HEXO Corp.
Q2 2021 Earnings Call Transcript

Published: 18 Mar 2021

[Operator:]

Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the HEXO’s Q2 2021 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 current internal views, estimates, expectations and assumptions. These statements should not be read as assurances of future performance or results. They may 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.

[Sebastien St-Louis:]

Good morning, everyone. Happy to get on this call to celebrate our big Q2 and some reasons for optimism. We’re starting to see vaccine rollouts to hopefully end this COVID pandemic once and for all by later in the year. Our safety of the employees at HEXO remains paramount for us and we’re doing a phenomenal job continuing to avoid COVID and also reduce workplace accidents. A huge thank you to all our employees, the whole team, phenomenal work in getting us to EBITDA positive this year, this quarter, which has been a huge achievement, and also for being so successful, we haven’t required any government handouts in the - during COVID. So – and really winning on our own, so I think that’s a testament to the hard work we put in. Unfortunately, it does look like we’re kicking off the roaring 2020s a year too late given the situation, but we will be kicking it off. So we’re looking forward to putting this behind us and having consumption patterns return to normal, people celebrating and getting back into social occasions once they’re all vaccinated. It’s been another record quarter of $45.7 million gross and $32.8 million net. We’re adjusted EBITDA positive for the first time in HEXO’s history after seven straight quarters of adjusted EBITDA improvements. Our net revenue is up 12% sequentially from the first quarter and 93% versus the same quarter last year.

[Trent MacDonald:]

Thanks a lot, Sebastien. So, look, it’s been another sequential quarter of no inventory write-downs or provisions, which keeps our P&L quite clean from that perspective. Another sequential quarter with no impairments of long-lived assets, such as goodwill intangibles and PP&E, so again that goes back to our clean-up of the balance sheet at the year-end. Our operational cash flow usage remains quite low, only using $2.9 million in the quarter and $8.1 million combined for the past three quarters, and that’s not including non-cash working capital items. Over $250 million of working capital on our balance sheet at the end of the quarter with over $130 million of cash to cover our near and midterm needs, so lots of pathway from an operational perspective. Our gross margins, including adult use beverage, were 40%, with Up having higher margins due to our war on COGS that we continue to wage within our organization, and we continue to compete on price against the black market and other LPs who are trying to capture the same customer segment. So within that realm, still able to propel ourselves into very healthy margins. Ongoing restructuring to lower our SG&A is still taking place. We want to get our SG&A down as a percentage of sales, so you’ll see $860,000 of restructuring charges in the quarter in relation to that strategy. Our G&A, marketing, selling and promotion, and our R&D when adding together now at – now represent 47% of our net sales, down from 51% in Q1 and well ahead of industry norms. We believe there are still more improvements to make in the near and midterm.

[Sebastien St-Louis:]

Thanks Trent. I’d like to wish everybody safety and health as the global pandemic continues and as we get to the tail end of it. I’m very proud of the HEXO team for their dedication. They have navigated through this ever-evolving and unpredictable environment to positive EBITDA. Despite the many dire economic and social consequences the pandemic has caused, the cannabis industry continues to grow with strength. That’s a testament to consumer demand for safe, legal, high quality products that are offered by some of the licensed producers. The industry has a $2.9 billion run rate. We continue to grow. HEXO is in a top three market position in a market that’s the size of California. We’re closing in on begin top two, which we believe will cement HEXO as one of the leading cannabis brands in Canada and giving us a platform for the world and to enter into the U.S. for years to come. Look forward to discussing more during Q&A, so we’ll turn it over to questions.

[Operator:]

Thank you. Your first question comes from Aaron Grey of Alliance Global Partners. Your line is open.

[Aaron Grey:]

Hi, good morning, and nice job on inflecting to profitability there.

[Sebastien St-Louis:]

Thank you.

