HEXO Corp.
Q4 2021 Earnings Call Transcript

Published: 29 Oct 2021

[Operator:]

Good morning. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the HEXO Q4 2021 Earnings Call. I would now like to turn today’s call over to Jennifer Smith, Director of Investor Relations. Please go ahead.

[Jennifer Smith:]

Thank you. Good morning. Before we begin, we would like to remind you that certain matters discussed in today’s call or answers that may be given to questions asked, could constitute forward-looking statements. These statements are based on the company’s current internal views, estimates, expectations, opinions, forecast, beliefs, assumptions and other statements that are not statements of fact regarding the future of the business, future plans, strategies operational results and other future conditions. These statements should not be read as assurances of future performance or results. They involve known and unknown risks, uncertainties and other factors that could cause actual results, performance or achievements to differ materially from current expectations and those implied by such statements. This morning’s discussion is qualified in its entirety by the cautionary notes regarding forward-looking statements and the risk factors that are included in the annual information form management discussion analysis and annual report. Please review these materials for more information about the forward-looking statements and the risk factors that could cause actual results, performance, development, or events to differ materially from our current expectations and those implied by such statements. HEXO disclaims any intention or obligation, except to the extent required by law to update or revise any forward-looking statements as a result of new information or future events for any reason. I will now turn the call over to Dr. Michael Munzar, Chairman of the HEXO Board of Directors.

[Michael Munzar:]

Good morning. I’d like to welcome everyone to this call. My name is Dr. Michael Munzar, Chair of HEXO, and I’ve been acting CEO in the interim since Sebastien St-Louis departed the organization a little more than a week ago. This morning, I’m very excited to introduce you to our incoming President and CEO, Scott Cooper. The entire team at HEXO has been working tirelessly to onboard Scott and bring him up to speed on our organization, and many thanks to all the members of HEXO for being so incredibly cooperative and hardworking to allow this to happen. I believe Scott is going to be an exceptional leader for HEXO as we take the next step in our strategic evolution. With that, I will turn the call over to Scott for some brief remarks.

[Scott Cooper:]

Thank you, Dr. Munzar. Good morning, and thank you for joining our year-end financial results call. I’m Scott Cooper, incoming President and CEO of HEXO. I’m joined today by Trent McDonald, HEXO’s, Chief Financial Officer; and Valerie Malone, HEXO’s Chief Commercial Officer. Before Trent presents our quarterly and year-end results, I wanted to provide an overview of my immediate priorities. First, I’m quickly getting my arms around the business. Over the coming weeks, I’ll be having as many conversations with customers, employees, boards, partners, analysts, and investors, as I can cram into each day. These will help inform me as I set the strategic direction for the business and refine our strategic choices. They’ll also help me understand where HEXO can capitalize on strengths and where we may need to augment capabilities to compete for and run our customers and consumers business. While doing that, I will also focus on supporting the team to effectively complete the integration of our recent acquisitions, break down barriers within the organization to ensure the team has the resources they need to successfully achieve our targets, and address the risk presented by our debt structure. Well, I’m new to HEXO in my role as President – well, I’m new to HEXO in my role as President CEO, Truss Beverages, I did have an opportunity closely work with many of the HEXO team. Based on that experience and reinforced by many discussions I’ve had over the past nine days, I know that HEXO has a strong foundation, strong set of brands and the right fundamentals to build the best cannabis company in the world. I look forward to updating you on our past growth over the coming months. And I will now turn the call over to Trent to provide an overview of the financials.

[Trent MacDonald:]

