HEXO Corp.
Q1 2021 Earnings Call Transcript

Published: 14 Dec 2020

[Operator:]

Good morning. My name is Sharon and I will be your conference operator today. At this time, I would like to welcome everyone to the XO Q1 twenty twenty one earnings call. 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 and assumptions. These statements should not be read as assurances of future performance or results. They involve known and unknown risks and uncertainties and other factors that could cause actual results, performance or achievements to differ materially from current expectation and those implied by such statements. Also note that we utilize certain non IFRS measures in our financial reports, which may be discussed on today's call and reconciliations between any such non IFRS measures to their closest reported IFRS measures are included in our MBNA.

[Sebastien St-Louis:]

Thank you, operator. Good morning, everybody. Before we get going, I'd just like to. I wish everybody good luck. Of course, during these unprecedented times, HEXO has certainly kept the safety of its employees as a paramount priority and we've taken many precautions to ensure that everything goes smoothly and that we continue our essential service of supplying Canadians with high quality cannabis during this pandemic. Big thank you to everybody at Hextall for your role in supplying our consumers and customers. Before we discuss Q1, I'd like to take two minutes and share with you a look inside our Bellville Center of Excellence. I'm very excited to share with you what we've got going on inside Delvaux. A game changer for us and we're now up and running. Operator, would you please start the video? Of course, it was thrilling to be able to share a virtual introduction to that site with you a few days ago and again today, I promise you, the feeling when you walk in is even more exciting. This facility is highly automated and we believe that it delivers a competitive advantage and it really leverages the capital molt that Hextall has erected in Canada with this facility. We have the ability to go to market quicker than most competitors. We have the ability to ramp up new product lines and we have the ability to continue to lever economies of scale, to push better pricing to our consumers.

[Trent MacDonald:]

Thanks very much, appreciate it and good morning, everyone. The one the first thing I wanted to point out really was, oddly enough, not the result itself, but the cleanliness of our people. I think that goes back to Q4. You know, we made some tough decisions at the end of the year around cleaning up our balance sheet. So we took a lot of write downs, a lot of big impairment because we no longer want to do what the industry tended to be doing and that piecemealing this clean up over time. We wanted to come into this year with an extraordinarily clean set of financials so that when we came to market, as we did just now in Q1, people could see and digest the results the way they should be able to do. And so what you see here is a very clean, understandable PNL, and that is where we are going to continue in the future each quarter successively from here on out to show beautifully clean so that people can digest. That is very simple to understand. You know, if you look at our results getting into them, our operational cash flow was only minus six point one. Add that to the two to four. And you're talking about in a half of the year, we've only gone through 10 million of operational cash flow. A lot of that came from from inventory this particular quarter. We did build up inventory. But I want to talk about that. Inventory has been an area of risk for Eltis, not for us. We've cleaned it up. We had a great harvest near the end of the quarter and that was a higher yield, higher yield harvest than we had anticipated, which was a great thing, because since that point in time, we've been able to turn all of that into value added stamped finished goods that are available facility which are now out into market. We are not creating any risk for the first time in our history. We are actually using more trim on a weekly basis than we can actually produce. And I don't know of any other LP today that we are in a great place and inventory and. And that is. The use of our cash in Q1, which we don't expect going forward, it was just a timing issue, but we're in a great place. So if you look at our total cash flow, I mean, our total cash flow would have been only a use of 11 million dollars for the quarter had it not been for one thing. And that's a 23 million dollar move from cash to restricted cash, which was to fund a captive insurance policy for ourselves and our D.A. We've saved up between 10 and 15 million a year in premiums. So a great move to do that, a very high return. So right now, we're sitting with one hundred fifty million dollars cash on the balance sheet. That's, you know, just think about that and the 10 million we've gone through from the operations perspective in a half a year.