[Aaron Grey:]

So first question for me, Sebastien, you mentioned the partnership you guys have right now with Molson Coors and potential additional partnerships within CPG, so can you just give us an update kind of on that hub and spoke model is kind of progressing? You’ve previously spoken about kind of moving away from the JV model to maybe some other models in terms of these partnerships. So while I know you can’t go into detail in terms of specific partners, could you kind of go into some -- give us some color in terms of how those could potentially be structured, if shifting back to the JV or still looking to do some other types of models as those evolve? Thanks.

[Sebastien St-Louis:]

Happy to, Aaron. The JV with Molson has been really a fantastic learning experience, not just from a beverage perspective, but just from an overall structure and business perspective. And so the agreements we’re currently in pretty final stages with are being negotiated around a royalty-type arrangement. So how the - what we’ve done is we’ve removed a lot of the weight of the JV structure. We leaned it out a lot, which is tied into our strategic objective of bringing positive EPS soon. And so, what the agreement will most likely result in is HEXO producing edibles at our Belleville facility in the food technology complex on behalf of these major CPGs with their technology and engineering assistance. At that point, HEXO will distribute and run it like our own business. We’re going to brand those products under major recognizable brands because we’re not limited like we are in the alcohol space. So, for example, with Molson, originally the plan was to launch an infused Coors-type beverage. We were planning on leveraging the existing Molson brands, but we were not able to do that because of a change in regulations along the way. We also have certain restrictions around products like our Little Victory product, which is hugely successful, people love the taste. That product is made with real dealcoholized wine, and unfortunately because of regulations, we’re often not allowed to say that it’s made with dealcoholized wine, and I think that hurts the value proposition. We don’t have those restrictions on edibles. And so, by taking a leaner structure, by being able to lever existing brands, making that here and simply paying back a quarterly royalty, which we expect to be able to do in cash and more often than not in stock, so it won’t affect negative cash flow, we think that will be a leaner proposition to get us quickly to market. Perhaps the most exciting part of this structure is we flipped it for U.S. and rest of world. So, in the U.S. and the rest of world, the real advantage of the Powered by HEXO model is we can lever not just the distribution, but also the manufacturing capabilities of our CPG partners. We’re bringing world-class facilities to bear, world-class knowledge and distribution that’s already in place, so a very capital-light approach. We’re exporting HEXO IP. I remind everybody on the call HEXO remains top two from an IP portfolio patent perspective in Canada, so we have phenomenal IP and it keeps growing every quarter. So we’re going to move that IP into those states legally. We’re going to start in CBD from hemp, so not touching THC for the moment, but setting up all the infrastructure to do so when the legislation changes in the U.S., which we’re closely monitoring. That gives us access to about five states today in which we could operate. We’ve already test bed Colorado with Molson by launching in January. And so we think that that structure will allow us to rapidly proliferate product in the United States by using mass channel distribution.

[Aaron Grey:]

Thanks for the color. That’s super helpful. My second question on the pending Zenabis acquisition, so you’ll be acquiring some indoor cultivation, low-cost production, adding to your own capabilities. Can you talk about how you’re kind of looking to use that indoor cultivation in terms of your own brands? Do you look to leverage that more for your premium brand, Up, because it might be a little more controllable with the indoor cultivation, how you’re planning to leverage Zenabis’ legacy brands or bring them in with HEXO’s, or just some of the plans you’re looking to do once that acquisition closes and you bring on the additional cultivation in? Thanks.

[Sebastien St-Louis:]

Yes, first of all, we’re going to continue some of the phenomenal success that Zenabis has had with their brands. Namaste has great traction in the market and we’re still evaluating and working with the Zenabis team to make sure that we take a holistic approach and take the best from all brands to make sure that we can really round out the consumer occasions. The second part, the Alphaville facility is a world-class facility. It’s certainly one of the best indoor grows that exists in Canada today. I know, over the last eight years, I’ve visited most of them and the - that’s certainly going to bolster our ability to take Up to new heights. So our Up product and our Original Stash Reserve product are certainly going to benefit from that additional ultra high-quality indoor control and capacity.