Thank you, Scott, and good morning, everyone. Before we delve into our results. This quarter has also has some key developments that I would like to highlight. On June 1, we completed the acquisition of Zenabis. More recently, we also closed on the acquisitions of 48 North and Redecan. We are currently focused on completing these integrations, including taking best practices from each organization, as well as bringing our cultures together. We are also carefully assessing each site and brand in order to maximize the perform of value of the combined entities. Subsequent we are at year-end, we closed on an underwritten public offering for total gross proceeds of $144 million. We use the net proceeds from the offering to satisfy a portion of the cash component of the Redecan purchased price and for other working capital transaction integration and CapEx requirements. We’ve made several strategic changes to our global leadership team. We appointed Valerie Malone as Chief Commercial Officer. She brings more than 20 years of experience managing businesses across different verticals, including CPG, technology and consulting. We appointed Guillaume Jouët, as Chief People and Cultural Officer. He also brings more than 20 years of experience as a senior international executive, leading human resources, sustainability, public affairs and communications functions. And we are of course also pleased to have Scott Cooper join us as President and CEO. Scott’s experience with Truss, Molson-Coors and several other publicly traded consumer packaged goods companies make him exceptionally well positioned to lead us through the next phase of our strategic evolution. We’d also like to take this opportunity to thank Sebastien St-Louis for his tremendous efforts in establishing growth and delivering a solid position from which we can move forward. Now, let’s jump into our results. In fiscal 2021, we generated net revenue of $123.5 million, an increase of 54% from last year. We saw a strong organic growth of 41% with core HEXO non-beverage sales over the prior year with contributions from new brands, such as Bake Sale and new products like Original Stash pre-rolls, hash and click. In September of last year, Truss beverages were launched in this short time, Truss beverages is already the market leader with 46% market share across Canada. We also saw our sales outside of Quebec grow 96% year-over-year, as we continue to focus on national expansion and distribution. International and wholesale revenue also saw growth, which was offset by decrease in domestic net medical sales. Let’s move on to our fourth quarter results. In the fourth quarter, we generated net revenue of $38.7 million, the highest in our history and an increase of 71% from the prior quarter. Net adult-use revenue, excluding beverages increased 28% from Q3. Zenabis brands, such as Namaste and REUP contributed $4 million through two of those three consolidated months. As we continued to diversify our provincial sales mix, we saw growth in Alberta up 76%, in Ontario up 31%, quarter-over-quarter, and are continuing to maintain a top position in Quebec. We also saw our net beverage sales decrease – increase 70% from Q3 to $5.2 million. Again, maintaining number one market share and beverages in Canada at 46%. If you recall the Israeli government recently revised its protocols resulting in HEXO’s inability to export in Q3. We are happy to report that HEXO was able to quickly gain compliance and have recognized $6.8 million in international sales to Israel in Q4. This will remain an important focus for HEXO as we move forward. Overall gross margins decreased from 22% in Q3 to 20% in Q4. Gross margin on adult-use, excluding beverages decreased to 12% as the result of a decrease in average selling price due to increased competition and a change in sales mix. Additionally, the accounting rules related to business acquisitions resulted in the crystallization of fair value adjustments to the carrying cost of Zenabis’ inventory. This then flowed through the P&L as an increase to the cost of sales, which further reduced gross margin. Gross margins on beverages increased to 33% as we continue to scale up to optimal production levels. International sales generated a gross margin of 65% bolstered by the fact that they’re not subject to excise tax. Wholesale generated a negative gross margin of 65% as the result of the previously mentioned crystallization the fair value adjustments on Zenabis inventory, normalized for this impact gross margins would have been 21% on wholesale. We are seeing price compression across the industry. In fact, much of this compression specifically dried flower has been led by HEXO and its brands. Looking ahead, HEXO is laser focused on approving our gross margins. In the short-term, the company expects to see much of these improvements as the synergies from the company’s recent acquisitions begin to appear within the company’s financial results. We are actively reviewing margins for all products and categories, which through acquisitions has recently expanded and are applying best