[Sebastien St-Louis:]

Before we get to questions, I'd like to again wish everybody safety and health as the global pandemic continues. I'm so proud of what the team has achieved for them and also for their dedication as we navigate through an ever evolving environment. Despite the many challenges that this economic and social construct has posed here, the cannabis industry continues to grow and that's a testament to consumer demand for safe and legal high quality products that are offered by licensed producers and Texel. The industry is running at about a two point nine billion dollar run rate that's just in Canada and it continues to accelerate. We're in the top for market share position that Hexham. We are closing in on the top three spot, which I continue to believe will be necessary to be in those top 3s to ensure a long term sustainable business with high value brands that can be leveraged internationally. We've proven now that the Hextall model of partnership is one that leads, that can lead to being number one in important categories. We've shown that the US story isn't the be all end all. When you look at Beveridge is a part of the market in the U.S. it's not just one percent, it's not one and a half percent. In fact, after two months and market in Canada, it is one point nine percent of Canadian sales. That means that categories when you hit the product right. When you truly create a proposition that delivers to consumers what they want, you are able to redefine the market and create a larger opportunity. We're currently number one in Canada, it's possible for Hextall to be number one in the USA. We can take what our Canadian run rate is and multiply it dramatically in Canada, but our strategy following US legalization provides a ton of blue sky and taken mine that are just the Canadian opportunities currently running at a 12 million dollar run rate annualized for Hextall. That and that's just us. That's not the whole industry. Remember that beverages have a high capital moat around them and that the technology in the manufacturing behind them cannot be easily replicated. And the expertize that Hextall is developing and that our partners are contributing is hard to match. We've now proven our ability to win categories, we've proven the model and we continue to negotiate, we've never really stopped with other CPG partners to multiply that success. We look forward to updating everybody on our next call, it should be an exciting next quarter, a very exciting next year, and I'm very happy to be able to take some questions.

[Operator:]

Now, if you'd like to ask if you'd like to ask a question at this time, please press star one on your telephone keypad if you'd like to withdraw your question. Press Apparently, the first question comes from Tamy Chen with BMO Capital Markets.

[Tamy Chen:]

Hi, good morning, thanks for the question I wanted to ask about the U.S., I guess first is to provide a bit more commentary on trust us. You mentioned you've you've launched in Colorado. Can you just talk a bit about how you're thinking about additional states, just kind of expansion on that front? And then also curious how you think about Texas strategy for the THC side in the U.S..

[Sebastien St-Louis:]

Thank you, Tammy, at the U.S. expansion is really going to follow the follow the regulatory path, and that regulatory path is not fully defined. We've obviously seen the first vote on the borak that probably getting shut down in the Senate. So that that is probably not the immediate path. So before going to multistate, Texel is going to make sure that we are in full cooperation with all federal and state laws in the USA. So the current operations in Colorado are fully legal at all levels of government. They're within state lines from hemp derived CBD. There are other states that have a current legal environment from our interpretation. What really the advantage of our strategy is we wanted to prove out the product in Canada. That was number one. Now we are proving out the nuances to the product for the U.S. consumer base, which is slightly different when you start to talk about branding, concentration and taste profiles. And that's really where leaning on the expertize of Molson Coors there. But certainly we're keeping a close eye on expansion opportunities. So those will come to.

[Tamy Chen:]

Ok, got it, and my follow up question is just wanted to revisit the prelaunch versus the, you know, the original Stasch product line. So looks like there was good growth on the original Stasch side. So just wondering in the market, are we seeing an acceleration in that value segment again? And with respect to the relaunch and can you talk a bit more about how that's going as you try to endeavor now to pricing your consumers and other value consumers, you know, kind of upset that pricing here? How do you how do you do that and how is it going? Thanks.

[Sebastien St-Louis:]

Thank you. Before we before we start to talk about raising prices for consumers, it's critical that we develop better we deliver a better feature set and better value for them. And this is really why we're very excited about because our cultivation has gotten so much stronger. Now, we're able to deliver that at a predicted, predictable, guaranteed 20 percent plus THC with a very strong terpene profile. We've redesigned our genetics lab in Brantford. So we have an entire indoor facility now at Hextall that is 100 percent dedicated to the development of World-Class Genetics. And so we're leveraging the existing massive genetics bank that Hextall has and we're further developing on top of that. So we're in R&D. And as we introduce new feature sets, we expect to be able to offer competitive pricing for what that feature set is. The launch has gone very well. So since we've hit market, we're getting a great consumer response. And I think that's because we're meeting the expectations of the consumer. We promised a certain concentration. We promised a higher quality product, and we're still competing at a very reasonable price. So if you compare high end up product to see some of the higher end black market products, we're still in the right pocket. From a consumer demand perspective, original stash and lower priced value offerings still continue to be a large part of the demand profile. And we've seen a ton of competition in market. But as I mentioned earlier, most of our competitors don't have the robust infrastructure that Hextall has. And so they've been able to kind of come in and out. But original staff remains a mainstay for consumers and continues to gain traction.