[Aaron Grey:]

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

[Operator:]

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

[Tamy Chen:]

Thanks. Good morning. Sebastien, I wanted to go back to the comments you made with respect to the update on your current hub and spoke model. You mentioned some interesting points there. And I’m just wondering, to the extent that you can discuss or expand a bit on this, these current discussions that you’re having, are there elements such as exclusivity for HEXO, and are they more focused on the Canadian market or you’re having concurrent discussions for geographies such as the U.S. and rest of world? And when you’re talking about sort of these markets outside of Canada, is that also similarly a royalty structure or are discussions a bit more than that, such as a direct investment in you? Just a bit more color there to the extent that you can would be helpful?

[Sebastien St-Louis:]

Thank you, Tamy. Yes, so we’ll start with the direct investment. I don’t – HEXO has plenty of access to capital, and in fact we haven’t diluted in a couple of quarters now. We’re very well set up, I mean, operationally over 18 months of cash, our CapEx plan is fully funded. We don’t see that as a priority. That can create leverage to miss the point of these partnerships. So to your question on exclusivity, the exclusivity and especially the IP and the control of the IP that will emerge out of these partnerships is critical as part of long-term value build. If you develop the best IP in the world and then end up having to compete with one of the largest companies in the world with the same IP, I believe you will lose. That’s why HEXO is making sure that in these partnerships, both partners win, both partners are heavily invested in the IP, and where the direct investment goes is in pushing the business line. So for example, what we’ve done with Molson Coors was both invest and now about $115 million into standing up beverages in both Canada and the United States. These partnerships we’re working on in the future, similarly, they’re meaningless if they’re Canada only. Canada is important. HEXO has all the distribution in Canada. HEXO delivers more value in Canada than the CPGs bring in. However, where it really shines is in the value that we’re able to lever together outside of Canada. And as such, we’re really focused on making sure that these are multi-country agreements, sometimes global completely, obviously with some nuances depending on which market and which product line specifically. But yes, we’re looking at exclusivity, yes, we’re looking at global.

[Tamy Chen:]

Got it, that’s helpful. Okay. my follow-up question is, and Trent, it’s specifically for you, with respect to the capex, I think so far we’re about halfway through your fiscal year. I think it’s about $7 million on capex, and I recall your previous commentary was for this fiscal year $40 million to $65 million, so I’m just wondering if that’s still the outlook and so we should think that the capex will really ramp up in the back half of the year. Thanks.

[Trent MacDonald:]

Yes, look - it’s definitely going to be back half heavy, Tamy, but we were doing a few things in getting our operational teams lean, this war on COGS that we’ve been waging, and so some of the projects that we had planned to start are now just beginning, and a couple of the big ones that we think are going to be extremely accretive to us - that’s what we’re hoping to see, anyway, in the future. Those had gotten a bit delayed but not substantially, so some of the things that we thought would happen in third and fourth quarter might be fourth and then first-second quarter of next year before they’re fully stood up. But it was the right thing to do on a couple of our major, major projects to make sure that we had the fundamentals right so that we could add on top of something strong versus adding something else into a very complex, unorganized environment. We’re very solid right now and have started the process going with all these additions.

[Tamy Chen:]

Great, thank you.

[Operator:]

Your next question comes from Vivien Azer of Cowen. Your line is open.

[Vivien Azer:]

Hi, thank you. Good morning.

[Sebastien St-Louis:]

Good morning Vivien.

[Vivien Azer:]

I wanted to follow up on your commentary, please, on the United States and the CBD beverage test in Colorado. You noted that you were evaluating five other states. Interested to understand what initial insights you’re gleaning from consumers and what key KPIs you’re monitoring before you make the determination to expand beyond Colorado. Thank you.