practices from our top performing categories to make improvements elsewhere. Further, the company is confident that it’s best-in-class manufacturing and operational capabilities will continue to drive margin performance across the business. This is particularly true with the acquisition of Redecan and its industry leading lean production facilities. When looking at gross margin it would be beneficial to evaluate the company’s performance on a category-by-category basis. For example, the company made the informed decision to reduce margin of products like bulk low THC flower to hedge against impairments and capture market share. In addition, the company continues to invest in innovation and scale and high margin products such as vapes, where we current currently command less market share. Our adjusted EBIDA was negative $13.9 million representing a decrease of $2.2 million from Q3. As a result of again, the crystallization of fair value adjustments on the inventory from Zenabis and the direct operating expenses of Zenabis. We are continuing to work through the integration and expect to obtain additional synergies. SG&A, as we define it is SG&A marketing promotion and research and development. When added together, this increased $9.4 million over Q3, much of this was due to the impact of the Zenabis acquisition and the initial impacts of increased insurance and audit type fees. While our SG&A increase in dollars, such expenses represent 61.3% of net revenue down from 63.4% in Q3. While certain expenses have increased with the size and complexity of the organization and will continue to in the future. As we endeavor to grow our market share, we are focused on achieving synergies, through integration and streamlining of operations and expenses, wherever possible, as such we will continue to aggressively strive to decrease SG&A as a percentage of our net revenue. Marketing and promotion specifically increased by $1.2 million over Q3 as a result of a relaunch of UP brand expansion of Bake Sale and outreach into retail. Acquisition and transaction costs increased to $14.9 million. This is related to the acquisitions of 48 North and Redecan, which were finalized after the period, as well as the transaction and acquisition cost for Zenabis. We did impair PP&E $19.4 million. This was primarily due to the impairment of non-core assets acquired from Zenabis. Our financing expenses increased to $23.2 million, $18.8 million relates to broker advisory and legal fees related to the senior secured convertible note and $3 million related to the acquired debt of Zenabis. We had a loss from operations that increased from $20.7 million to $69.5 million, which was significantly driven by the acquisition related cost, financing expenses and transaction costs, I just spoke of. I’d like to give you an update on the progress on our integrations. We have now successfully closed all three transactions. We’ve switched from integration planning to integration execution. As we move forward through the robust plan we created. We originally thought we’d be able to achieve approximately $35 million in synergies and now believe we will exceed that target. Due to the timing of acquisitions, Q4 of F21 and Q1 of F22, we’ll only see partial period consolidations with Q2 expected to have full consolidation of Zenabis, Redecan and 48 North for the entire quarter. We look forward to sharing these results. The team continues to focus on ensuring good margin management as well as controlling SG&A expenditures and decreasing SG&A as a percentage of revenue. As a result of these acquisitions, we’ve also had success in expanding the geographical reach of the brands in our portfolio, including the introduction of Redecan into Manitoba. I’d like to speak about ESG. We recently entered into a partnership with Offsetters, a Vancouver-based organization that supports renewable energy and carbon projects across the world and became carbon neutral in September, 2021 as well as offsetting 100% of the company’s operational emissions in addition to the personal emissions of our 1,200 employees, something we are very proud of. In addition to carbon emissions, we are also counteracting the use of plastics in our packaging. The convertible debenture, the company acknowledges the ongoing concern with the senior secured convertible notes issued on May 27, 2021. The company has maintained a positive relationship with the holder, with the holder having negotiated and agreed to two amendments favorable to the company while there exists a risk that significant cash outflows may be required over the next 12 months under the terms of the seniors secured convertible notes. The company has been working with the holder to renegotiate the terms of that note. As an outlook going forward our focus remains on growing market share, consumer-led innovation and completing the integration of our transformative acquisitions. On a final note, I would like to thank everyone at HEXO for their commit and effort over this past year. This now concludes my prepared comments, and operator, I would be happy to take questions