[Tamy Chen:]

But I don't think you.

[Operator:]

Next question comes from Aaron Grey with Alliance Global Partners.

[Aaron Grey:]

A good morning and thanks for the questions, you know, first one for me, guys, is on the beverages. So many guys remain, you know, very bullish on that. Now, one point nine percent of Canadian sales. So I just want to know if you guys have done kind of any initial kind of studies or conversations with consumers in terms of how much of that, you know, has been kind of trial versus repeat purchases and maybe some of that initial feedback that you've been hearing that gives you kind of further confidence in the overall trends. I'll kind of help that category continue to grow as you and competitors continue to launch new products and build that out. Thanks.

[Sebastien St-Louis:]

Thanks, Aaron. The trial is certain, the trial rate certainly high. What's exciting is Health Canada is now taking a look at the regulations and there's there's early regulatory interpretation that that should allow us to go from a five drink limit point of purchase to six drink limit. So that's already a meaningful improvement because that's been some of the feedback our consumers are saying. They're saying, can I please buy more of this stuff, especially at once? Can we reduce friction? And when you look at the concentration, for example, the the current equivalency factor, so what which is what drives and regulations, how many drinks you're able to buy is based on the milliliters or the volume of the beverage. So it really is not aligned with consumer and public safety. And I think Health Canada is well aware of that. They've gone to consultation right now. I think we will see that change. And as that changes in the next while, that will really allow not just a six pack at point of purchase, but a case quantity consumption. And as you start to hit that, that really conflates with our production ability to. So you saw in our video this morning our Bellville facility with TRUS, we can produce 400 units a minute. And if you do the if you do the math and you start to annualize that, that's a tremendous amount of beverages. But we've really built that facility for what we believe the market will be in the future. And I've said a few times, I believe beverages could be as high as 15 percent of the total CAD category, a massive part of the market. And so I think as regulatory changes shift, we're hearing loud and clear from our consumers, we want to buy cases. Health Canada certainly listening as well. And I think as those things fall, beverages will continue its climb as a meaningful part of the category.

[Aaron Grey:]

All right, great, thanks for that call. That's helpful. And then the second question for me or go on with pricing as well with more on the vape side, so say you guys had, you know, increased sequentially on the sales, it looks like looking at MDMA. So I just want to, you know, get some commentary that you might have in terms of, you know, what you're seeing within the vape category. You know, we've kind of started to launch some of those products, especially as we've seen kind of overall, you know, a lot of competitors launching their own products and some competition on price there. So it's in competition in terms of what you're seeing on the vape category and how you kind of see that evolve and increase yourself, you know, kind of having a competitive edge would be helpful there. Thanks.

[Sebastien St-Louis:]

Thank you. Yeah, so VAP is where flour was 18 months ago as a general category. What I mean by that distillate pricing in Canada is still egregious and that translates to high unit costs in vapes and then essentially a high price for the consumer. So when the consumer is still looking at VAW overall and this isn't just for Hexa, but overall they're priced out of the market compared to black market. The black market is our number one competitor. Let's make no mistake, we have to get the pricing right and we have to beat black market pricing without qualification. So before we can get the, say, 90, 95 percent of the total market, a consumer has to know and trust that what's available in legal channel is better priced than what they can get from their dealer on the street. After that, once they know they're getting the best price, then we can talk about the future set. Then we can talk about concentration. Then we could talk about safety, legal channel, consumer protection, protection of children, all that kind of stuff starts to matter, right? Environmental footprint, all those all those other features. And so VAP is to let the front end of that because licensed producers as a whole have not fixed the supply chain. Now this is where Axle's advantage comes in. We've been hard at work developing great formulations. So initial responses to the actual distillate that we have in our vapes is phenomenal. But to scale up is not enough, is not actually full fledged. So we haven't actually turned on our vape machine the way we've turned on the beverage machine. And I talk as a machine. It's not one discrete piece of equipment. I'm talking about the whole system and process to produce our vapes. That is something that will be coming up for PAREXEL. And it's a category we're certainly playing in. And when we do that, we expect to be able to do to the market what we did in flour, what we did in hash, and what we're doing in beverage, which is to deliver pricing. That's a black market competitive and which in turn will simply box out, you know, 50 percent to 80 percent of our competition that is unable to operate at the same scale.