[Sebastien St-Louis:]

Thanks Vivien. The first thing is just to monitor the brand traction and consumer tastes, and this is a market by market business. When we look at Colorado, it’s certainly very different than Quebec, very different than Ontario, and we anticipate will be very different than California and New York, etc. We’re looking at a total of five states where the regulations right now allow us, and I’m purposefully being cagey around the names of those states - we believe that’s a competitive advantage at the moment, to participate in CBD. The first step was really to establish that we could build these mass channel grocery store penetrations, which has been done, so now anecdotally we’re on most end caps in groceries in which we participate. The product has displaced other CBD beverages that were available, so consumers are responding much in the same way that they’ve responded in Canada by making Truss Beverages 43% of the market share, because the taste is simply more preferable to those consumers. They are responding in Colorado now and we’re taking on those end caps, so what we’re going to wait to see is just to see the traction over the next few months for our actual sales numbers, reorders. We’re gaining experience with the case quantity concept that we don’t have in Canada because of regulatory. We are working on the ecomm support for those businesses and basically setting up the whole infrastructure. During this time, we’re also working on reducing COGS by shifting from the third party manufacturing to Molson manufacturing specifically, and so we’re working that out as well so that we can get a good sense of capex expansion rollout and on what scale we can really bring this. We’re expecting to have meaningful data, say by the end of May, by which we would start to activate the next state-by-state strategy.

[Vivien Azer:]

That sounds great. Thank you for that color. A quick follow-up for me on Canadian beverages from a regulatory standpoint. Any progress in expanding the unit limitations for consumer purchases?

[Sebastien St-Louis:]

We’ve had some progress on XMG. XMG, which is a smaller format can but that did not necessitate regulatory change, so within the same regulatory framework, our XMG products - our Mango Pineapple and our Fruit Punch are now the two top selling SKUs in Canada from a beverage perspective, and those are available in eight-packs, so you can essential buy eight cans of XMG versus five bottled beverages, because of the milliliters We have not had success on a regulatory basis in actually effecting change. We have had quite a bit of success as an industry to get Health Canada and the regulator to listen, but understandably they have their hands very full with the pandemic right now and so cannabis reform has not been a priority. It’s more a matter of--we’re pretty convinced it will come. They accept all the regulation. They understand that from a consumer health perspective it really makes no sense to limit the beverage purchase at the point of purchase, how many you’re going to buy, but to make the actual regulatory change, we’ll probably see that as part of a larger regulatory package update that will include a number of changes over the next 12 months.

[Vivien Azer:]

Very helpful, thank you so much.

[Operator:]

Your next question comes from David Kideckel of ATB Capital Markets. Your line is open.

[David Kideckel:]

Hi, good morning. Thanks for taking my question. Congrats on the quarter Sebastien, Trent and team. A couple of questions. I want to start off with how would you describe your overall strategy now moving forward, Sebastien? I know with the Zenabis acquisition, it creates a potential top three contender here. How do we view HEXO moving forward? Looking at your liquidity, by our calculations today you have about $120 million. How should we think about your growth? Is it organic or inorganic, or maybe a combination of both at this point? Thanks.

[Sebastien St-Louis:]

HEXO’s been growing now quarter over quarter for many quarters, and so I think organic growth is the name of the game. Displacing market share from other competitors is the name of the game. Seeing, really eliminating weaker competitors that don’t have the wherewithal to offer consumers the right price point and to displace black market, that will drive organic growth. Inorganic growth remains one of the strengths that we have, so I’ve talked a little bit about the advantage of having a very large world-class manufacturing center in our Bellville site, so when you start to look at, say, midsized or smaller licensed producers, they often don’t have the manufacturing wherewithal, and so you really get phenomenal synergies when you start to pair that into manufacturing capacity like HEXO’s Belleville, which has an abundance of capacity that can be filled with extra cultivation. From that sense, I don’t think M&A is over by any stretch. With that said, we have to be very cautious on M&A, and there are not a lot of high-quality targets in Canada, and so we are entertaining discussions. HEXO is in a--it’s a little known secret in the industry, but just about every CEO rings me every once in a while to say, hey, what are you thinking on M&A and can we join forces with HEXO, because they see the fundamentals and there’s a disconnect between the fundamentals and the value of the stock at the moment, so very attractive for other companies to, when they’re looking at joining up with a larger partner, to pick HEXO as that partner. We’ll certainly see more M&A in the space, and we’re in ongoing discussions.

