HEXO Corp.
Q4 2019 Earnings Call Transcript

Published: 29 Oct 2019

[Operator:]

Good morning and welcome to HEXO Corp’s Fourth Quarter Fiscal 2019 Earnings Call. After the presentation, we will conduct a question-and-answer session. All lines have been placed on mute to prevent any background noise. Please note that this call is being recorded today, October 29, 2019 at 8

[Jennifer Smith:]

Good morning. I am Jennifer Smith, the Director of Investor Relations for HEXO Corp. Thank you all for joining us this morning for our 2019 Q4 earnings call. We will start with the presentation by our CEO, Sebastien St-Louis; followed by a recap of our fourth quarter results by our CFO, Steve Burwash, before opening the floor to questions from financial analysts. Before we begin, I would like to remind you that today’s presentation contains forward-looking statements that involve known and unknown risks and uncertainties and other factors that could cause actual events to differ materially from current expectations.

[Sebastien St-Louis:]

Thank you, Jennifer. Good morning everybody. I’ll just start by highlighting what an incredible year 2019 has been for the cannabis industry as a whole. We just passed the one year anniversary of recreational marijuana legalization in Canada. This is something you see once in a lifetime. Over the past year, we’ve made significant steps forward. Canada became the first G8 country to legalize adult-use cannabis. HEXO’s first plants were moved into our new B9 expansion on January 2019 five quarters after the project was announced. We signed a long-term lease for state-of-the-art manufacturing center, our center of excellence in Belleville, and began retrofitting that facility. We closed our acquisition of Newstrike Brands. We significantly increased our distribution across Canada to nine provinces. We strategically expanded our brand portfolio with both up and Original Stash. Together with our partner, Molson Coors, we made significant progress towards launching beverages in Canada in anticipation of cannabis 2.0. We’re just getting started. Our company is still young. Despite all that we’ve accomplished, we’ve had some shortfalls. We recently retracted our fiscal 2020 guidance. Our fourth quarter revenues came in below our original expectations and we hold ourselves accountable to that. We’d hope to achieve $400 million in revenue for fiscal 2020. there were several factors that contributed to the retraction of this guidance. So, let’s walk through the major ones. The retail store rollout in Canada has been slow to develop, particularly in Ontario and Quebec, which represents approximately 60% of the Canadian population and currently, less than 10% of the stores. While both provinces are committed to improving access to legalize cannabis, this has been slower than originally expected to develop. SQDC store rollout was less than originally expected and Ontario is now considering changing their distribution model. We don’t believe the Canadian market will successfully penetrate the black market and see meaningful sales numbers until we can address the issues around access to legal cannabis and the in-store experience. I do want to add that the stores despite having a slower rollout, this is the first across the world and we’ve still had quite the success. There are still customer lineups around most SQDCs. Our contract with SQDC originally contracted for – pardon me, so SQDC originally contracted approximately 58 tons for year one from all licensed producers. due to supply shortages, initial sell-through is expected to be a little less than half of that amount. I want to stress that HEXO was part of that reduced amount. So, shipping about 10 tons in of our 20-ton initial commitments, but what I think is more important is to point out that HEXO maintained a 33% market share in Quebec.

[Steve Burwash:]

