. Our net revenue was $65.1 million, a 20% increase over $54.2 million in the second quarter. We produced almost 16,000 kilos of cannabis, double the volume compared to the previous quarter. With Aurora Sky ramping up very successfully, our cash cost to produce per gram fell by 26% while SG&A costs were relatively flat over the same period due to disciplined cost management.

In the quarter, Aurora continued to be a solid performer in the Canadian consumer market with leading market share and high brand awareness. Our consumer revenue has continued to exceed our expectations. We achieved 37% growth compared to Q2.

While increased production was a fundamental driver of growth, I think it's important to understand how well our products perform in terms of brand resonance. An analysis of over 6,000 reviews on lift.com conducted by a covering analyst showed how well the Aurora brands perform in this respect. Two of the tip three most highly regarded brands were ours, with all our brands in the top 11. While in an undersupplied market, the ability to produce remains key. Longer term, we know the brand strength will play a key role in capturing and keeping market share. Going by these numbers, we're very well-positioned in the consumer market.

We are also looking forward to an improved retail infrastructure across Canada, which will further increase consumer engagement. There are still many consumers that have yet to purchase their cannabis legally. Furthermore, people who do not transact in the illegal market but are interested in cannabis appear not to be engaged because the reported shortages and the underdeveloped physical retail infrastructure.

The launch of brick and mortar stores in Ontario is a great step forward in this regard and with increasing supply, we will see a growing network of retail stores. In this respect, I'd like to mention our partner, Alcanna, who recently opened another of its beautiful Nova Cannabis dispensaries at 499 Queen Street West in Toronto -- sorry for the advertisement, not really. In general, in line with what has happened in other consumer jurisdictions, a well-developed physical retail network should result in strong growth.

While we perform very well in the consumer market, medical cannabis remains a cornerstone of Aurora's identity. In the last quarter, we undertook many initiatives to strengthen our leadership position in this segment, both nationally and internationally. Some have suggested that legalization of consumer cannabis in Canada would result in a drop-off in the number of patients buying in the medical system, as people who head to stores to self-medicate.

In our experience, nothing is further from the truth. Every day, the number of global physicians prescribing cannabis to address real medical issues, from PTSD to palliative care, is growing. Many of these patients would only seek treatment through traditional channels, such as their trusted family doctor or clinic, rather than seeking advice in a dispensary.

In addition, through the medical channel, patients can seek reimbursement for their expenses through tax reduction and increasing number of companies, including medical cannabis, in their benefits policies. So, despite the introduction of consumer legalization, we continue to experience growth in our patient numbers, up 5% this quarter to over 77,000. As of yesterday, our patient numbers in Canada have increased even further to 82,745, in line with our production acceleration toward the end of the quarter and into Q4.

Additionally, three of our brands were included in the Shoppers Drug Mart online marketplace for medical cannabis, which opened this past January. In the quarter, we also introduced product identification numbers or PINs to 78 of our medical cannabis products to make it easier for patients to apply for reimbursement under health insurance plans.

We are recognized as the leader in medical cannabis. This is not just due to the high and consistent quality of our products provided by our three medical brands, but also because as an organization, we are integrated throughout the value chain to advance medical knowledge, to support physicians and other health practitioners, and to service our patients with excellent products, customer care, and information.

To our knowledge, we have the broadest medical research program in the industry, with over 40 clinical trials and medical case studies under way and completed. This creates incredible brand strength with physicians worldwide who are still the key drivers of growth for the medical sectors.

We own Cannabis-Rx, which provides critical services to both patients and physicians looking to understand medical cannabis and its uses, we engaged with health authorities internationally, with physician networks, and with pharmacies. It is this rigor in our medical cannabis program that has enabled us to grow our presence in the medical cannabis markets, both domestically and globally.

Currently, we are present in 24 countries on five continents. This past February, we added to our European presence with the purchase of a 51% ownership interested in Gaia Pharma. Renamed Aurora Portugal, this new division has received permission from the Portuguese Health Ministry to construct an EUGMP, European Union Good Manufacturing Practices-compliant cannabis cultivation facility.