[Operator:]

Your first question comes from the line of Aaron Grey with Alliance Global Partners. Your line is open.

[Aaron Grey:]

Hi, good morning. Thank you for the questions. So, first question for me is around gross margins specifically, adult-use X beverages seems given to you strip out the crystallization instead of 12% be 14%. So still you’re down sequentially. You mentioned some of the bulk lows THC flower being sold and how you guys are kind of leading some of the pricing pressure. I guess my main question is towards, kind of on the go forward basis, the product they now have left. Do you feel like that’ll be more high margin, flower sales and then working in some of the more, derivative products like vape do you feel like that mix will start to come up or do you feel like this prolonged price pressure will continue to impact the gross margin line on that adult-use X beverage segment? Thank you.

[Trent MacDonald:]

Sure, Aaron, thank you for the question. Let me address the obvious, we are seeing price compression across the industry. In fact, much of the compression, like we said, especially on the price of dried flower has been led by HEXO and its brands. Looking ahead, look we continue to be laser focused on improving our gross margins. In the short term, the company expects to see much of the improvements as the synergies, the companies of the company’s recent acquisitions to begin to appear in our financial results. Looking ahead, the company is actively reviewing categories across HEXO and all of our newly acquired organizations where we see strong margins and we’re going to apply best practices from these categories to make improvement elsewhere. Further, the company is confident that it is best-in-class manufacturing and operational capabilities will continue to drive margin performance across the business. This particularly true with the acquisitions of Redecan and its industry leading lean production. If I could point out, one other remark on margin when we look at gross margin, we evaluate the company’s performance on a category-by-category basis. For example, the company made, the informed decision to reduce margin our products like bulk low THC flower to hedge against impairments and capture the market share. In addition to the company continues to invest in innovation, and scale and high margin products, such as vape as an example where we currently don’t have as much market share.

[Aaron Grey:]

Okay, great. Thanks for that call. That’s helpful. And then second question I was kind of keeping on the gross margin line. You mentioned some of the other in acquisitions, that not closed that weren’t included in the quarter, maybe could you provide some color maybe pro forma sales or gross margins would’ve been including, 48 North and Redecan acquisitions, or maybe how you think gross margins should trend once you kind of bring those into the fold? Because I think that’d be really helpful to help people going forward. Thank you.

[Trent MacDonald:]

Yes, good question, Aaron. We’re not going to be giving any guidance on what we expect from margins going forward at this point. Again, I’ll reiterate that we are looking at all of the organizations that we’ve just acquired and looking at all the products and categories within those acquisitions and are looking at best practices and are very much monitoring what we’re going to be doing around margins going forward.

[Aaron Grey:]

All right. Great. Thanks I’ll jump back in the queue.

[Operator:]

Your next question comes from the line of Tamy Chen with BMO Capital Markets. Your line is open.

[Tamy Chen:]

Hi, good morning. Thanks for the question. I wanted to go back on comments about integration. So, can you speak a bit more about this part specifically? I recall when you made the acquisition of Zenabis, one of the things you wanted to do was they had the indoor facility in Alphaville that you wanted to grow more premium strains in. And that to me would be if you were successful a way to increase your margin, because as I see it now, it seems that correct me if I’m wrong, but it seems like your penetration in the more premium category of the flower segment is still not meaningful enough. And hence you’ve pushed more into hard value with a brand like Bake Sale. So can you talk a bit more about that aspect? And furthermore, like with Zenabis, I think they’ve contributed just under $7 million of sales, but you said G&A increased $9 million quarter-over-quarter just seems like there’s a decent amount of work that needs to be done there to integrate this acquisition successfully. So, can you speak a bit to that?

[Trent MacDonald:]

Sure, Tamy. Look, we’re still early in the integration process, as you know, Alphaville, I want to say is an extremely good property for us. It is definitely part of our ongoing initiative of THC improvement and things you just spoke about. Again, we originally thought we were going to get $35 million of synergies, now believe we’re going to be well beyond that target. And as we’ve taken in a world-class set of consultants to help with the integration process and we feel confident on where we are in that process at this time. We will be continuing to execute on the original integration plans that we developed and look forward to giving you even more updates as we go forward.

[Tamy Chen:]

Okay. And my follow-up question is more specifically on Quebec, I think we’ve all seen that you’ve lost a bit of share here. Can you just revisit what has happened here besides the increase of more players there? Are there any new dynamics to call out in that province and how your thinking is to gain back from share? Thank you.

[Trent MacDonald:]

Yes. We have a lot of learnings from Quebec. We still have a great relationship with the ESGDC and we played significant role, in the province of Quebec now. And we expect to have that in the future. At the same time, we’re continuing to grow and achieve the top two market share there. So there’ll be more announcements to come, but we are looking at a plan and we’ll have more information as time goes on.

[Tamy Chen:]

Okay. Thank you.

[Operator:]

Your next question comes from Pablo Zuanic with Cantor Fitzgerald. Your line is open.

[Pablo Zuanic:]

Thank you. Good morning. May be just a question for Scott, and I know this is maybe bit simplistic question and bigger picture, but to someone that would be new to the industry and looking at the many Canadian piece of they are Scott, what would you say to them are HEXO strengths compare to the other peers? And related to that, if you can expand on your comments about refining strategic choices going forward? Thank you.