Thank you, Sebastien. Good morning, everybody. Q4 was an incredibly busy quarter. The total gross revenues were $20.5 million for the fourth quarter, an increase of 29% over Q3. net revenue was $15.4 million. Gross adult-use revenues increased 30% from the prior quarter to $19 million, up from $14.6 million in Q3. Adult-use sales volume increased 45% to just over 4 tons from 2.7 tons in Q3. Flower and dry products accounted for 89% of gram and gram equivalent sold during the quarter with oils accounting for the remaining 11%. We achieved adult-use revenues per gram of $4.74, a decrease of $0.55 over the last quarter. This is due to a provision for sales returns and price adjustments as Sebastien earlier mentioned. the provision is reflective of a general best estimate provision for returns and price adjustments based on our assessment of sell-through and slow moving inventory. Based on the assessment, the company has taken the $3.8 million provision on the – based on the estimate impact of returns on inventory held by provinces and price adjustments as a result of reevaluation of HEXO’s pricing strategy. We saw a shift in our geographical reach with 971 kilograms being sold to ALGC, representing 24% of adult-use volume during the quarter. The closing of the newstrike acquisition partly through the quarter, also added 396 kilograms representing 10% of the adult-use volume and 15% of gross adult-use revenue. Cost of sales increased 56% to $10.3 million, compared to the prior quarter, which was at $6.6 million as a result of increased sales volume, partially offset by transformational cost savings as of the result of shifts in product mix. Cost of sales included the cost of dried flower, transformation costs related to oil and value-added products. The fair value adjustment on the sale of inventory was $7.3 million, which was an increase from $4.7 million in Q3. This is due to the increase in sales, which was offset by lower fair value per gram on the adult-use market. The fair value adjustment on biological assets was a negative $5.3 million compared with a negative $20.1 million in Q3 as a result of the change in estimates. the company recorded an impairment loss on inventory of $16.9 million in Q4. this is due to price compression in the market. The impairment loss was realized on cannabis purchased in fiscal 2019 to help meet the demand of the adult-use market and the original cost of this inventory now exceeds the net realizable value. Gross margin before fair value adjustments for Q4 2019 was $5,133,000, or 33% of net revenue from sale of goods compared to $6,440,000 and 49% in the prior quarter. as a result of the previously mentioned provision, adjusted gross margin before fair value adjustment for Q4 adjusting for the sales provision we mentioned, would have brought the gross margin to $8,561,000, or 45% of adjusted net revenue from sale of goods adjusting for the sales provisions that we made. gross margin after fair value adjustment on biological assets with a negative $13.7 million. Now, I’ll run through our operating expenses. G&A increased $22.4 million in Q4 2019 from $10.5 million in Q3. This reflected the scale up of our operations as we continued to strengthen our general finance and administration – administrative staff for an increase of $1.9 million. we added $3.3 million in costs related to the Newstrike acquisition and an additional $4.1 million from the addition of newstrike’s G&A activity during the period of Q4. Professional listing and legal expenses increased by $1.1 million as a result of increased financial reporting and regulatory requirements from the TSX and NYSE. insurance increased by $1.5 million due to the increase in property, plant and equipment being covered and the D&O premium increase as a result of the listing on NYSE. G&A is expected to decrease through 2020 from Q4 2019 levels as we right-size the business for lower revenue expectations. We are striving to refocus the business on achieving operational excellence by developing lean, repeatable and scalable processes by leveraging IT. marketing and promotion increased to $9.5 million in Q4 from $5.1 million in Q3. this increase is primarily related to seasonal activations in brand marketing to build brand recognition in the adult-use market. Newstrike contributed an additional $800,000 in Q4. we are reevaluating the way we deploy our capital across marketing and expect this to decrease significantly as a percentage of revenue in 2020. Stock-based compensation increased to $10.2 million in Q4 2019 from $8.2 million in Q3 2019. during the quarter, the company added the unvested outstanding options of Newstrike to its outstanding balance, which contributed an additional $1 million of expense in the period. The net loss from operations was $60.7 million in Q4 compared with $2.3 million in Q3 2019. the increase was driven by increased operating costs due to the expanding scale of operations of the company as I’ve outlined as well as the previously mentioned provisions for sales, price adjustments and returns and the impairment loss on the purchased inventory. As Sebastien mentioned earlier, management is reducing operating expenses with a focus on becoming EBITDA positive in calendar 2020. We ended the year with $139 million in cash and cash equivalents including short-term investments. We have just announced, as Sebastien mentioned, a $70 million convertible debentures private placement. Looking ahead to fiscal 2020, we have an additional capital expenditures of $100 million to $110 million, primarily Belleville, but also with the completion of B9. We anticipate Q1 net revenues to be in the range of $14 million to $18 million. The reason for the range is that it could be subject to retroactive pricing adjustments as we continue to reevaluate our pricing strategy across the country. We expect sales to grow starting in Q2 in a stepwise fashion and combined with our operational rationalization, it should lead our business to be adjusted EBITDA positive in calendar 2020. These are estimates based on the assumptions we have today regarding store counts, operational improvements, and cost savings. Well, I’m new in this position. I have been at HEXO since March of 2019 and I’m extremely excited to have this new role. I know some of the analysts and I look forward to meeting all of you in the upcoming months. I’ll now turn the call back to Jen.

[Jennifer Smith:]

Thank you, Steve. We will now take questions from our analysts.

[Operator:]

Thank you. And your first question is from Tamy Chen from BMO Capital Markets. Please go ahead.

[Tamy Chen:]

Yes, thanks. Hi everyone. first question, I’m just trying to understand taking a step back, how, and where did things go wrong, because HEXO started off with a sizable supply contract from Quebec. The B9 greenhouse was constructed on time. We saw that sell-through data in August looks pretty good. So, just wondering what’s going on here? Why are you calling out such drastic pricing headwinds, doing pricing and product strategies like the Original Stash? Is it something specific to your product mix that’s maybe not hitting the right mark?