The first phase of the facility is expected to be complete in Q3 2020 and will have a capacity of 2,000 kilograms per year with a further 2,000 kilos coming on when the second phase is complete.

Another significant advancement in Europe was our win in the recent public tender competition in Germany to cultivate and distribute medical cannabis. Aurora was one of the three winners in the competition, which was judged based on the design, quality, security, and logistics of the growing facility.

On the 79 applicants, we received the highest ranking and won the maximum number of lots in the tender. The lots will allow us to provide a minimum supply of 4,000 kilograms of medical cannabis over a four-year period. We will start constructing this month and expect to ship cannabis from the facility starting October 2020.

We are very pleased with this win, which solidifies our leadership position in Germany and reflects our industry-leading facility design. This was an important scale that we developed early on with our acquisition of the facility design business Larssen in 2017.

While the quantities of the tender are very much smaller than what we anticipate the size of the German medical cannabis will grow to, it is a critical win that will strengthen our brand in the local market as well as throughout the rest of Europe. Another development strengthening our brand in Germany is the introduction of full spectrum extracts. Hereto, we've established early mover advantage and are developing the market.

As an aside, using the Canadian medical market as a proxy for how other international markets will develop, this provides a good indication of the scale of the opportunity we're pursuing. In Canada, we already have over 1% of the population registered in the medical system. Translating this to the international markets in which we have very strong first and early mover advantage, it's clear to see that very substantial additional capacity is needed. Hence, our upscaling of Aurora Sun in Medicine Hat, and the construction of Aurora Nordic in Denmark.

With scientific studies increasingly augmenting word of mouth and anecdotal evidence, we think it's fair to assume that destigmatization of cannabis and adoption by physicians will follow an accelerated curve in comparison to Canada. Work is to be done to develop these markets obviously. For now, they remain supply restricted, but the opportunity is there and we are executing extremely well in this regard.

In terms of our production facilities, in the third quarter, both MedReleaf Bradford and Aurora Sky in Edmonton were fully licensed by Health Canada. Bradford is now fully planted and provides a production capacity of 28,000 kilos of premium hang-dry and hand-manicured cannabis. Aurora Sky is, we believe, the single most advanced cannabis cultivation facility in the world. The 800,000-square foot facility has a production capacity in excess of 100,000 kilos annually.

Sky, a massive closed system indoor facility with a glass roof deploys state of the art technology that produces cannabis of high and consistent quality while benefiting from a high degree of automation to increase efficiency. This means target production costs of less than $1.00 per gram. Sky is now fully planted and successfully ramping up to maximum capacity. The increase in production seen in Q3 over Q2 will continue with increased product availability for sale in Q4.

At Aurora Sun in Medicine Hat, our newest and most evolved Sky class facility, construction is progressing very well, with the erection of the metal structure and glass installation almost completed. The design of Aurora Sun includes a number of technology advances as compared even to Aurora Sky and will further improve our economic efficiencies. As I mentioned, we announced an upscaling of Aurora Sun in the quarter. The facility will now measure 1.6 million square feet and with Sky class efficiencies is targeted to produce over 230,000 kilograms per anum.

Sun also represents an advance in our production process, with the facility focused solely on high efficient production, with the dry cannabis shipped to other facilities for further processing. In February, we announced a new facility, Aurora Polaris, that will focus on post-harvest processing. Strategically located adjacent to Aurora Sky in Edmonton, Polaris will be EUGMP compliant and serve as our center of excellent for the production of high-margin value added product such as edibles.

Our product development team in collaboration with our market development specialist and internal market forecasters have identified those products that we anticipate will sell best and have the best margins. These projects include edibles, such as hard baked goods, chocolates, mints, as well as vape products, cosmetics, and soft gels that we will produce at Polaris. Products such as infused beverages are also under development. Considering the anticipated relatively low market share of these products, we're not rushing this, as we'd rather get it right than get there fast, launching a product with limited market resonance.