[David Kideckel:]

Okay, that’s very helpful, thanks Sebastien for that. Moving on here, my second question has to do more with your sales in Colorado. I’m just wondering, when you describe, Sebastien, your success in the U.S. and Colorado specifically as this test pilot for beverages, what are your metrics for success besides simply sales, number one? Also, can you maybe give us a bit of a guide or goalpost for over the next year, what percentage of sales you expect the U.S. to represent of overall sales? Thanks.

[Sebastien St-Louis:]

Well I won’t guide anything, David, but I can talk a little bit about our goals. Truss Canada has achieved its goal, which was to be the number one beverage brand in its market. Truss USA has the same goal. Truss USA wants to be the number one beverage brand in the markets in which it operates - cannabis beverages, obviously, and so I think that’s the largest milestone, which is really a sales milestone. The second one, though, which is quite exciting, is in the lean operations, so where Truss USA differs, I’ve mentioned we can lever existing infrastructure. We don’t have to build everything from scratch. If you look at what it costs to build from scratch, I mentioned about $115 million invested by both Molson and HEXO - well, about $105 million, $110 million of that was to stand up world-class manufacturing facilities in Canada. In the U.S., we’re addressing a population now of 5 million people in Colorado, and we’re doing so on single digit millions by being very lean and leveraging the IP that we have, so we have a number of capital spend KPIs and profitability KPIs on which we’re leaning on, of course, the phenomenal experience at Molson Coors to help guide us through that to deliver positive cash flow from those operations. That’s another big yardstick we’re using.

[David Kideckel:]

Thanks for taking my questions, and congrats on the quarter.

[Operator:]

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

[John Zamparo:]

Hi, thanks. Good morning. I wanted to ask about the industry in general, Sebastien. The general view from some producers at least seems to be that the first few months of the year have been a bit softer for a variety of reasons - seasonality I think you mentioned, but also some SKU rationalization and reductions in inventory held by some of the provinces, and store lockdowns this time around don’t seem to have that boost in customer stockpiling that we saw a year ago. Generally, would you agree with that for calendar Q1 for the industry, and any color you can provide on what you’re seeing either from consumers or provincial distributors would be helpful.

[Sebastien St-Louis:]

I’ll nuance it a little bit for you, John. I think that the industry is entering its most competitive phase that it’s faced since its inception. It is no longer okay for a licensed producer to simply create a product, throw it on the shelf and move it. You now have to contend directly with very competitive pricing in every category, very competitive listings with every customer, and a relentless pursuit of a better product in the face of consumers. The reality is that most licensed producers are not up to the task. You will hear more and more refrain of difficulty, you’ll hear more and more the industry is having trouble, but the fact is it’s growing, growing, growing. Our industry is up almost 100% year-over-year, and there is not many companies like HEXO that have also grown with the industry, so it will be not enough just to grow at the speed of industry but you’ll have to actually be able to displace, and that’s what we’re seeing through this refrain. I’ve talked a lot about how--I think the end game here will be three companies that control 70% market share. The number one spot will be a 40% controlling stake - nobody has proven they can take that number one spot yet, and that’s why HEXO is shooting for top two. But in this competitive set, we’re now right on the cusp of that top two position with a shot at that number one, and to do that you have to have world-class manufacturing to lower your COGS. You have to world-class greenhouse production like we have in Masson and Gatineau, and you have to have world-class indoor production like we’re acquiring very soon with Zenabis in Alphaville.