[Aaron Grey:]

My great thanks for calling. I'll jump back into the queue.

[Operator:]

Next question comes from Rupesh Parikh with Oppenheimer.

[Rupesh Parikh:]

Maureen, thanks for taking my question and also congrats on a nice quarter. So just going back to the progress that you guys are seen in the beverage category, I'm just curious what skills you have today in the marketplace and in going forward with the opportunity to use it to gain more distribution and more provinces.

[Sebastien St-Louis:]

So distribution as a whole, Rupesh. Thank you for pointing that out. Is getting a lot more sophisticated and a lot more competitive. So the our provincial partners, in fact, are demanding that we have a high throughput rate. So, I mean, you're looking at, you know, in Ontario, for example, the filter order has to be above 98 and a half percent. Axle's goal is to get well above 99 percent in that market and to deliver the same kind of preferred partnership service that has made us number one in Quebec in beverage. That means that the provinces are more and more relying on portfolio providers that can stay on shelf, that have a good understanding of the consumer, that can provide that whole portfolio offering. And so trust has really become the beverage company of choice throughout Canada. And that's not even in being in every store. So that's with trust sitting at about 60 percent distribution right now. So there's a lot of low hanging fruit to get more listings simply as we get in more retail stores. So when I say 60 percent distribution, there were about six out of 10 retail stores throughout the country. And that will rapidly increase, we hope, to that that 90 percent plus number in terms of listing them out. Like when you look at our stew's, that's the beauty of the trust portfolio. Our little victory wine spritzers made from real the alkalis wine with a 2.5 milligram THC and 2.5 milligram CBD composition. We just launched a new SKU with a dry white wine base in our dry grapefruit line so that that comes and joins blood orange and dark cherry are SMG line is proliferating and having really good success. That's at the higher end of the spectrum. Ten milligrams of THC offering in a tropical punch. And now the new flavor, mango, pineapple, which is really dynamite. Huge, huge, huge improvement in flavor profile on that one. We have a list, a line of CBD, sparkling waters. Right. So under the very best brand. And so there's quite a few ice cubes. Actually, I think we're up to 14 or 15 now. Excuse in market, but we're also rapidly adapting to consumer preference. So we saw, for example, that our House of Terpene brand has had tremendous success with limiting. But consumers are having a bit of a slower uptake and understanding the properties of the value prop under mercy and mercy. This is a very flavorful word product. It was designed to go after the Scotch drinker market. And so the first time you taste it, you're not sure what to expect because you never actually tasted that flavor. And that's the really cool thing that we were able to develop with Molson Coors and Trust was to come and take the unique characteristics of cannabis and not only deliver an experience that's unique, but actually to deliver a flavor. And so the uptake has been a bit slower on that product. But as consumers are starting to try it, starting to build a niche, but we're adjusting then supply in response. So still a lot of opportunity for proliferation, a ton of opportunity for improvement. And we're dialing in, for example, in the USA specific flavoring. That's for the US market. And so I'll be really excited to see what that does. It's too early to see the sales numbers, but that'll be a good thing to monitor.

[Rupesh Parikh:]

Ok, great, and maybe just one follow up question, so the gross margin performance was pretty strong this quarter. So as we look for the there to think that we build on the improvement that we've done, we've seen this quarter going forward.

