HEXO Corp. (NASDAQ:HEXO) Q2 2023 Earnings Call Transcript

HEXO Corp. (NASDAQ:HEXO) Q2 2023 Earnings Call Transcript March 17, 2023

Operator: Good morning. I would like to welcome everyone to HEXO Corp’s Second Quarter 2023 Conference Call. Joining us today is Charlie Bowman, President and Chief Executive Officer of HEXO Corp; and Julius Ivancsits, Chief Financial Officer of HEXO. As a reminder, this conference is being recorded. Please note that all financial information is provided in Canadian dollars, unless otherwise stated that a copy of the Q2 results can be accessed on SEDAR and EDGAR. To open the call Charlie and Julius will provide their commentary on the quarter, followed by a question-and-answer session to ensure that we get to as many questions as possible. We ask participants to limit themselves to one question. With that, I’ll now pass the call over to Charlie Bowman, President and CEO of HEXO Corp.

Charlie Bowman: Thanks and good morning everyone. I’m pleased to review our results from the quarter ending in January 31, 2023. We’ll begin by detailing some of our financial accomplishments, highlight a few of our key products and operational achievements that happened this quarter, our goal is to take you along the journey to a leaner operation focused on the quality and near-term profitability. Afterwards, Julius will walk us through HEXO’s financial results. First, before I just start, about nine months ago, I had an opportunity to sit down with a number of the original shareholders, none of who have sold a single share of stock. Their advice to me was once we reset the balance sheet is to take off my corporate tie and to focus on the key consumer elements of why people purchase campus high THC, price and terpenes, grow the best strains to deliver this consumer experience at the lowest price we can.

And that’s what we’ve been doing. So let’s address this legacy balance sheet, which was my first priority. Over the past six months, our aggressive cost cutting strategy has reduced HEXO’s overall debt whilst improving our balance sheet. We repaid a total outstanding principle of 40,700,000, which was matured on December 05, 2022 with an all accrued and unpaid interest. This was the first major step of strengthening our balance sheet. Next, we focused on strengthening our margins with a higher value product mix, leveraging a series of intense cost reductions and pricing disciplines. We focused on quality. We measure it by pharmacopoeia test methodology procedures. We focused on the critical items and improved our first-pass success rate. All in our team decreased our operation expenses and significantly reduced our trade receivables.

Photo by CRYSTALWEED cannabis on Unsplash

Now turning to our product and operational development, we’ve streamlined our recreational cannabis portfolio, focusing on delivering the best consumer experience. We expanded our health and wellness portfolio by addressing unmet consumer needs that only cannabis can address, featured on our Redecan Medical Platform. We signed a long-term agreement with Entourage Health, securing a multiple channel distribution network into the medical cannabis market over the next three years. This partnership is key to expanding our health and wellness portfolio and accelerates our ability to grow the business and deliver premium cannabis products to more Canadians, but to especially our veterans. In the recreational market, we are focused on creating a unique, sensory experience by highlighting some amazing terpenes and high THC strains from our in-house developed TnT strains.

We launched three new Redecan branded products and two new Original Stash products all using the new TnT strains. These strains were released after about 20 months of research and development, which reinforces our belief that properly balanced terpenes dramatically enhanced the cannabis experience. In fact, consumers validated our commitment to this unique cannabis experience. Our first TnT launch, Animal Rntz, sold out within 24 hours of its release, replenishment sold out in two days and the third order sold out in less than a week. The fourth order is in the process of packaging this week. It was if not the fastest selling strain in Ontario cannabis board history. The good news Violet Fog is next. As we move towards a leaner portfolio, our long-standing commitment to innovation remains strong.

First, next generation of products from our internal genetics program highlights total cannabinoids, high THC percentage with a wide range of terpenes. It is this continued pursuit to deliver the highest quality cannabis that allows our premium strains to wear the crown on the Redecan cam brand. We produce some of the industry’s highest THC percentage, and without a doubt, the total cannabinoid content. And with an incredible breadth of terpenes and flavonoids, it’s an outstanding consumer experience. Furthermore, these new cultivars give us a high production yield with greater margins and the industry’s leading terpenes, THC percentage, and total cannabinoids. In fact, that’s TnT. So lastly, our team is committed to the ongoing cost efficiency by reducing the overall footprint.

We’ve deployed resources into our profitable segments and eliminated unprofitable business brands. For example, we saw the high growth potential in the pre-roll segment, specifically in the infused pre-roll area, we expanded our capacity in our Popular Straight Edge Pre-Rolls facility in Fenwick, Ontario at the end of this quarter. This increase of fourfold of Rede’s Straight Edge. Capacity, and expands our product offering and capabilities it enables HEXO to deliver the preferred cannabis experience to all of our Redecan and Original Stash customers. And with that, I’ll turn the conversation over to Julius to discuss our financial results.

Julius Ivancsits: Thank you, Charlie, and good morning everyone. I’d like to remind you that all numbers I share today are Canadian dollars, unless otherwise stated. Before diving into the financial results, I’d like to comment on one of our biggest financial challenges, cleaning up the balance sheet. Our strategic redeployment over the last two quarters has included a thorough review of our underperforming assets and taking a strong action to repair the balance sheet. The early financial results of our physical year demonstrate a prudent path towards long-term profitability. As Charlie noted, the debt repayment has helped delever our balance sheet, positioning HEXO for long-term financial success. I would also like to note that despite difficult marketing conditions and intensifying competition, which has to put significant pressure on pricing, we have made the decision to maintain our fair pricing as part of taking a sustainable approach and our commitment to quality.