[Scott Cooper:]

Well, thank you for the question. Just getting started. So learning a lot. What I would say in my first nine days is, I’ve had a chance to talk to people across the organization and I’m really humbled by the commitment and a quality of people that I’ve met at HEXO. So that’s one thing I would say. Second, we had a strong, solid foundation, strong operations, quality product, number of great brands and significant consumer traction. Like any organization, there’s some areas where there’s room for improvements, and I’m going to continue assess in the organization and we’re reporting my findings in observations next quarter.

[Pablo Zuanic:]

Okay. Just to thank you on a follow up for Trent. Tent can you maybe talk a little bit about cash burn? I mean, CapEx plans and also just, just related to that in terms of a senior convertible note, the way I calculated, if you got to issue stock right now to pay it back it would be about 40 million shares, but maybe help me out with that math there. Thank you.

[Trent MacDonald:]

Sure. Look the company acknowledges the ongoing concern with the senior convertible note. Again, we’ve maintained that positive relationship with the note holder. And look, we understand the risk, this note poses, and we’re taking it very seriously. So, we’re actively working to address that issue. And as soon as we have a material update on that, we will absolutely notify our shareholders.

[Pablo Zuanic:]

Okay. Thank you.

[Operator:]

Your next question is from the line of John Zamparo with CIBC. Your line is open.

[John Zamparo:]

Thank you. Good morning. Can you talk about how Redecan performed in the quarter, if you’re not willing to get into numbers on the wholesale side? Maybe we could just talk retail, because generally speaking, it seems like the retail sales of all three of your acquisitions have seen some declines at times sometimes meaningfully since those acquisitions. So can you address that, and what might be causing them?

[Trent MacDonald:]

Well, first, I’d like to address the Redecan. There are no actual results in the quarter. As you know, we closed Redecan on September 1, which was a subsequent event. So there are no Redecan results within our P&L. As it relates to market share HEXO is still very focused on building on the unique skills of all of these organizations. And we have – we’re meaningfully entering into plenty of new categories. As part of the integration process, we’re also bringing experience and expertise from each of the integrated companies to the whole. So, HEXO is confident that we were able to complete an increasingly crowded marketplace, and the company’s industry leading operational capacity utilization and excellence should propel us into a better position.

[John Zamparo:]

Okay. Just to clarify and Redecan, I’m not referring to the statements you posted, of course, but their calendar Q2 or calendar Q3 performance, is it materially different from what you have publicly said about their calendar Q1 performance?

[Trent MacDonald:]

Yes, again, we can’t disclose non-public information. If you – but look refer back to the June – sorry the July 15th pro forma and that gives you an idea of what Redecan is, and how perform to that point. And we look; we really hope to provide more insight once we come out with consolidate results in Q1 and Q2 where you’ll see Redecan within the P&L.

[John Zamparo:]

Okay, understood. Thanks. And then my other question is on the balance sheet. You’ve talked a lot about the converts. What level of confidence do you have on being able to refinance these through some form of traditional debt, even if it’s expensive rather than having to tap equity markets again?

[Trent MacDonald:]

Well, again, look, we’re actively working to address the issue. Okay. And so we are working with partners, and we’ll get back to you as soon as we have a material update. There’s nothing really to report at this time. But we are working with the debt holder themselves and we have a very positive relationship.

[John Zamparo:]

Okay. Thank you.

[Operator:]

Your next question comes from the line of Andrew Carter with Stifel. Your line is open.

[Andrew Carter:]

Thank you. Good morning. First off, I guess Dr. Munzar are still on the bigger question for him. I’m just very confused by the change here. I mean, the fundamentals here, aren’t really any worse than peers, and there’s a lot of hope with market share leadership trust that this could be something good fundamentally. But everything that’s happened here has been driven the stock price has been related to the financings that were themselves approved by the Board of Directors. So, I’m not sure if the board wasn’t aware the features, the details of financings, but that’s where it is today or so. And then second kind of a follow-on, and I’ll keep this to one. Returning to the convert, as I read it, the holder’s redemption feature given they have to approve the equity price change. It almost seems like they have the ability to kind of put to force you in force, now force something pretty serious given they, I believe it’s senior secured on all asset. Maybe you could help me understand those questions? Thanks.

