HEXO Corp.

Good morning, my name is Sharon and I will be your conference operator today. At this time, I would like to welcome everyone to the HEXO Q1 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's current internal views, estimates, expectations, and assumptions. These statements should not be read as assurances of future performance or results. They involve known and unknown risks and uncertainties and other factors that could cause actual results, performance, or achievements to differ materially from current expectations and those implied by such statements. We would also note that we utilize certain non-IFRS measures in our financial reports, which may be discussed on today's call, and reconciliations between any such non-IFRS measures to their closest reported IFRS measures are included in our MD&A. This discussion is qualified in its entirety by cautionary notes regarding forward-looking statements and the risk factors that are included at the end of this morning's earnings and news release. And NRMDMA and AIF filed with our fourth quarter 2020 financial statements on CDAR this morning and which will also be filed on EDGAR. Please review these materials for more information about forward-looking statements and the risk factors that could cause actual results to differ materially from our current expectations and those implied by such statements. HECSO disclaims any intention or obligation, except to the extent required by law, to update or revise any forward-looking statements as a result of new information or future events or for any reason. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. I would now like to turn the call over to Sebastian St. Louis, CEO of HECSO.

Thank you, operator. Good morning, everybody. Before we get going, I'd just like to wish everybody good luck. Of course, during these unprecedented times, HAXO has certainly kept the safety of its employees as a paramount priority, and we've taken many precautions to ensure that everything goes smoothly and that we continue our essential service of supplying Canadians with high-quality cannabis during this pandemic. A big thank you to everybody at HEXO for your role in supplying our consumers and customers. Before we discuss Q1, I'd like to take two minutes and share with you a look inside our Belleville Center of Excellence. I'm very excited to share with you what we've got going on inside. Belleville's a game changer for us, and we're now up and running. Operator, would you please start the video? Oh, my God. You just got a look into our truly world-class center of excellence in Belleville, which also houses our trust operations, our JV with Molson Coors. It was thrilling to be able to share a virtual introduction to that site with you a few days ago. And again today, I promise you the feeling when you walk in is even more exciting. This facility is highly automated. And we believe that it delivers a competitive advantage and it really leverages the capital moat that HEXO has erected in Canada. With this facility, we have the ability to go to market quicker than most competitors. We have the ability to ramp up new product lines, and we have the ability to continue to lever economies of scale, to push better pricing to our consumers. We've been hard at work over the last few quarters, and especially in Q1, matching timely supply and demand. And that's down to the SKU level. We're really moving beyond talking about tons and kilos at HEXO and really starting to talk about discrete SKUs, velocities, sell-through at retail. And this is an area that's remaining top of mind. We understand some of the frustrations that our consumers and our customers feel when we introduce great new products into the markets and then it rapidly sells out and they have to wait until we replenish. With our Belleville facility now, we are getting control over that SKU by SKU velocity and getting that additional supply in market is really unleashing the potential that HEXO has. In the first quarter, We deliberately took our time to really understand the forecasted demand and to build a planning organization that can make sure that popular products and rarer products are available to consumers throughout Canada at all times. We're starting to see the early benefits of this. You saw in our video, secondary packaging has increased fivefold. So that capital moat and that ability to go quickly to market means that we're putting fresher product into market. The manufacturing capability of taking a freshly harvested flower and bringing it quickly, say under 60 days, into a retail store gives us an ability to simply have a higher quality product. Consumers started measuring quality by price and obviously Belleville contributes there and HEXO has been a price leader now for over a year. They have also continued to measure quality by potency. And we've recently launched our Up Cannabis brand, which is the first brand to promise a potency guarantee to our consumers of over 20%. The next bastion where we need to be able to win is freshness. And competitors of ours that do not have access to a facility of the scale and complexity of Belleville will simply not be able to compete on that freshness because you need a very, very nimble and complex supply chain to be able to take that fresh flower and bring it to market quickly. Our goal is to keep the most popular and successful products in market so our consumers gain access to the whole HEXO portfolio and that