[John Zamparo:]

Okay, that’s great. Thank you for that. Appreciate the margin disclosure in the MD&A. I wanted to follow up on margins for the beverage side. You took a meaningful step forward in revenue, but gross margin is still negative on these, so can you talk about the nature of the contribution margins of these products, or maybe talk about what percent of costs are fixed? I’m really just trying to get a sense of what sales need to be for that gross margin number to look a little more like your other categories, so any color on the margin profile for beverages would be helpful. Thanks.

[Trent MacDonald:]

Yes, sure. Look, with Truss Beverage and the cannabis-infused beverage category, there’s still fairly low volume. It’s a little more capital intensive, as you can imagine, than 28-gram bag of flower, so you’re going to have more overhead applied with each unit of production, so there is a lot of fixed overhead there. You have to get up to a certain volume before you start seeing positive margin. I can’t tell you the exact number but you can see that we’re pretty much breakeven at 3, 3.5 million, so it’s not a huge number. To Seb’s point, there was a--in beverage, Molson Coors is educating us all the time and it’s very predictable that there’s a slowdown coming out of the holiday season in beverage. January and February, if you think about it, in most people’s lives, not a huge event-driven type of season, so the volume isn’t going to be there, so you’re still looking at that 3, 3.5 million that we came off of Q1 with, it’s grown 10%, which at 12% back, which is great. But look, I think over time you’re going to see that volume increase, and our hope is that it’s going to increase dramatically and that if we’re breakeven at this level, I think it’s fair game to say that our margins are going to improve as we apply those overheads to more and more grams, so it’s being spread out across that entire category.

[John Zamparo:]

Understood, thank you very much.

[Operator:]

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

[Andrew Carter:]

Hey, thanks. Good morning. I wanted to hone in on the beverages. I guess kind of year one, biggest takeaway seems to be the beverage is it tastes good are winning. No doubt a slowdown is coming over the next two months, but I wanted to ask going into the summer season, are there discussions with retailers to feature the category heavily? I know you’ve got the coolers - can you give us any update on cooler penetration? Just kind of starting at maybe some more sophisticated category management that could help you guys with this leading spot, or is it kind of just more of the same, everybody is just looking for growth? I’ll start there with my first question.

[Sebastien St-Louis:]

Thanks Andrew. No, I think more of the same is precisely what we haven’t done at HEXO and with Truss. Truss is first and foremost a beverage company. They don’t think of themselves as a cannabis company, and I think when they built the brands, Scott Cooper and his team really took a look to say, what are the beverage occasions here that we can go after specifically, so that brings into your question, what are the limited time offerings, what are the coolers, what are the promos we can do with certain retailers, obviously sticking to regulations, and the summer season is a very exciting season. I think a big part of the success of Truss has been that we have focused on those beverage occasions first and not just putting a strain in the bottle. We’ve really focused on crafting a really unique beverage experience so when we walk into summer, it will be a really exciting time for that. I think there’s plenty of opportunity to further refine that category management.

[Andrew Carter:]

Got it. Second question, I wanted to ask about Quebec. I know sales have been kind of flattish. You made up for it with the momentum outside Quebec. Just wanted to ask about that - when will that line be a more healthy contribution? I get that there are limitations in Quebec, but is this what we should see or do you expect that to re-accelerate ?

[Sebastien St-Louis:]

Are you talking specifically about beverage or overall?

[Andrew Carter:]

Sorry Sebastien, just Quebec, just the Quebec adult use side, putting aside the beverages.