[Sebastien St-Louis:]

Yeah, I think I mean, you're talking beverage side specifically or portfolios in general, this portfolio. So in general, yeah. Super proud of what the team's done. We're hard at work on continuing to remove cogs. But the flip side is we want to flow through those savings to the consumer. I mean, Hextall is not out to try to achieve 80 percent gross margins. We we've been striving for a 40 percent type portfolio margin. But if we have to be at 35 for a while in order to make sure we are relevant to the consumer and that we beat black market pricing and that we continue to grow market share and total share of market, that's certainly something we're going to do. I think what we're proving out is we have an ability to be the most competitive among the most competitive companies in this whole sector. And as long as we keep doing that and delivering great value for price, I'm confident that we'll get the volume to keep sustaining a better profile.

[Rupesh Parikh:]

Great, thank you and happy holidays.

[Sebastien St-Louis:]

Thank you. Next question comes from John Zamparo with CIBC.

[John Zamparo:]

It takes good morning. I want to ask about pricing was a fairly significant decline in the corner, but that was clearly a shift towards large format value. Just would like to get a sense of how you see that category playing out in pricing for the next few quarters.

[Sebastien St-Louis:]

Yeah, well, I think from pricing. John, thanks for that one, you didn't you did not see the impact of our portfolio. So the prelaunch, as we said we had we had taken a specific action to delay that, to make sure that when we did launch, we would be we would be in market all the time. So that should provide some positive momentum. But overall, if you look at kind of the stabilized pricing over five quarters, you know, you'll be trending up down. You tend to stick around. The pricing that we have now, I think is reflective of the of an ability to keep pricing go forward. But overall, I guess investors I wouldn't caution investors on seeing any kind of massive price drops, but the bulk of that on a per gram basis, I think that's not where we want to look at pricing. I think on a per gram basis, there's still some room to move a little bit lower just to really dial in the competitive nature against black market. And then simply, if we get a little bit tighter and this depends on certain products, right. Like if you take original Sassone a gram, you don't need to drop the pricing on that product. It's more competitive than what black market can offer. When you take you take 120 dollar ounce. Right. What's available for 100, 120 dollars on the black market? Simply, it's not even near the quality that you get an original stash. So but there's still a lot of room to refine pricing on categories like Napes, for example. There's still some room to refine pricing on categories like Hosch, the exciting things that Hextall has, the infrastructure to do that. And as we've proven with original stasch, as we drive pricing, most of our competition can follow and then at least a larger basket for us.

[John Zamparo:]

Okay, that's helpful. Thanks. And then my second question on the beverage side, as you have conversations with retailers and distributors, is, is there a sense that there's kind of a cap on how big that category can get just because of the lower revenue per square foot of that item versus, say, dry flour or other category? Is that something they mentioned to you? Is that something you're thinking about when you when you mentioned the 15 percent of sales, the category just trying to get a sense of how that plays out in your conversations with partners?

[Sebastien St-Louis:]

Yeah, I mean, we talk about that all the time. We're talking to our preferred retailers, right? We talk to retailers literally every day. And so one of the things we've done is we've actually we have a capital fridge program. So TRUS provides fridges that provide for a very nice set up in retail stores and nice experience, refrigerated beverage ready to drink. So that's one of the things we've done. But the other thing we've done, and this is where the capital around Velvel comes up. You know, in Quebec, for example, we're shipping twice a week. So we're reloading those stores often. And that's something that we've started to take. I mean, I commend the EPS has on the Ontario government for the progress they've done. They've got the brand new distribution center coming up very soon in the Gulf and that that facility allows for a just in time sort of approach. And as they look at an overall SKU rationalization for the industry and really focus on a core SKU program, TRUS is part of those core skewes. And what that means is that we're in market, we're replenishing often. And then that paired with the longer term regulatory development at the federal level that will allow quantity. Absolutely. I think that if we are able to blow past that barrier, you're seeing a bunch of new retail store operators open and we're working closely with those new retailers to make sure that beverages, you know, is more than a one percent of in their mind that they really start to think of beverages 10 to 15 percent as a category because it is a differentiator. And so I that certainly is a challenge we need to overcome, but it will be overcome over the medium to long term.

[John Zamparo:]

Ok, thank you very much.

[Operator:]

Next question comes from David Kideckel with ATB Capital Markets.