[Sebastien St-Louis:]

Tamy, thanks for the question. I don’t think it’s specific to HEXO. I think HEXO is they had, and we’ve – if you remember last quarter, I talked about pricing headwinds. I was foreshadowing that HEXO would drive this pricing penetration strategy. And so we were the first to do it. Other competitors will have to adjust now. I think in the broader context, what’s important to note is that we’ve maintained market share. So, if I bring you back to a quote I’ve said in a few different conferences, the challenge for investors right now is not whether cannabis will be a huge industry or not. We know that that’s a pretty clear fact. It might be a bit slower than we thought, but cannabis is here to stay. What’s less clear now is that the 150 or so companies in Canada, which ones will be Amazon and which ones will be the pets.com and forgotten. And I think if you look to the metrics and the way HEXO was managing its business, the way we’re making hard decisions on operations and the market share, we’ve managed to keep that tells a much stronger story than the quarterly revenue numbers. And so I’m more confident than ever that within the next year as we see that number of licensed producers dwindle drastically. And as we see only a handful of licensed producers with the cost structure that are able to compete at prices that HEXO is already at. We are almost certain to be one of those survivors setting the stage to be one of the winners. I think that right now, we’re in a very challenging pullback in the market and I think that that’s a very healthy thing. I think that if, again, to take that analogy from the tech days, we’re seeing the end of a first bubble and now, we’re seeing the real operating companies emerge. And I’m extremely pleased that we’ve achieved and maintain our 33% share and cutback, despite of course, a slower store rollout.

[Tamy Chen:]

Okay. Got it. Thanks. And my second question is on the cash position. So, I think you noted that, in October, you ended with about $64 million of cash. And then adding on the $70 million financing, you were seeing that announced now, at the current rate that you’re burning through cash, I mean, that would last you two more quarters. I recognize you’re now right sizing the business, but can you help us understand, you gave some color on the CapEx, but how about other aspects such as just operations, working capital investment. What are other big upcoming spends and you mentioned an ATM that you’re working through on – would that provide you sufficient capital to keep you going? Should you require additional funding?

[Steve Burwash:]

Yes. So, CapEx is the largest driver in our business by far. I mean if you look historically, HEXO was raised about $400 million, including this latest $70 million converts that’s all the money that’s gone into the company. and CapEx sales in our buildings improvement leaseholds, everything is already over 250 million. So, almost 75% of our cash has gone to CapEx. With the current cash balance, including the investment, led by insiders and myself that we’ve made into the company, we have sufficient cash to hit adjusted EBITDA profitability. And that takes us through the next 12 months. The ATM is really about building additional capital reserves and is going to gauge how fast we can do international expansion. So, I’d have mentioned on the call that we are concentrating our efforts in the U.S., specifically coming down from the eight-state target and that’s largely a function of capital. So, if the ATM provides more capital that provides more speed and more reach, and if we need to be more cautious than we go more concentrated, we do have sufficient capital to go into the U.S. even without the ATM.

[Tamy Chen:]

Okay. That’s it for me. Thank you.

[Operator:]

Thank you. Your next question is from Rupesh Parikh from Oppenheimer. Please go ahead.

[Erica Eiler:]

Good morning. This is actually Erica Eiler on for Rupesh. Thanks for taking our questions. So, I was hoping maybe, you could share your latest thoughts and the advanced product that I mean obviously a lot of vaping headlines here in the U.S. So, I was curious if you could share your thoughts in the vaping market and then how you see the advanced product rollout, maybe particularly on the vaping front, playing out from here from your perspective?

[Sebastien St-Louis:]

Absolutely. So first of all, when we look at HEXO, our philosophy is safety, quality, speed, and from a safety perspective to us that is non-negotiable. So, our vape technology has been concentrated on delivering nothing but cannabis. So, our innovation team has succeeded in putting together formulations that will – that don’t have any carriers and that is – that technology that we’re looking forward to elaborate on as we continue to make progress on some various patents. We think that from where we sit today, that’s one of the only ways, if not the only way to do safe vape. it’s by providing consumers with only what’s in naturally occurring in the plant. So, we’re tremendously excited about that technology that moves us away from all the solvents and excipients that are used, especially in the black market, because I had noted that most of the worst occurrences on vape have happened in black market. but it’s not sufficient for us to just say we’re better than black market. We want to deliver safe products. our clinical evaluation team is also hard at work on actually proving that out. So, we’ll get some preliminary data and over the years, we’ll continue to invest and make sure that all our offerings are as safe as possible.

[Erica Eiler:]

Okay, great. And then just given all the dynamics that are happening right now, I mean, are there any updated thoughts you can share, on gross margins here in the intermediate term?

[Sebastien St-Louis:]

Absolutely. So, I think that HEXO can comfortably deliver a low 40% gross margin business from a portfolio perspective. And that’s a mix obviously of some products like our Original Stash, which are at the lower end of the margin scale, but then some higher end products like beverages and vape, which bring that margin up. We won’t be disclosing individual product margins for competitive reasons, but we’re very confident in 40, low 40s gross margin on a go-forward.

[Erica Eiler:]

Okay, great. Thank you. I’ll pass it on.

[Operator:]

Your next question is from Adam Buckham from Scotiabank. Please go ahead.

[Adam Buckham:]

Good morning. Thanks for taking my question. So just on the outlook, I was wondering if it would be possible to share some of the assumptions that have gone into the positive EBIDTA guide, particularly on the storefront expansion. Are you expecting Ontario and Quebec to just expand to 75 and 25 stores, or what are your assumptions there?