Now, I will discuss Q2 results. This quarter, the company has hit two important milestones. First, positive net income and the second positive cash flow from operations. This is attributable to an 11% reduction in SG&A spending from the prior quarter, along with a 20% reduction in trade accounts receivable. Revenue did however slow in the quarter with a 26% decline to $24.2 million when compared to Q1 2023 of $35.8 million. The decline can be attributed to a number of different factors, price reductions by our competitors in our biggest markets, Ontario, Alberta, Quebec, and British Columbia leading to HEXO market share declines. Also, the revenue was impacted by returns of seasonal products due to low velocity, unavailable supply for certain demanded products and specific products being placed on hold due to pricing reductions in key Ontario markets.

Lastly, we ceased recognition of cannabis infused revenue as the result of the trust operationally €“ operationalizing their cannabis selling license. At the same time, our net sales declined 54% relative to Q2 2022, due to increased competition and diminished performance of HEXO brand in key markets of Ontario, Alberta, and Quebec, along with the removal of product portfolios from the divested 48North business and Zenabis brands. Looking at our adjusted EBITDA in the quarter, we saw a loss of $2.4 million, which is an increase of $1.8 million from the prior quarter Q1 2023. On the positive note, the Redecan branded sales did increase 9% from Q2 2022 as a result of the increased emphasis on the Alberta market. Furthermore, our increasing gross margins confirmed that we’re on track to profitability.

On a final note, I would like to thank anyone €“ everyone at HEXO for their ongoing commitment and positive outlook. We look forward to leveraging this team’s experience to becoming the standard of the excellence in the industry. Thank you for continued support. Now, I turn the conversation back to Charlie.

Charlie Bowman: Thanks, Julius. Before we open the floor to questions, I’d like to echo that the successes we achieved in the second quarter resulted from our strategic alignment, which including tackling the legacy balance sheet, stripping all non-productive processes, capitalizing on our strengths, these adjustments will continue to create a more profitable entity for the balance of the year. Finally, I’d like to thank all of my fellow Fenwick, Cayuga, Masson, grow sites, and all of our employees and partners for their continued commitment to our business and customers. This transition has not been simple or easy, but I can’t thank my team much more for their commitments and efforts in making HEXO a success. With that, we’ll continue our remarks and open the floor to questions.

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Q&A Session

Operator: Thank you. The first question is from Matt Bottomley with Canaccord Genuity. Your line is open.

Matt Bottomley: Yes. Good morning, everyone. Thanks for the question. I just wanted to get a little bit more color on what you believe the sustainability is in the €“ let’s call it medium-term for the strategy of maybe for giving some revenues to protect profitability. When you kind of look around some of the dispensaries and just the restrictive nature of the regulations it just seems increasingly difficult for any LP to kind of get differentiation on math with respect to branded products or things that are more the characteristics of the products themselves as opposed to pricing. So I’m just curious not trying to tease guidance out or anything like that, but just where you sort of think the top line erosion could go proportionately from where you are today given the dynamics in the sector.

Charlie Bowman: Thank you, Matt. That’s an outstanding question. We took a hard look when the price war began last quarter, a little before the last quarter, and measured out what would be the impact to us if we actually participated, maintained that volume, revenue number €“ volume and revenue, and what that would impact into our net income as it would come down and this €“ it was significant. We €“ you’re talking anywhere from $5 million to $8 million loss, and it just wasn’t something that we wanted to entertain. At the same time, we were in the process of getting ready to launch our TnT series. And with that, to your point, right now, cannabis is cannabis. And so the key point of differentiation is that consumer experience.

The consumer experience comes from THC, it becomes from total cannabinoids and it becomes from terpenes. And so our points of differentiation was to launch these high THC, high terpene strains and place them in across the different parts of Canada. So in some parts, we have Animal Rntz and Violet Fog and other parts of the market, we have Ghost Gelato, Sex Panther. Across the Board, we have the CBD Kush,which is more of a medical brand and fitness and wellbeing. And so the goal here was to get the strains out and allow those strains to start to differentiate. In addition to our straight edge, we recognized the growth of the infused pre-roll, and we had launched our atomic sour haze into this area, and we’ve got a series of other products coming on.

So for us, it was to reset the balance sheet, to reset the operation, so that we could not provide me too products into the market, but to have truly differentiated cannabis products withstanding experience from the consumer side. And that’s what we focused in. That’s a great question.

Matt Bottomley: Appreciate that. And then just one more quick one for me, just on the cash flow generation profile. So some of you guys inflected into positive territory from operations. It looks like though when you look at the dynamics, there’s pretty big swings still in working capital that are causing for some of the volatility. So I’m just wondering how you see that smoothening €“ smoothing out over the next little while. And if you think the inflection into positive territory is sustainable within the next couple of quarters.

Julius Ivancsits: Yes, I can take that one. A large chunk of it is if you just look at trade AR from quarter-to-quarter, you see a significant drop, while it was flat from Q4 to Q1. And so we very aggressively improved our cash collection efforts and then changed our invoicing procedures a bit to basically move up those payment cycles. That coupled along with, if you look at our SG&A footprint, and just overall footprint, those expenses are down quite significantly. So, we’re happy on how that is trending in the business. Hopefully, that answers your question.

Matt Bottomley: Got it. Thanks a lot guys.