[Sebastien St-Louis:]

Yes, so the headwind at Quebec, and we’re still very much number one, we remain a preferred supplier and we continue to have phenomenal traction in a lot of our products in Quebec, but the main headwind has been the introduction of a number of craft Quebec growers, so there’s a number of small type growers that have introduced higher THC potency offerings and that craft grow has taken a portion of share overall. The issue as a larger company - I mean, craft simply has not been our focus. To be top two, we need to be over 20% share long term of the market, and to do so, you can’t do with craft. You also have just the attention and scale, right - it’s very hard to do craft at that large scale. With that being said, this is where strategic investment and the acquisition of Zenabis. The on-lining of Alphaville and the higher potency products that we can come out of there paired with our mass offering will allow us to move more into that premium masstige category. This is where the traction around our brands like Up, which we still haven’t fully deployed in Quebec, will be very important. Specifically on certain SKUs, there’s also regulatory differences, so in hash, for example, there’s a restriction on THC potency that is not out there in other markets, and so that can cause a slowdown, and there’s also certain restrictions on individual units. On that note on individual units, when you look at beverages, we just recently made a deal with Quebec to launch a five-milligram version of our XMG product beverage, which is usually a 10-milligram product in the rest of the country, so that will start to create meaningful traction. We maintain a very healthy dialogue and Quebec is doing a phenomenal job at being, I think, certainly the most profitable provincial distributor in the country, and we’ll keep refining the product offering to continue to have share.

[Trent MacDonald:]

Andrew, just let me jump in there - thanks for jumping on the call here. In Quebec actually, Zenabis is a very heavy competitor in Quebec. They’ve been gaining traction in the province with their premium brands, specifically Namaste, and have been doing a great job. A lot of uptake by consumers in that province, and so the combination of the two of us is going to be a pretty heavy competitor for others to try to come in against.

[Andrew Carter:]

Thanks, I’ll pass it on.

[Operator:]

Again if you’d like to ask a question, press star then the number one on your telephone keypad. Your next question comes from Matt Bottomley of Canaccord Genuity. Your line is open.

[Matt Bottomley:]

Good morning everyone, thanks for taking the questions. I just wanted to turn back again to Zenabis and maybe get a little more color on a couple things. One, any sort of granularity on potential synergies that would come out of this deal and maybe the classifications of them? I imagine back office and things like that. Then the other side of it, just on the infrastructure side of what you’re acquiring, when you consolidate clearly there will be a PCA there and everything will be at fair value - apologies here. But when you look at some of the takeaways from your transaction with Newstrike and the overall infrastructure in the sector that seems to be saturated, is there any risk, do you think, of needing all that infrastructure or do think there’s specific reasons or specific core competencies that you don’t think that that’s with the infrastructure brought on by ? Thanks.

[Trent MacDonald:]

Sure, great question, great question. Look, we alluded to it earlier - we have Belleville, right, and they have Alphaville which is, again, just a great indoor grow facility here in Canada. We’re going to have plenty of synergies. As soon as you start pushing their cultivation through to our Bellville facility with the overhead costs relatively fixed, you’re going to be applying less overhead per gram to end production, and it’s going to lower the COGS. We also believe there’s going to be a great amount of synergy on supply and inputs. We have some good, solid supply agreements on a lot of our cultivation techniques and a lot of the packaging and labeling, and so on and so forth, and I think we’ve looked at it and said, you know, between that and then of course SG&A, where you’re always going to have synergies on combinations, and we’re getting very aggressive right now on our integration planning, both our team at HEXO and the Zenabis team combined. We’re looking anywhere between $15 million and $20 million with upside from there, so it’s going to be a good news story from our perspective. Now around infrastructure, look - we’re still going through the planning stages of our integration. We know Alphaville is a flagship for us, it’s going to continue to be for them and for us. They have their Langley facility, they have Stellarton here in Nova Scotia - I just happen to be sitting in Nova Scotia right now, and so we’re going to be looking at it all and trying to understand what’s going to be the best use of assets and where it all fits in the long term. We’ve mentioned this before - we have had a capacity issue looming coming up, and we knew that, so this solves a big problem for us and it does in a way that’s even more accretive than going out and getting more greenhouse. I think in general, there’s room to be optimistic that we’re on the right path in terms of infrastructure.