our customers at the boards can continue to rely on HEXO as a partner of choice. We've had a phenomenal Q1 and start to the year. Record revenue, $41.3 million, which is the highest in the company's history. We're up 14% sequentially from the fourth quarter and more than doubled year over year. Our net revenue was $29.4 million and is also up substantially from prior periods. More, maybe even more impressive than that, and what really gets me excited is that we're proving Hexo's ability to win important categories. We have won the hash category. We are the clear number one national supplier of hash. And resoundingly, we have just taken the number one position in beverage. Now, this will be a highly fought for category. I think it'll be a much more important category. to the industry than anyone realizes so far. In fact, I'll talk about this a bit more on the call, but we are now as an industry rolling the beverage business at about 1.9% of total market. So some of you on the call might say, well, okay, 1.9%, that's not an interesting number. And this is where I beg to differ. And I think it's a very significant milestone. For years now, we've been talking about beverage as a piece of cannabis being between the 1 and 1.5%. In fact, in the USA, beverage occupies about a 1.4% piece of the market. The fact that we have now demonstrated that by creating a best-in-class product with better taste, with a recyclable glass bottle, and with a wide variety of portfolio and effects, that we can overtake the total category space that exists in beverage in the US proves how important this category is. I'll talk a bit more about that during the call. Our sales momentum has increased across Canada and we're still holding the number one position in Quebec. So take that in for a moment. HEXO has been concentrated on being the number one supplier to Quebec and we are continue to achieve that. We're still sitting on a 29% market share in our home province. and we will continue to serve Quebec as the preferred supplier to the Quebec marketplace for years to come. However, what's very significant this quarter is you're seeing a meaningful uptick outside of Quebec. So as our supply chain has become more robust, we've been able to put attention outside of Quebec, and you've seen us become top three now in Alberta. We're moving up in Ontario. We're in sixth position in that market, and we expect that trend to continue so that in future quarters, we actually expect that we will have more revenue coming from outside of Quebec than in Quebec while keeping our number one status there. We're launching products that resonate with consumers. We started the year with Original Stash taking over price point and really redefining the market. When we launched Original Stash, it was a 28 gram format at a very competitive price point. that product was met with a lot of market skepticism. And today, those types of 28-gram good value offerings are over 50% of the market throughout the chain. Our hash product, as I've mentioned, is number one, and we continue to be able to out-innovate. Our vapes are getting phenomenal reviews, and across the board, HEXO is seen as a leader by our consumers. We really took time to match supply and demand and that meant some difficult decisions. So our up product, for example, our upline relaunched in Q2. So you don't actually see the benefit of the up relaunch in Q1. That's additional upside and it's going very well. This is our sixth consecutive quarter of EBITDA improvement. Our first quarter where we've improved 87% from a negative of 3.25 million in Q420. to a negative of about $400,000. So getting very tight on our EBITDA control now, losing under a million dollars. Our gross margins excluding adult use beverage were 39% and continue to be very robust to go forward and prove out the sustainability of a CPG marijuana company. And beverage itself has gone from a whopping minus 125% gross margin to 1% positive in just one short quarter. Our CPG partnerships, I think the most significant part about our deal with Molson and Beverages is that it really proves out the model that Hexo embarked on three years ago with our Powered by Hexo model. So Hexo believes that we will never be the best company at making a coffee, a beer, a chocolate bar. We believe there are world-class companies that make those products. And we believe that HEXO is a world-class company at understanding consumer experiences built from the molecules that come from marijuana. And I think that this foray now into beverage with Molson Coors through trust has allowed us to demonstrate that that strategy is a winning strategy. For less capital than some of our competitors, we've taken the number one spot in Canada. We've just recently launched at the United States. So we now have CBD beverages derived from hemp on the shelf in Colorado. And we're very excited to see how that develops. Although today I won't talk to specific numbers in that market because this is very fresh news. But we've been hard at work on these partnerships now for, and we've never really stopped over the last three years. They are extremely complex partnerships to negotiate. And that's what we've been doing. So we believe that as we are able to land successive partners to Molson Coors, that will really continue to prove additional upside for Hexo and our shareholders. I'll now turn it over to our CFO, to Trent MacDonald, to go through a little bit more about the numbers.