[Steve Burwash:]

Thank you. We’re just pulling the exact number for you. Just give us a moment. So, specifically in Quebec, it’s 43 stores by March is what we’re expecting. So that’s the near-term. the Canada wide store count within the next 12 months is expected to be north of 700 stores.

[Adam Buckham:]

Great, thanks. So obviously, you guys had a big ramp here in G&A in the quarter. With the adjustments to your operating structure, how do you think this comes down over the next two quarters?

[Sebastien St-Louis:]

So, there’s a lot of abnormal expenses in the Q4 number, that for example, the newstrike acquisition costs and the newstrike additional expenses that came in. We also had marketing up R&D was sort of the first full quarter of having an R&D group. the depreciation and insurance that are also up, and then staff and G&A in general. That said, as we moved forward in 2020, we have taken a very hard look at all of our expenses to ensure that our expenses will line up with what we expect our revenue number to be. And we – as you heard from Sebastien, we made the hard decision last week of actually adjusting our workforce and adjusting our cultivation. We believe by doing those things and ensuring operational effectiveness, we can get to a positive EBITDA by calendar 2020.

[Adam Buckham:]

Okay, great. Thanks. just one final question and I’ll jump back in the queue. So, I was wondering if it might be possible to get an idea of what the severance costs are associated with the change in C-suite executives post quarter?

[Steve Burwash:]

We won’t share a specific severance cost at this time.

[Adam Buckham:]

Okay, thanks.

[Operator:]

Thank you. Your next question is from John Zamparo from CIBC. Please go ahead.

[John Zamparo:]

Thanks. Good morning. I wanted to ask about the inventory impairments. So, it seems related to a product you purchase in the wholesale market and you mentioned the price compression you’ve seen there. I guess what I’m wondering is that given the lack of stores and sell-through isn’t where you want it to be, what’s the thinking behind buying so much product on the wholesale market at this time?

[Steve Burwash:]

Well, John I think purchasing that product was before we had full visibility on the store count. And so quite frankly in hindsight, that’s a mistake – purchasing that product was a mistake.

[John Zamparo:]

Okay, understood and we can move to pricing. So, I guess two parts. First, can you confirm that three – I think it was $3.51 per gram on a net basis. That is reflective of the provision you’re taking. but secondly, just broadly, what do you think about pricing for the next year, particularly in Quebec? yes, just any thoughts there would be helpful.

[Sebastien St-Louis:]

I think what’s critical is to keep being very competitive with black market, especially when we’re targeting those specific consumers. So that’s about half your consumers. the pricing seems fairly stable on the legal market consumers – so current legal market consumers. but that does put pricing pressure overall as I indicated last quarter. but we think that should stabilize as a blend of the low-40s.

[John Zamparo:]

Okay, that’s helpful. Thanks. And then just to confirm, Sebastien, you reference that 30% or 33% market share in Quebec in year one. It was that true also in Q4. And has it moved around since the beginning of legalization?

[Sebastien St-Louis:]

Yes, it’s certainly moved around. So, when we first launched in Quebec, I mean, there were just two LPs that were supplying, HEXO was one of them. So, we took 60% share right off the bat. 60% share is not sustainable. I believe that any one player will never get above 40% share in any sort of rationale market. And so our contract commitment was to put us at about a third market share. So, we’ve varied in and out. We’ve gone lower than that number temporarily. And we’re a – this 33% market share number is the number we’re getting directly from SQDC at this state for the past year. So that’s a blended number that that takes into account the year.

[John Zamparo:]

Okay. And if I could sneak one more in, how do you feel about your positioning for derivative products given Quebec’s more restrictive approach on edibles and topicals, and how do you plan to gain share among the other provinces offset them?

[Sebastien St-Louis:]

Our investment in technology has really been fantastic. and so I’m really excited about our beverage launch with trust. We’re very well positioned in Quebec for beverages. our gummies line has been down-scaled. So, we’re going to do that as a proof of concept for our next fortune 500 partner. So, when we do the full international and national rollout for edibles, we’re expecting to do that with a partner. We may do some pilot stuff on gummies and gummies, obviously, not allowed in Quebec. So, it will be a more challenging from a revenue perspective. Our vape formulations are all complete and we’re standing up that line as we speak in Bellville. So that will be very positive, because from what I’m hearing, we’re only one of the two licensed producers that are providing safety profiles to the provinces. And so we’re getting a really favorable response to that. We’re being a little bit more cautious in putting our consumers first. So, quite excited about the 2.0 lineup. We’re also continuing to upgrade our Elixir offering, both from a cost restructure. So, you saw us drop the price significantly on Elixir to be more competitive while maintaining margin. So that was a function of a scale up. But we’re also working on Elixir 3.0, which includes some of our nanoemulsion technology, which will make it work faster, taste better, et cetera, that we can do under the new technology. So we’re quite excited about our 2.0 offering and I think that the provinces are as well. Quebec is really our first and home base, but we are looking forward to the rollout in especially in Ontario where we only fully got listed with all our products really a few weeks ago. So that’s also a story, I think, that’s very important to think that not only do we have 33 share in Quebec, but that this revenue that’s you’re seeing now is really representative of partial penetration in Alberta and a full penetration in Quebec. We still haven’t shown what we can do in Ontario, but that is on its way now that all our flower SKUs are fully listed in every store.

