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spk06: Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the HEXO first quarter 2022 earnings call. 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 would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again press star one. 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, opinions, forecasts, beliefs, assumptions, and other statements that are not statements of fact regarding the future of the business, future plan, strategies, operational results, and other future conditions. These statements should not be read as assurances of future performance or results. They involve known and unknown risks, uncertainties, and other factors that could cause actual results, performance, or achievements to differ materially from current expectations or those implied by such statements. This morning's discussion is qualified in its entirety by the cautionary note regarding forward-looking statements and the risk factors that are included in the annual information form, management discussion, and analysis and annual report. Please review these materials for more information about the forward-looking statements and the risk factors that could cause actual results, performance, development, or events to differ materially from our current expectations and those implied by such statements. HECSL 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 for any reason. I will now turn the call over to Scott Cooper, President and CEO of HEXO.
spk11: Good morning, everyone, and thank you for joining us today. Late last night, we released our Q2 2022 results for the quarter ended January 31st, 2022. Before I jump into the results this quarter, I wanted to provide an update on a couple of key developments that occurred over the course of the last couple of months. When I joined HEXO in November last year, I was immediately tasked with preparing a very challenged balance sheet as a result of the retican acquisition and the related convertible debenture that was put in place at that time last summer. The proposed agreements we've announced with Tilray will restructure and reduce our significant debt burden and provide an ample liquidity cushion while minimizing dilution to existing HEXO shareholders, a key pillar underpinning our path forward strategy. This was indeed a transformational quarter for the company. While the convertible note was a significant inhibitor to Hexel's growth prospects, I am pleased that we can now, as a result of our recently announced proposed strategic alliance with Tilray, put that behind us and continue to position ourselves to retain and grow our significant market share while we become a cash flow positive business within the next four quarters. Let me begin by reviewing the proposed strategic partnership with Tilray before providing an update on our path forward strategy. On March 2nd, HEXO entered into a proposed strategic alliance with Tilray Brands, in which Tilray will acquire U.S. $211 million of senior, secure convertible notes that were originally issued by HEXO to Hytrail Investments. This proposed alliance between HEXO and Tilray achieved several goals, including It deleverages the balance sheet to a more manageable level. It raises sufficient liquidity to fund the path forward, including unlocking of US $80 million of restricted cash. It preserves value and minimizes dilution to existing shareholders. And it offers significant commercial benefits to HEXO, representing upside to the path forward. Further, the separate three-year Canadian $180 million equity backstop commitment demonstrates the support and belief of our existing shareholders. The Tilray Agreement is expected to deliver up to $50 million combined cost synergies within two years of the completion of the transaction and will leverage both companies' commitments to innovation and brand building to strengthen market positioning and capitalize on opportunities for growth. Most importantly, the terms of the agreement provide HEXA with the financial flexibility to execute on the path forward with runway and strong liquidity profile enhanced by the standing commitment to be used monthly as needed. I am pleased to report that this proposed transformative strategic alliance is on track and is expected to close in May. As you may recall, last quarter we introduced the Path Forward, a strategic plan that utilizes HEXO's current assets and our capabilities to drive accelerated organic growth build market share, and become operationally cash flow positive within the next four quarters. The path forward is made up of five priorities. Continue to reduce manufacturing and production costs, streamline and simplify the organizational structure, realize cost synergies from acquisitions and recent plant closures, focus on revenue management, including more disciplined pricing, and five, accelerate organic growth like building market share, capturing market share gains, and capturing missed revenue opportunities. This plan is underpinned by specific actions to fortify our balance sheet, strengthen the leadership team, and enhance our corporate governance, which have already been successfully executed. The plan is expected to generate incremental run rate cash flow of $37.5 million in fiscal 2022 and an additional $135 million in fiscal 2023 for a total of $172.5 million over the next two years. from a combination of cost reductions and anticipated revenue growth. I would now like to provide a brief update on each of the core pillars of the strategy. Reducing manufacturing and production costs. The company expects to reduce manufacturing production costs by leveraging existing capabilities across facilities. We are actively applying best practice and learning from our highest margin categories and top facilities across the entire operation to improve and optimize productivity. To date, we've identified approximately $30 million in savings from optimizing HEXO's production network and leveraging the capacities of recent acquisitions. Specifically, this includes transition from co-packing agreements towards in-house production, leveraging HEXO's scale to deliver on procurement savings, and reconfiguring the company's production network to achieve greater efficiencies, for example, moving vape production and distillate production to the Redican facility. Two, the company expects to streamline and simplify its organizational structure and more closely align operating costs with overall revenue. We announced that these cost reductions will be achieved through a combination of reduced reliance on outside consultants, streamlining the organization as a new IT platform is implemented, right-sizing the organization, and realizing the synergistic benefits of previous acquisitions. These initiatives are expected to represent a 30% reduction in the company's SG&A, by fiscal year end 2023. As part of these initiatives, subsequent to the quarter end, the company announced the reduction of 180 positions resulting in savings of approximately $15 million on an annualized basis. Half of these positions were related to previously announced closure of Stellarton facility and the remaining reductions were related to reducing back office positions where there is significant overlap as a result of the recent acquisition, simplifying EXO's operating model to drive clear accountability and de-layering management. Third, the company expects to continue to deliver on synergies as a result of the recent acquisitions. Fourth, HEXA will continue to focus on revenue management, including more disciplined pricing across our entire range. By leveraging our brand continuum, we are well-positioned to differentiate ourselves across features and price balancing our approach to both volume and profit. HEXA will offer great value to consumers, strong margin for customers, and grow our own margins. And fifth, to increase revenue, the company plans on accelerating growth through organic marketeer gains and capturing revenue opportunities through better demand planning, acting on proprietary consumer insights, and building strong customer relationships. For example, in the past, the company was delivering only 65% to 70% of its demand to customers. The company has now connected its demand forecast to what it intends to harvest. We're taking learnings from the legacy of Redican and applying them across the entire organization. Earlier this year, we executed a proprietary quantitative consumer survey with thousands of consumers that identified usage occasions and demand spaces in the cannabis category, and we'll use this to drive unique innovation and brand building in our new marketing leadership. The company will also put a focus back on medical and consolidate our medical efforts with Redican given their strength in this category. We are making substantial progress on our plan in only one quarter, and it is yielding results. With that, I would like to now turn the call over to Kurt.