[Matt Bottomley:]

Okay, appreciate that. Thanks guys.

[Operator:]

Your next question comes from the John Chu of Desjardins Capital. Your line is open.

[John Chu:]

Hi, good morning. My first question is just more on cost of goods sold and just overall OpEx savings. Last quarter, you mentioned that you might try to pass on some of those savings just to help drive sales. I’m just curious whether or not that was the case for the second quarter and if that’s still the plan for going forward.

[Sebastien St-Louis:]

Yes, thanks John. Overall in Q2, I would say not really, would be the answer to your question, so in terms of Q2. Go forward, absolutely, so we will continue to pass on those savings. We’re targeting mid-30s margins and we think--I say we’re targeting, you have to bring back to the overall strategy. We believe that price is dictated by black market, and I want to take a moment to maybe congratulate the whole industry - I had an anecdote the other day, I went to one of the black market--one of the large black-market sites that feeds the whole country, and that black-market site a year ago had over 50 flower SKUs. I’ll credit our move at HEXO on resetting the industry pricing on the ounce bag with Original Stash, but today that black market site had one single flower SKU, and it was north of $400 an ounce. I think that as an industry, when you look at the $2.9 billion number at retail, that is consuming a majority of the black market and has really pushed it out. HEXO specifically has a strategy to price to and to beat black market, and to do so we have to keep flowing through our COGS. The advantage is that given that we have so much automation and technology going into Belleville, we’re nowhere near the bottom of what we can do in terms of that war on COGS, and we keep finding new significant synergies, and that’s without of course talking about--I mean, Trent mentioned that the M&A synergies, which are going to be significant on their own, but on a unit basis we keep improving, so that will flow through to the consumer. That’s what eventually brings us to that market that will have three competitors.

[John Chu:]

Okay, great. Then just following up on one of the earlier questions, when it comes to Ontario, we’ve heard that they’ve been delaying their restocking efforts, and obviously the departure of the CEO of OCS probably doesn’t help, but can you maybe just give us some insights in terms of whether or not you’ve been seeing any restocking or reordering by Ontario? We also had they had eliminated around 1,800 SKUs, and whether or not any of your SKUs were eliminated and/or if you actually saw a net increase in SKUs with the Up brand and whatnot, so any insights there would be helpful. Thanks.

[Sebastien St-Louis:]

Yes, so Ontario has undertaken a rationalization strategy, so we’ll wait to connect with David Lobo and his team to see if that remains the case as they’re waiting for their potential new CEO to come in. There’s been an overall major rationalization. HEXO has had that as an opportunity more than a headwind, and so again it’s a question of rationalizing to SKUs that consumers want, and that ties into first being able to achieve that black market pricing. But there is a lot of uncertainty right now, of course, with the leadership, so we are looking forward to clearing that up, but we’re in tight communication and intend to continue to build a preferred partnership with Ontario.

[Trent MacDonald:]

Yes, I’ll even chime in there a bit. If you recall, we were the 17th LP into the market in Ontario. We’ve been making steady progress in terms of our penetration into the Ontario market and we’re fifth in terms of Canada rec sales at the end of Q1, and now we are going back and forth between third and fourth in terms of the Headset data we’ve been seeing in the last four to six weeks, so lots of momentum through the OCS.

[John Chu:]

Okay, great. Thank you.

[Operator:]

There are no further questions at this time. I will now return the call to Mr. St-Louis for closing remarks.

[Sebastien St-Louis:]

Thanks everybody for your questions. Great to continue to share the HEXO journey with all of you. Thanks to the whole team for making it happen, getting to EBITDA positive, and big thanks of course to our consumers. They like our pot and they like our stock, so let’s go. Thanks very much. Talk soon.

[Operator:]

Ladies and gentlemen, this concludes our conference call. Thank you for your participation. You may now disconnect.