[John Zamparo:]

Okay, that’s helpful. I’ll pass it on and thank you very much.

[Operator:]

Your next question is from Owen Bennett from Jefferies. Please go ahead. At this time, our next question is now from Brett Hundley from Seaport Global. Please go ahead.

[Brett Hundley:]

Hey, good morning guys. Just a couple of quick questions on the EBITDA bridge and then more of a philosophical question for you, Sebastian. So just first on the EBITDA bridge, does your target of positive EBITDA within calendar 2020 assume production restarts at Niagara and Gatineau?

[Sebastien St-Louis:]

No, it does not.

[Brett Hundley:]

It does not. And then secondly, can you give us a sense of what percentage of sales mix you’re baking in for Original Stash? I mean, what do you have that kind of growing too as a percentage of your sales mix going forward? Or maybe a better way to ask that question would be, you know, when you model out pricing across your portfolio into calendar 2020, are you kind of assuming a steady state as everything is today? Or are you assuming things go down, go up related to 2.0? Can you just give us some color written on that?

[Sebastien St-Louis:]

So I’ll stay away from specific color just because we’ve gotten, Brett, in the past with guidance and basically talking about the future I given where the stores rollout. So what we – we know a few things about Original Stash. We know where it works. We know what the target consumer is and I’m not sharing that here because I don’t necessarily want to tell my competitors how to compete. But that product has had a resounding success in specific markets. So we’re going to double down on that. We think it’s going to be very popular. The reason I can’t give you a specific number or that I won’t share what’s in our forecast is because depending on where the stores rollout and how that rollout is accomplished. It will meaningfully affect the percentage of Original Stash, but we do think it will be a stalwart of our business. So looking forward to what the next 12 months bring, so we can look at it and talk hard numbers.

[Brett Hundley:]

Okay. Now, I appreciate that. And then Sebastien, just my philosophical question for you is do you think HEXO is at an important crossroads here in so far as rebranding itself and its strategy. As you guys have come to market, you’ve been strategizing around this hub and spoke model. And even today, you’re continuing to mention potential Fortune 500 partners. The hub and spoke model just doesn’t seem to be gaining traction. And so, I’m just curious to kind of get an assessment from you on whether or not you are at that crossroads and try and get a sense of what you still believe in your company’s role in the future cannabis market. Thank you.

[Sebastien St-Louis:]

Thank you for that. So, first of all, the non-negotiable is we have to be profitable in Canada and we have to be a top two brand in Canada. That means 20% market share nationally. And I believe that we have the assets, the people, the cost structure to do that. That will give us the base by which to reinvest in our technology. The second thing I believe in that has never changed is that we cannot succeed in cannabis by being farmers only. So we do have a nice regulated barrier to entry to cultivation. We have technology and know-how around our cost structure of cultivation, which are nice market hedges. There’s only by my estimate say four licensed producers today that have a cost structure that’s even near HEXO. And so, we’re very confident that we’re going to be one of those top branded players on the flower side. But that’s not enough and that’s not what shareholders are asking for. That’s not what consumers are asking for. And so from a Powered by HEXO perspective, we’ve delivered on quite a few things. We now have emulsion technology that we’re using with Molson Coors that works better than anything else I’ve seen in the market, works better than anything else that exists in the United States. You’ll see how we enter the U.S. with our partners in the future. That strategy is a capital-light model and I think it’s a strategy that’ll be differentiated from what’s currently happening from the retail dominated MSO space in the U.S. I still think it’s the right way to go. I certainly agree with you that from an uptake, it’s taken a lot more time and still taking a lot of time to deliver the full wheel under Powered by HEXO. But I don’t think that we should jump to conclusions now on that model, especially in the wake of us delivering our first spoke with Molson Coors. So we’re tremendously excited to get to their earnings. And then the subsequent to that to share more news with the market at what we’re doing, our relationship with them has – is stronger than ever and the products are absolutely fantastic. Having done that experience, having lived that with Molson, I’m convinced more than ever that had we tried to do beverages alone, we would not have come up with something as wonderful as what trust has delivered. And so I am convinced that the model is sound in terms of executing that model, it remains challenging, but I remain committed to it.

[Brett Hundley:]

Thank you.

[Operator:]

Thank you. The next question is from Owen Bennett from Jefferies. Please go ahead.