[David Kideckel:]

Good morning. Thanks for taking my question and congrats on the quarter. First question is, Sebastian, you mentioned and this has been a recurrent theme over, I guess, quite some quarters, just increasing your market share in other provinces besides Quebec. So I'm wondering, just on that point alone, are you able to disclose what your market share is within the other big provinces? And also, what specific steps is Hextall going to take to increase market share? And will that be so driven or do you see that more as market related factors, for example, the opening of new brick and mortar stores? Thanks.

[Sebastien St-Louis:]

Thank you, David. Yeah, definitely Axelle Driven, I mean, our our war on the floor strategy, our brand strategy. So with the up launch now Hextall has a full portfolio offering across the value chain. Right. We've got our Hextall core offering. We've got original stasch towards the value. We've got up the up relaunch at the premium portfolio so we can really offer retailers. And then that's just from a pricing perspective. But we can offer retailers across categories now to a full slew of products. Right. When you look at vape hash, prerelease, the flour across all categories, beverages, there's not a lot of competitors that can do that. And so we're having a lot of success and being part of that at both the retail level and also with the provinces and having those conversations as a preferred supplier. So that will drive volume. The second piece that drives volume is our ability to compete directly with the illicit market on price for like quantity, like quality and better. And so that that is also driving volume. And you also have a flushing out of competition, which is driving volume. So you're seeing a lot of our competitors. I mean, there's still over 400 licensed producers in Canada, but 10 of the licensed producers control 90 percent of the market share. Hextall as part of that 90 percent. And you're seeing that success. And now that we've unlocked the supply chain and that we're really focused outside of Quebec while maintaining number one position in Quebec. But while we're focused there, you've seen in this quarter it's almost 30 percent of our revenue now that's coming from outside of our core home province. So a meaningful a meaningful upgrade from where we were before. Let me call this a trend here.

[Trent MacDonald:]

Let me follow up quickly, if I didn't have the figures right in front of them. But you've asked about market share and we're number three in Alberta. We have seven percent market share. We're number six in Ontario. Don't forget, not too long ago, we're 17 in Ontario. Now we're number six. And we still we're very close to five percent market share now there and more of our market. It's more than 30 percent. We're 18 percent of our our total sales in, you know, right now as of today. In fact, right now, today, today is 18 percent, 18 percent of our sales are in Alberta, 15 percent are in Ontario. You know, and then we are not just in those two problems that we're in other provinces like DC. So like I said earlier, our goal is our goal and we're progressing there extraordinarily quickly is to have more than 50 percent of our basket outside of Quebec while again maintaining that market share in Quebec and we're on our way. But that's not a year from now. We're getting there very quick, very quickly.

[David Kideckel:]

Ok, thanks, guys, very helpful. My follow up question goes back to your original stash brand and our channel checks and due diligence. It suggested that consumers are not really loyal to any value priced brand persay, and they're willing to go with whatever's the cheapest price in store. So my question is, number one, do your channel checks, verify that as well? Or actually is original stash perhaps working outside the box here? And secondly, on that one as well, to what extent you and besiege original staff contributed to your top line revenue number just as a value brand X?

[Sebastien St-Louis:]

Well, David, I think that you're touching on a core point there, and I've been saying now for years that brands don't exist yet in cannabis, although we are starting to see them build and original star certainly as a name to watch. So I fundamentally believe that the build brands and for the brand to cycle back into value, to really build value from the brand itself, that brand needs to first have an unbelievable distribution. And second, have a very good feature set the price it needs to be it needs to be priced right for the features that it offers. I think we've done those first two things with original stasch and we started to see search for product, especially in Web sales, people searching by brand name. So it's starting. But you're right that overall this is a highly competitive market and that we can't rest on any laurels. No brand is strong enough to command just from a brand name perspective to command shelf space. We have to keep driving value through price and feature set. And Hecks was very good at doing that. We're very good at remaining relevant and responding to the market. And so I see the fact that brands don't exist yet in cannabis as an opportunity for Hextall, as an opportunity to build our portfolio of brands. From a topline perspective, I think Trumpton can share a little bit where we're going.