Leveraging its proximity to the Edmonton International Airport, Polaris will also serve as a domestic and international logistics and warehousing hub. Polaris is expected to be completed by the end of thus year. In the interim, in anticipation of new regulations permitting these new products, we are installing production lines at our other license facilities to ensure that we will exceed market demand with a broad complement of products and not have the level of shortages that the industry experienced on October 17th of last year.

Polaris demonstrates the scale that we've achieved in our operations. We're not a cottage industry, but rather a pharmaceutical level industrialized operation that requires complex systems to drive operational efficiencies, consistent, high-quality output, and product innovation.

You've heard today the advances that we've achieved in the consumer and medical business both domestically and internationally. Polaris will help us institutionalize our innovation and our innovation culture and maintain our global leadership.

Now, Glen will discuss the financial highlights of the third quarter. I'll hand it over to you, Glen.

Glen Ibbott -- Chief Financial Officer

Thanks, Cam and good morning, everyone. Aurora's financial performance in the third quarter of fiscal 2019 reflected our continued robust execution across all market segments, as Cam just described. Our net revenue increased to $65.1 million for the quarter compared to $54.2 million in the second quarter of fiscal 2019 and just $16.1 million in the comparative period last year.

Of this, cannabis revenue was $58.7 million, 23% sequential growth across all three market segments, driven largely by a 37% increase in consumer market cannabis sales. Underlying this growth was the increased production that Cam discussed from Aurora Sky and our Bradford facility.

Medical cannabis sales in Canada grew by 8% or $1.9 million as a result of continued growth of our patient base. As Cam indicated, we continued to support the growth of the Canadian medical market and in line with our patient first culture, have increased availability of the medication that patients need.

We continued to take the position that medical cannabis, like all prescription drugs, should not be subject to excise tax. For that reason, we continue to absorb the cost of the tax for our patients. This negatively affected our revenue in the quarter by $3 million or 5%. Extracts represented about 18% of cannabis revenue in Q3 compared to 22% last quarter. Our oil extraction facilities have been operating at a maximum capacity for the past two quarters and as a consequence, the relative contribution from extracts fell slightly as our total revenues grew.

During the quarter, we installed additional extraction capacity at some of our facilities and that capacity is now online. Furthermore, our extraction partner, Radiant Technologies, has now entered commercial operations, which we anticipate will start making a noticeable contribution from the end of Q4 onward.

Finally, installation of EnWave's rapid low-temperature drying technology at our Aurora Sky and Sun facilities will increase speed of extraction in future quarters, taking it from a matter of weeks down to a day.

The average net selling price of cannabis decreased to $6.40 in Q3. This was partially a result of product mix as recorded a 48% increase of dried cannabis sales in the consumer market which has a lower wholesale pricing structure. The ASP was also impacted by the first full quarter of excise taxes on medical cannabis, which Aurora absorbs. And finally, and most importantly, the relative decrease in contribution to revenues from extracts impacted the average selling price as well.

Going forward with significant additional extraction capacity coming online internally as well as from Radiant, we anticipate the relative contribution from higher selling price products to increase toward the end of the current quarter.

A significant improvement in our cash cost to produce cannabis more than offset the decrease in average selling price. As Cam noted, it's a key driver of our financial performance and the cost to produce was down $0.50 from last quarter, 26%, to $1.42 per gram in Q3. The result of increased production coming out of Sky and Bradford creating significant economies of scale was also a result of a reduction in the temporary labor that we had employed to prepare for the commencement of consumer sales in Canada.

We expect production costs to continue to go down as Aurora Sky produces at full capacity in Q4 2019 and Q1 2020 and reiterate our expectation that production cost will be well below $1.00 per gram.