[Owen Bennett:]

Good morning guys and couple of questions please. First of all, just on the outlook because, I mean I guess what you’re trying to convince is for the market to really get conviction and your outlook around positive adjusted EBITDA. And I’m just kind of, I mean to that, I mean you don’t even give adjusted EBITDA currently and by my estimate, if you could confirm it’s gone from around minus 10 in the third quarter to minus 30 now and in the fourth quarter if you could just confirm that? And then secondly, I think to get conviction is enough for you guys to be held accountable to actual operational excellence in delivery. You need to give some more specifics around the assumptions you’re giving to that positive EBITDA in terms of you asked the store count, Steve, the quantity of cost savings coming through, whether that is 20% market share. Because I just feel if when you pull back on the floor, it was an easy excuse to blame that the retail store out because we never got any specifics in terms of what your assumptions were on delivering that. So yes, that’s just kind of, if you could give some more specifics around how you will get to that adjusted EBITDA and what you’re actually working on currently, which I think is around minus 30. And then secondly just kind of a more automated one, you spoke about the gross margin, support from beverages but as I understood before beverages, food shows was being bought below the line as a JV. Is that changing going forward now for that to impact gross margins? Thank you.

[Sebastien St-Louis:]

It’s a lot in there, Owen, thank you. And great suggestions in giving more feedback. So on the adjusted EBITDA line, your math looks right at a quick glance here. So in terms of sharing more details, we certainly shared the store count now today. And I think the transparency that we’re giving today is a step in the right direction. I don’t think we are where we need to be. I think over the next 12 months hopefully, we get more visibility into the market. Hopefully, we could resume guidance at some point. But again, until the market stabilizes I don’t think today that any cannabis company is in position to give you those specific numbers, would certainly invite you to engage in specifics on a follow-up analyst call. And we can discuss the specifics you’re looking for and we’ll take that into advisement for the next quarterly in the sharing broader – sharing assumptions more broadly.

[Owen Bennett:]

Great…

[Sebastien St-Louis:]

The third question, sorry on…

[Owen Bennett:]

Gross margin, yes.

[Sebastien St-Louis:]

Yes. Sorry, could you just repeat that question again for me?

[Owen Bennett:]

Yes. As I understood before, trust was always going to be bought below the line as a JV. So for it to impact gross margins now and since the beverages support is that changing now or you’re booking that above the line?

[Sebastien St-Louis:]

No, no. So that has not changed. The trust share should be booked as a, it’ll be booked as an investment. So you’re correct. That won’t hit gross margin.

[Owen Bennett:]

Okay. So that 40% where you said there’ll be support from beverages in that.

[Sebastien St-Louis:]

Yes. So the beverages are – you are correct. So I misspoke. So the beverages are a higher margin product on their own, but will not individually affect our gross margin on the HEXO financials, but you are getting the investment on the HEXO side from the trust JV, which should be meaningful.

[Owen Bennett:]

Okay. Cool. Thanks very much.

[Operator:]

The next question is from Matt Bottomley from Canaccord. Please go ahead.

[Matt Bottomley:]

Yes, thank you. Just wanted to touch again on Cannabis 2.0, Sebastian, if you could just give us a little more color, I know you touched on in your prepared remarks over where you are logistically in getting your products approved for Cannabis 2.0 and then the timing within that six month period of what provinces you think you’d come online first and then maybe the product classifications that you’ll be targeting as a part of that initial launch?

[Sebastien St-Louis:]

So Health Canada gave us our 2.0 license for our Gatineau campus. Now the Gatineau campus is in pilot scale. So what that would allow us to do, would allow us to pick-off, say a couple of different product streams in a couple of specific markets, but it’s not sufficient capacity for our strategy. For 2.0 we believe that the products will be differentiated enough. So when we look at vape, we’ll actually have safety profiles, we’ll have better technology. So when we actually launch that, I’m not in a rush to be first-to-market. I’d rather have a fulsome national launch, for that I need my Belleville facility licensed for Cannabis 2.0, so we just got licensed for 1.0 in Belleville on Friday. So 2.0 should follow relatively soon, which is putting us in timing for a national rollout in that first half of 2020. Obviously if the regulatory and licensing goes quickly, it’s towards the front-end and there is risk that it’s towards the back-end so that’s where we’re giving that broad range.

[Matt Bottomley:]

And what’s your view, just on the risk, I guess being, obviously you don’t want to be rushed to market if there’s going to be stumblings or if you have a better sort of national platform that you’d be looking at, but just in terms of – in term from a legal perspective, no one in Canada had legal vape pen yet. So not being, first out of the gate with what those first branding initiatives will be, how do you assess the risk of being further behind than maybe some of your peers with respect to getting those branded products to market?

[Sebastien St-Louis:]

Sorry, can you elaborate a bit on legal vape pen? Just – you mean that because there is no vapes in market?

[Matt Bottomley:]

Well, yes, just really the sort of average person on the street doesn’t really have any sort of brand awareness when it comes to any derivative products yet. So I imagine, getting first-to-market right out of the gate in January we’ll be an important consideration in getting mind-share. And I’m just curious how you view the market dynamics playing out, given that this is going to be a first for pretty much everyone that chooses to participate in the legal channel.