[Trent MacDonald:]

Yeah, I mean, look, from our top line, where we continue to grow and expand and where our goal is to be, you know. Well, we can't say what what's going to happen, we're not giving guidance. OK, but let's make it clear, our goal is to continue coming here quarter after quarter with very clean Pinnacle's, very digestible. That allows us to continue that. You know, that that ongoing dialog, another quarter of growth, another quarter of growth, another quarter of growth, top and bottom line. And so when we talk, there's been a lot of questions on pricing here. I mean, over the course of the D.A., tough questions, and that's fair enough. But that's why we have such great practices in our cultivation in that song, which we're not talking about a lot, but really great quality operations going on there as a result of, you know, led by our chief operating officer, Don, who who's a wealth of knowledge. And he's brought in some great people in that they're doing a wonderful job. And then you move that over to Balbo and what's happening, our price can come down and we can continue to be to be very good on margin. This is not a margin game. It's a volume game. You know, the more we sell, the better we can do on our on our dollars of margin, even at lower, lower margin rates. And that's the bottom line. We control our DNA. We get that war on cogs going. If we're at 35 percent, we're going to be profitable all day long. And that's a good place to be. And that's and we're one of the very few who can say that. So we like where we're at.

[David Kideckel:]

Ok, thanks for that, very helpful, I'll hop back in the queue.

[Operator:]

Next question comes from John Chu with Desjardins Capital Markets.

[John Chu:]

Hi, good morning. Maybe just following up on the beverages in the retail stores, one of the earlier questions about convincing the retailers for the value per square footage. But the other question I guess, I have is just more from a capacity perspective. A lot of the retail stores are pretty small footprints. And in terms of how do you convince them to take on a trust related refrigerator, to have something to drink and determine understand what small footprints that some of these stores have. How do you get to that target of 15 percent less space within the store is pretty limited.

[Trent MacDonald:]

Yeah, I'll let me take this one just for that can clearly jump in if I miss anything, but, you know, my background is in retail, so I spent my better part of my career in retail. And I can tell you that's a great question. You know, how do you get listings? How do you convince retailers to take on new listings and provide space inside of a fixed quantity of square footage that talked about it earlier? You know, there's three different programs. There's the refrigeration. You know, you're taking capital expenses that they would have otherwise that out of their pocket. You're doing it on their behalf. And the return is in return. You say you have to take certain listing, but there's also the fact that we have multiple course. You know, we can't understate the fact that we have a global partner, global, you know, and this isn't not to take shots here, but it's not it's not a craft beer location in one state. You know, this is a global partner. And when they want listing, they get listing. And, you know, and that's the beauty of it. In retail environments, you know, they're going to give what they see. They're going to give space to whatever moves and so we can get a listing. But somebody asked earlier, are we getting more people coming after the fact? We are. You know, that's the truth of it. We started off first quarter with one point nine. Now we're at three point one. And let's be honest, we have not tapped out here. You know, this is a growing segment for us and you're going to see that. And so, you know, we're continuing to grow what we're seeing that this is the retailers are wanting more and more of this product systems earlier, once to introduce like people can say, oh, it's not that big a not that big of a category because products are let's be beyond not good. They're they're just not good. They don't have a good taste profile. People are trying it like somebody pointed out. They're trying it, but they're not coming back for it. That has changed. That has changed dramatically. Little victory was just named the name was named Top Beverage in Canada in the Qantas wars, that kind. And, you know, that's because it has a great profile. People are going to come back and they are coming back over and over. And when you get volume going to retail, the deep emerging is retailers will get a shelf this and that. And that's outworks.

[John Chu:]

Ok, great. And then the second question is just maybe a bit more of an update on Velvel Sebastian. You mentioned that it's up and running now, so maybe just give us a sense on the transition to Bellville where that's at. And what do you think? You'll be mostly transitioned over there, excluding the trust part of that?

[Sebastien St-Louis:]

Yeah, John, it's done, we're fully transitioned, we have no more there's no significant manufacturing operations happening in Massawa outside of outside of Velvel now. So we've really we've consolidated. That's why we took that virtual introductory tour. Now, what's great now is that we're done moving everything to Velvel, the improvements and the proliferation within that facility that we're just getting started. So super exciting over the next few years to see, you know, best in class, pre roll manufacturing, keep being integrated for better and for for manufacturing. And as we start to put those elements there and hopefully a few more partners next to Truss, which which we've got, we've got about 400000 square feet sitting in Bellville waiting to accommodate those partners. And that's the license square footage that can accommodate the next Fortune 500 CPG partners. As we do that, that center really comes alive. But right now, it's active. I mean, the parking lot is full. You've got 350 Hextall employees working at that center. So it's it's quite operational.