So, tying all of this together, in Q3, our consolidated gross margin was 56%, up slightly from Q2 of this year. This reflected the improvement in our cash costs, offset by a lower percentage of extract sales and the increase in the consumer market sales. We expect gross margins will continue to improve as we introduce new product lines, expand our extraction capacity, and increase international sales. All of that combined with our continued improvement in production efficiency.

Cannabis production in the quarter increased by almost 100% to 15,590 kilograms, driven mainly by the ramp up in production at Sky and Bradford. Much of this production increase came toward the end of the quarter. At March 31st, we had WHIP inventory exceeding $45 million in fair value, which reflects the significant harvests during March.

A few more words on our ramp up at Sky -- in order to reach the 100,000-kilogram production capacity, two parameters are critical, the frequency of harvest and the yield per harvest. I'm pleased to note the frequency is nearing our target rate. Sky is reaching a real cadence in production.

This means that we will comfortably reach the stated capacity of more than 100,000 kilograms per anum harvest rate in the first quarter of the new fiscal year. I should also note that the yield per harvest has actually been substantially above target. The average of the last ten harvests there has been more than 20% above our targeted yields.

With the successful ramp-up of Bradford and increasing production yields across our other facilities, we anticipate harvesting at a rate in excess of 150,000 kilograms per anum by the first quarter of our fiscal 2020. On a planted rooms basis, our capacity already exceeds 150,000 kilograms per anum.

For Q4, we expect to have over 25,000 kilograms of cannabis harvested and dried. With the implementation of new regulations permitting the sale of a broader portfolio of derivative products later this year, we are planning to allocate a sizable fraction of this production to inventory for further processing to ensure we'll have a broad portfolio of new products in sufficient quantities available for sale when the higher margin products will be permissible in Canada.

Over the past several quarters, we have invested significantly in building out the talent and the infrastructure to lead the Canadian in the international cannabis industry. Now, much of that infrastructure is in place and ready to support our growth. In Q3, SG&A costs grew by 1% compared to Q2 of this year. Within SG&A, sales and marketing actually decreased 28% as the reduction in pre-cannabis spending was partially offset by higher shipping costs, which are related to our increased sales volumes, and an increase in sales representative headcount.

For G&A, while we saw 16% increase, greater than 6% of this was due to a new Health Canada cost recovery fee, which was calculated at 2.3% of sales. Q3 2019 G&A also reflected the first full quarter of ICC integration and a partial quarter of Whistler costs. Going forward, we anticipate SG&A to show increases in line with the growth of the organization, but certainly at a rate significantly lower than our anticipated revenue growth.

In Q3, 2019, our adjusted EBITDA loss decreased by 20% in the quarter to $36.6 million from the $45.5 million in Q2. I should note that we have defined adjusted EBITDA in our Q3 2019 MDNA.

Through the combination of substantial revenue growth, a decline in unit cost of production, increased availability of higher margin derivative products, increased shipments to the EU, and ongoing disciplined operating cost management, Aurora continues to track toward achieving positive EBITDA beginning in this current fiscal Q4 2019.

Our financial position remains solid. At March 31st, we had almost $350 million in accessible cash and over $70 million in accounts receivable. This compares to both $75 million in cash and $15 million of AR at June 30th, 2018. The increases are largely due to draws on the BMO-led credit facility, the issuance of senior secured notes in January 2019, and the increased level of sales in our business.

In addition, we recently completed the filing of a base shelf prospectus, an ATM supplement, a long-term strategic measure that provides the flexibility to access growth capital if or when required to provide the gas to continue executing on our global expansion and partnering strategy. We implemented this base shelf prospectus and ATM supplement as part of a prudent, maturing capital structure, a normal part of housecleaning as we filed our Q3 results.

In conclusion, I'm very proud of the team at Aurora. Kudos to all for delivering yet another strong quarter. We continue to boast stronger fundamentals each quarter, expect significant growth, and our financially healthy. We are executing our growth strategy and consequently, I believe we are very well positioned to further strengthen our position as a clear leader in the global cannabis industry.