[Sebastien St-Louis:]

I’ll tell you one thing. So one thing we know how to build brand, I mean we’ve done it on flower yet, people walking into the Quebec now, with our third share, they’re asking for Helios, they’re asking for Lagoon. So that’s been very successful. I can tell you as well that the thing that keeps me up at night is losing that brand value. And you can have the best vape pen rollout in the world on day one. If you hurt somebody, you will vaporize your brand. And that is unacceptable to both, HEXO to our shareholders and our consumers. So I’m less worried about that first-to-market. I’m more worried about the quality and on the quality side we’ve got some amazing technology coming down, IP-backed, patent protected, really looking forward to talk some more about that over the next quarter or two.

[Matt Bottomley:]

Great. I appreciate that. And in the last just maybe a housekeeping item on my-end, normalizing for some of the reserves this quarter, going back to a gross margin of 40% to 50%, I think you guided in a future context to be closer to 40%, is there any sort of margin drag we should be factoring in for next quarter specifically given that there might be some less utilization in the facilities you’re taking your foot-off the pedal on, and if so, what sort of magnitude should we be looking for?

[Sebastien St-Louis:]

We’re not guiding quarterly margin on that, but again, the kind of medium-term, I think a low 40% margin is where this business should stabilize.

[Matt Bottomley:]

Okay. Thanks again.

[Operator:]

Thank you. Your next question is from Chris Carey from Bank of America. Please go ahead.

[Chris Carey:]

Hi. Thank you very much. So, can you hear me?

[Sebastien St-Louis:]

Yes, Chris. Thank you.

[Chris Carey:]

So, I hear you on the on the comments around cash flow expectations over there kind of say, just think about fiscal 2020. But I suppose if I take the cash level as of October and the credit facilities and the $70 million private placement with cash burn over fiscal 2020, I’m still kind of coming up with negative cash. And so the ATM was quoted as being additive to kind of bolster the cash levels. And so, is there something that I’m missing here or perhaps you can comment on your expectations for operating cash flow over that time period because clearly CapEx is going to remain at least over $100 million over the course of this fiscal year given your capital projects?

[Sebastien St-Louis:]

Thanks, Chris. So again getting into that dicey territory of guiding without guiding, so we’re going to stay away from that one because if I gave you too many numbers and we box ourselves in. Based on the modeling that we’re doing, based on the store count that we’re seeing, based on the market share that we expect to have in the various jurisdictions. We’re confident that without the ATM, so if I don’t raise another dollar, we’d make it to profitability. And so we’re confident that that’s going to happen. As first specifics, we’re going to sit tight while the market stabilizes before we get into more detail.

[Chris Carey:]

Okay. Perhaps as more visibility on this front emerges, then there’ll be an opportunity to provide a bit more clarity on that line item going forward, because I do think it’s a key item for the market right now, given the capital environment.

[Sebastien St-Louis:]

I agree with you, it’s critical and I think specific also critical is in this space and back to my comment of which licensed producers are going to be around for the long-term. I think it’s important to note which companies are able to raise money in an up-market. And of course HEXO was one of those companies, but perhaps more important is which company is enabled to fund its initiatives and hit profitability in a down-market. And HEXO was demonstrated a resounding confidence from its shareholders from its insiders with the $70 million private placement. And so I’m very encouraged by that and that commitment will remain, so the shareholder base that’s there is absolutely phenomenal and I think that’s one of the HEXO’s strengths.

[Chris Carey:]

Okay. And if I could, you’ve commented a couple of times on the 20% market share dynamic and my best guess I suppose is that the market share is trending more in the high-single digit range, if not mid-single digit range right now, I fully appreciate that. There are many moving pieces and there is a level of variability that comes with that sort of estimate. But it does appear to me at least that there is an implied big ramp-in in market share relative to current levels, which I suppose some of the new strategies are with Original Stash and others are meant to address. But if that is the case and I’m sort of extrapolating your 700 store count model on my own market model, it seems to me maybe Street estimates are still a bit too high if not far too high for HEXO right now unless you can hit that 20% number in. And actually I fully appreciate that you don’t want to guide and I think that’s actually very smart, given the current uncertainty. But I guess if I just sort of think about the puts and takes here, it does imply that you need quite a big ramp on share in the context of the 700 store environment with the Quebec rollout that you had noted to hit kind of numbers where they are today. And so, maybe you can just comment on whether that sort of framework is not justified or whether that sort of share ramp is not how you see it?