That's very much appreciated. And good morning, everyone. The first thing I wanted to point out really was... Oddly enough, not the result itself, but the cleanliness of our P&L. I think that goes back to Q4. We made some tough decisions at the end of the year around cleaning up our balance sheet. So we took a lot of write-downs, a lot of big impairments, because we no longer want to do what the industry tended to be doing, and that is piecemealing this cleanup over time. We wanted to come into this year clean. with an extraordinarily clean set of financials so that when we came to market, as we did just now on Q1, people could see and digest the results the way they should be able to do. And so what you see here is a very clean, understandable P&L. And that is where we are going to continue in the future each quarter successively from here on out to show beautifully clean P&L that people can digest that is very simple to understand. You know, if you look at our results getting into them, our operational cash flow was only minus 6.1 million. Add that to the Q4 and you're talking about in a half of the year, we've only gone through 10 million of operational cash flow. A lot of that came from inventory this particular quarter. We did build up inventory, but I want to talk about that. Inventory has been an area of risk for LPs, not for us. We've cleaned it up. We had a great harvest near the end of the quarter, and that was a higher yield harvest than we had anticipated, which was a great thing because since that point in time, We've been able to turn all of that into value added stamped finished goods at our Belleville facility, which are now out into market. We are not creating any risk. For the first time in our history, we are actually using more trim on a weekly basis than we can actually produce. And I don't know of any other LP can say that. We are in a great place in inventory. And that was predominantly the use of our cash in Q1, which we don't expect going forward. It was just a timing issue. But we're in a great place. So if you look at our total cash flow, I mean, our total cash flow would have been only a use of $11 million for the quarter had it not been for one thing, and that's a $23 million move from cash to restricted cash, which was to fund a captive insurance policy for ourselves and our D&O. which saves up between 10 and 15 million a year in premium. So a great move to do that, a very high return. So right now we're sitting with $150 million of cash on our balance sheet. That's, you know, you just think about that and the 10 million we've gone through from the operations perspective in a half a year, and we have 150 million on our balance sheet. We are not doing anything dilutive right now. We have chosen, cognizantly chose not to do anything dilutive and to be opportunistic. as many of the LPs have been over the course of the last several weeks when the industry has taken off as a result of much of which was due to what was happening in the United States. And there are lots of LPs who have absolutely no exposure to the United States, yet their stock are driving forward. Not like us. We have exposure to the United States. And even still, you know, we are sitting in a place where we don't have to be opportunistic, which is great. and therefore we have the cash to support what we need to do on an ongoing basis. One of the things we want to talk about is the improvement in that EBITDA and that path to EPS. So that starts with our war on COGS to keep those margins being very healthy while we know that the market is severely price competitive and we are a leader there. We want to offer great products at a competitive price. And so that means we have to be extremely good on the cog side so that we can continue to deliver healthy margin, which we are doing. The other thing is SG&A. With SG&A, we have been doing a lot of things to control those costs. In this quarter, if you look at G&A, marketing, selling, and promotion, and R&D. Those are your three core SG&A that you see on the face of the P&L, very similar to other LPs. For us, that figure was $15 million in total, or 51% of net sales. That's down from $15.5 million in Q4, which at that point was 57% of net sales. We need to be better there, and we know that. So we've already made significant improvements in Q2. We've done some restructuring. and are going to continue to do some restructuring over the next two quarters beyond this to get to a place where we know we are going to be best in class in SG&A. We have some very high targets for ourselves in terms of getting that percentage down to a reasonable level of net sales. Within a year and a half, we're hoping to get that down under 25% and even better. of net sales. That is a great target and a good place that allows us to have that clear path to earnings per share. Earnings per share is where it's at. And when you look at market valuations today, there is what you would call an implied level of earnings inside of market cap. And if you look at an industry like ours where it's growing, even if you said, okay, market caps represent 40 times an implied earnings stream on behalf of the company that you're talking about. Well, if you look at that 40, and I encourage people to go out and look at this, okay? I encourage you to go to all the LPs and us and look at our market cap, divide it by 40, say, what does that mean for implied earnings? Then compare that to the reality. So the reality is you take margin, you minus out that SG&A I talked about earlier, which is the G&A, marketing, selling, promotion, and R&D, just minus that for margin. And you say, okay, what does that look like as a number? And what is the depreciable capital base that everyone's using to get that number? That's another thing. We're under 300 million. We have been very diligent in our way of managing the P&L or managing the balance sheet. Others, you know, you can look it up for yourself. Billions, multi-billions of capital, depreciable capital to get their earnings, not us. So you take that and you take that net margin, minus out the SG&A, minus out the depreciation, and where are you? What does that earnings look like today? What is the reality? And multiply that out by four, you know, because it's a quarter. What does that look like for annual earnings? And how does that compare to what was in the market cap? You're going to get a disparity. You're going to get big disparities across the board between what the reality is and what's in the market valuation. Some of the LPs out there are as high as $750 million of annual earnings as a disparity. Not us. We are under $45 million right now. That is by far, bar none, the best of all the top five or six LPs. And it's not even close. We have the lowest disparity between our valuation on the market and the reality of what we are delivering today. We have a path. We are headlong into this path of eliminating that disparity and then moving well beyond it with regards to earnings per share. And that is what's extremely important to us and where we're going to continue to go. And we're going to do it off the back of a low capital base while not being dilutive unless there's some type of strategic initiative, something that we can bring to market to say, this is why we need to dilute because there's something that's going to provide a very reasonable return for our investors. At that, I do want to turn it back to Sebastian. And thank you, everybody, for listening in. And I think we're going to open up to questions soon.