[John Chu:]

Okay, great. Thank you.

[Operator:]

Next question comes from Doug Miehm with RBC Capital Markets.

[Douglas Miehm:]

Good morning. Two questions question, Sebastian, I just wanted to delve a little bit more and I know this has been the death, but I do want to understand your thinking because you were a leader on the Aboriginal staff side. So I want to get your thinking on where you think pricing needs to go in the market relative to where it is right now, let's say, for half a gram or a ground type product. And if you're going to be leading that charge.

[Sebastien St-Louis:]

Thank you. So I won't disclose on this call where I'm taking the pricing just yet, if so, I apologize for dodging that question a little bit. But overall, for Axle's plan is to have a pyramid type brand strategy. Right. So think up. Excellent original staff and all feature sets do have price points that compete directly with the black market, and that will be largely driven by our ability to lower unit cost to and to flow that through to the consumer and to win through volume.

[Douglas Miehm:]

Ok, and where is the black market right now?

[Sebastien St-Louis:]

Oh, black market, so it depends on the quality feature set, but I mean, you'll you'll get a black market. Vapes could range anywhere from twenty dollars. I mean, you could get as low as 10 to 15 dollars on certain disposables in the sale environment to you know, you're typically towards the 30, 40 dollar range on something a bit quote unquote, higher end. Now obviously those are brand promises and the black market that are unvalidated and there's nothing to back it up. So they tend to say what they want about their products, but that's kind of your pricing.

[Douglas Miehm:]

Ok, and then my second question has to do with the capital fringe program, because I think it will be helpful. But can you sort of walk through the details of that if you do provide a fringe to a retail store? Are there any obligations on their part in terms of ordering a certain amount of product? Or can you just walk us through this fringe program and a bit more detail?

[Sebastien St-Louis:]

Now, we don't create any obligations for our retail partners and we do it as part of our overall like, for example, in Quebec, the capital for its program that we do in Quebec, we do as part of being the preferred supplier. It's the same sort of arrangement we do. I mean, we take care of the distribution for all Web sales in Quebec, right. That's not that's not an exchange, a quid pro quo. That's part of what we see is our relationship as preferred supplier. It's the kind of service that we do. We we deliver to our customers. And so that that's part of that that overall program. We believe that this the kind of when you look at it in aggregate and everything that Hectorol offers to our customers, that is the reason they come back and that they choose us willingly, has a preferred supplier. And that's the reason that we keep that we can keep our shelf space and that creates all through the consumer.

[Douglas Miehm:]

And what's.

[Trent MacDonald:]

Like for you, this part about the you think with the bridge program? It's very it's very similar to a lot of, you know, retail environments and even within the Kansas retail environment coming in and doing merchandizing and the retailers allowing them to put up displays, you know, not dissimilar to that. You know, there is no obligation, there's no incentive beyond just the fact that you have a bridge there. But, yes, I didn't want to leave it here.

[Douglas Miehm:]

And just to finish off, what is the expected cost of that program over the next two years?

[Sebastien St-Louis:]

Whether it's with interest rates, with interest, so we don't that that all rolls in eventually and as a reminder, Truss will be obtaining a license within the next six to 12 months. When that happens, the trust's earnings cost everything will move over to most, of course, consolidation from exile. And as trust becomes profitable, we expect to simply see, you know, contribution to net income below the line there. So it's not nothing material.

[Douglas Miehm:]

Ok, thank you once again.

[Operator:]

If you'd like to ask a question, please. Press star one on your telephone keypad. And we do not have any telephone questions at this time, I will turn the call over to Mr. Family.

[Sebastien St-Louis:]

Thank you, everybody, for joining the call. Have been exciting to share our progress as as we continue to remain and top four lists in Canada and looking forward to sharing continued progress and continue to roll out new products to more consumers. We'll see you next quarter.

[Operator:]

This concludes today's conference call, you may now disconnect.