[Sebastien St-Louis:]

Hey Chris, I think you make a lot of very compelling points. So first of all, so on share, your ballpark maths, I mean, whether the plus minus and assumptions, but ballpark national share where you’re at now, yes, you’re probably – we could dice it a couple of different ways, but we’re probably around that from a national share perspective. So how do we get the 20% plus? And that’s all based on a framework of, I believe that three companies will control 70% share eventually, based on a rule of threes, 40%, 20%, 10%, right, 40%, 20%, 10% share. Those companies are going to be behemoths right, because no matter what happens, we know the industry is sticking around and if you survive and make it to be in that top three, you have a phenomenal platform for worldwide growth, which then justifies a pretty accretive multiple, which in this current market we’re not seeing. How do we get that share? So we’ve already demonstrated that we can hold a number one spot. So we’re holding the 33% share in Quebec, and I think that’s why you want to bet on this management team and on HEXO products, because as I’ve said, we’re not – we weren’t listed in these numbers, you’re not seeing any meaningful share in Ontario and that was really a function of time to get everything listed in in-store, that’s done now. So you should start to see that market share creep up as we level Ontario and level Alberta, you should start to see that contribute. And note that, I don’t need to get to 30% plus share in those specific markets to achieve a 20% plus national average. On – what that means from an estimates perspective? I’ll leave the estimates to yourself on where the stock prices should be. But I would note that, if you take a look at market share and you take a look at some of our competitors, in fact, I would invite you to go take a look at the market share in adult-use cannabis of our top six competitors, I could pick two or three of them that have a market cap that’s about three or four times higher than HEXO’s, and no meaningful additional market share. In fact, some of them have less market share than HEXO. So I think whatever happens in the estimates, as we flesh out as competitors fail in the next 12 months and we’ll have lots of them failing, especially the small ones. I think that opens up a space for an equilibrium in the LP space where we will value licensed producers based on that chair. And I’m still confident, I mean HEXO is a top four player today and that’s certainly not reflected in our market cap, so lots of upside from a relative value basis.

[Chris Carey:]

I appreciate you tackling that one. And if I could just one sort of clean-up question, so to speak. There is a growing concern about this unfinished inventory that is building up in the channel. The StatCan data this week put it at, I think over 380,000 or I mean 25 months of inventory at the current run rate. But I guess what I also hear from companies, your peer companies is that, that unfinished inventory number includes a lot of unsellable flower, maybe that stocks or moulded material or seeded material. And I wonder, if you could talk to what you think is in that unfinished inventory number or whether that’s something that the market needs to be concerned about from the standpoint of pricing and maybe inventory write downs on a go forward basis?

[Sebastien St-Louis:]

Yes. I think your instincts bang on Chris, the market should absolutely be concerned about that inventory. At HEXO, we’ve taken steps and again, we’re talking. So we’re sacrificing short-term market BS, right, manipulating quarters, we’re not doing that. We’re taking a $3.8 million reserve this quarter, having not seen returns by the way, this is just being conservative and preparing for this. Our inventory at HEXO is good. But will it hold given pricing, do you need to do pricing adjustments? We’ve been proactive in taking on that pricing adjustment. Just like last quarter, I was proactive in foreshadowing the reduction in pricing, unfortunately that came true. This inventory situation will come true as well. And some of our competitors have been less proactive in adjusting that, which means that on aggregate, absolutely that’s something investors need to start taking a look at, sell-through becoming incredibly important versus sell-in. And something that I think the numbers – hard to see in the numbers, but if you really – if you dig in behind the numbers for our quarter, this has been a pretty good improvement this quarter, despite missing the guidance. So forget about the year, I mean going from $5 million to $50 million, but look at the quarter sell-through. This quarter Q4 didn’t have meaningful sell-in, it was all meaningful sell-through. And so that bodes well for reduced channel stuffing, real volume, real growth. And so I’m very happy where HEXO was positioned, I think a lot of my competitors will have to adjust to position themselves the way HEXO is doing so, they haven’t gone through that pain yet. We’ve now taken that pain and that’s reflected in our stock price unfortunately, but also creates a buying opportunity.

[Chris Carey:]

Thanks so much for answering.

[Operator:]

That concludes today’s Q&A. You may proceed with closing comments.

[Sebastien St-Louis:]

Everybody, thanks very much for your questions and continued support and interest in HEXO. I think that the key thing that is easy to forget in a world where we were talking about a certain number and obviously we’re not going to hit that number, and that’s on me. But what’s easy to forget as we went from $5 million revenue last year to $50 million, 10x, as far as I know, that’s the fastest growing revenue company in the entire Ottawa Gatineau region. This is a growth story, and despite the sad news that we had to let go 200 employees, we still have a 1,000 strong workforce of dedicated people that are moving mountains to come up with the next product, the next technology and being first with new offerings to market. We’re penetrating new consumers every day, seeing this market evolve where we know for a fact it’s $1 billion market today and it’s growing towards that $7 billion target. Cannabis worldwide is here to stay and will transform the world. HEXO is right there, we’re at the doorstep, we have some work to do to improve and I’m looking forward to share the journey with you. Thank you for listening.

[Operator:]

Ladies and gentlemen, this concludes today’s call. We thank you for participating and we ask that you please disconnect your lines.