[Trent MacDonald:]

Nope, no problem. I’m going to jump in for Dr. Munzar, Andrew, if you don’t mind. The – look, again, we continue to acknowledge that the senior secured debenture is an issue for us. And I’ll reiterate that we are in conversations with the debt holder themselves. They have been cooperative, like I said before, they’ve negotiated and agreed to a couple of amendments that were beneficial for HEXO. And we’re looking at resolving the issue as fast as we can. And we hope to give an update as soon as possible to our shareholders on what that might look like. So, I guess that’s as much as I can say about it for right now.

[Andrew Carter:]

Fair enough. I’ll pass it on.

[Operator:]

Your next question comes from the line of Doug Miehm with RBC Capital Markets. Your line is open. Doug Miehm with RBC Capital Markets. Your line is open. Your next question comes from Frederico Gomes with ATB Capital Markets. Your line is open.

[Frederico Gomes:]

Yes. Thank you. Good morning guys. Thanks for taking my questions. So maybe the first one, I think this is for Scott. Obviously Truss has been performing very well in terms of sales growth and dominated market here in Canada. So, I’m just curious what kind of key learnings from that market, from the beverage market. Can you bring to other segmented HEXO to try to mirror that performance? Thanks.

[Scott Cooper:]

Yes. I think the one thing that we did Truss has done really well as laser focus on meeting consumer needs in working with customers to create great programs and that’s completely transferable to HEXO. They’re already doing it and certain my experience will only augment with what’s occurring in the company today.

[Frederico Gomes:]

Okay. Thanks. And then a while ago, you guys mentioned an agreement with Fortune 500 company for the adult-use market, would you have any update there, and are you still looking for other partners to explore other segments of the market similarly to the Truss JV? Thank you.

[Trent MacDonald:]

Yes. I’ll answer that one. That’s a great question. Right now, to be honest, we’re not giving any forward-looking guidance in terms of our financials or strategies or what we expect to do with certain CPG partners. But we do expect to give more fulsome disclosures as we go forward as those things start to occur.

[Frederico Gomes:]

Okay. Thank you. I’ll hop back in the queue.

[Operator:]

Your next question comes from Rupesh Parikh with Oppenheimer. Your line is open.

[Rupesh Parikh:]

Good morning. Thanks for taking my question. I want to go back to your commentary, just price compression. I was just curious on what your outlook is for price compression in near to intermediate term?

[Trent MacDonald:]

Yes. Great question. Again, we’re – we know, we’ve led some of that price compression as we’ve met. Some of that coming from our more value brands, which were meant to solve a problem on inventory and to avoid any impairments in inventory. So that’s driving some of it, but we – again, we have just acquired several organizations and we’re looking at all products, all categories, and some of them are performing very well with margin, and we’re going to take those learnings and apply to weather categories as we continue to move forward.

[Rupesh Parikh:]

Great. And then maybe just one follow-up question, and I’m not sure how much additional detail you can provide. So, as we look at some of these recent acquisitions, like, is there any way to just provide some performing metrics, whether sales adjusted EBITDA, just so to help us model in the near term? It’s just very difficult, I think from ARPU position, just to model the business, just given some of the disclosures out there. So maybe – is there any, I don’t know if there’s anything that you can help us with at this point?

[Trent MacDonald:]

Yes. Again, we’re not going to get too much forward guidance here. But, I can’t say this again, we felt what we we’re going to get about $35 million of synergy. Synergy is coming through COGS and SG&A. We now believe we’re going to exceed that and where you’re going to see that in our P&L going forward is through margin management, and SG&A as a percentage of net revenue.

[Rupesh Parikh:]

Okay. Thank you all. I’ll pass it on.

[Operator:]

There are no further questions at this time. I will turn the call back over to the presenters.

[Trent MacDonald:]

Okay. Well, that’s everything. I would like to thank everybody for coming into the call, and listening to what we have to say. And we’re really looking forward to leadership under Scott Cooper, and all of our employees quite frankly for their work and effort over this past year, I can’t say enough about the talent and the commitment that our employees have shown and continue to shown to show and we expect good things in the future. Thank you very much.

[Scott Cooper:]

Thank you.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.