spk12: Thank you, Scott, and good morning, everyone. This is my first time in the CFO chair at HECSEL, and I look forward to working with you. Before drilling into the details, let me recap a couple of Scott's points. and give you a high-level summary of the quarter. Our biggest financial challenge has been to fix the balance sheet, to relieve the drain of the senior secured convertible note and establish liquidity. With Scott's leadership, we've made enormous progress on both of those objectives in Q2. Once we close the till rate transaction, the monthly redemptions will end, maturity is pushed out for three years, and we free up $80 million U.S. in restricted cash. Once we close on the equity backstop, we'll have another $60 million of cash per year, if necessary, through the sale of equity. As the new management team settles in and we dive deeper into the business, we're seeing what I call a target-rich environment. We're continuing to improve our profitability through cost savings, revenue enhancement, improved capacity utilization and operational efficiency, and better inventory terms. We remain confident in our ability to capture the run rate cash flow improvements previously outlined in the path forward of $37 million by the end of fiscal 22 and an additional $135 million by the end of fiscal 23. At a high level this quarter operationally, On a quarter-to-quarter basis, we raised unadjusted gross margins from 25% to 36% and added $5 million to EBITDA. In this quarter, we also reexamined the valuations of our business and concluded that we had to recognize substantial impairments. We took $100 million in fixed asset impairments, $141 million in intangibles, and wrote off the entire balance of goodwill of $375 million. Finally, despite improving EBITDA by $5 million quarter on quarter, we didn't breach EBITDA breakeven. And as a result, we breached the covenant on the senior secured convertible note. The note holder subsequently waived enforcement of the default through the earlier of May 17th foreclosure of the till rate deal. Nevertheless, under accounting rules, we revalued the senior secured convertible note to the default rate of 115% of face, triggering a fair value loss of $50 million. Once the till rate transaction closes, that note will be revalued to actual face value at the time of that transaction. Now, I'll discuss the results in more detail. First, with respect to revenue, total revenues were 52.7 million and were our second consecutive quarterly high, representing a 60% increase over Q2 of the prior year. International sales were a particular bright spot, growing 36% quarter on quarter. Zenebus International sales nearly doubled quarter-on-quarter and accounted for 54% of our total international volume. Medical revenues had a healthy quarter-on-quarter 21% growth, reflecting a reinvigorated product innovation pipeline and renewed focus on deployment of our commercial capabilities. We continue to be optimistic about HEXO's ability to capture revenue and market growth. we're overcoming the operational challenges that left as much as 70% of our orders unfilled. For example, we are aligning our cultivation with market demand through weekly meetings between the market and operational sides of the business. We've also made great strides in de-bottlenecking key parts of the production process, increasing throughput and reducing unit costs at the same time. Turning to gross margin, our adjusted gross margin improved quarter over quarter from 25% to 36%. This was a function of multiple factors, strong performance in general at Retican, favorable product mix within adult use, successful introduction of several new products, and growth in medicals we noted above. Also, HEXO's total non-beverage gross margin before adjustments increased by 15%
spk09: from the previous quarter.
spk12: While this is a striking improvement, it is not out of line with our larger industry peers. Turning to SG&A, those expenses remained flat from a prior quarter and have decreased on a prorated basis from expenses realized after the acquisition dates of Retican and 48 North in the first quarter. Impairments to PP&E, intangible assets, and goodwill were taken after the Canadian cannabis market experienced adverse changes, as I noted. These impairments have been reflected in significant adjustments to management's forecasts of future net cash inflows and earnings from previous budgets and forecasts. As noted, our adjusted EBITDA increased by 5.6 million from a negative 11.2 to a negative 5.6 million. This increase was driven by increased gross margins and flat SG&A expenses. In addition to the previously mentioned restructuring of the secured note, HEXL is also in negotiations with CAAS Capital and partners to finalize a standby equity purchase agreement. It's expected that the standby agreement will permit HEXO to demand that CAOS and its partners subscribe for an aggregate of Canadian $5 million of common shares per month over a period of 36 months, with the maximum standby commitment to be $180 million over the term of the agreement. A 5% standby commitment fee, payable in common shares will be due upon execution of this agreement. The proceeds from the standby commitment are expected to be used to fund interest payments under the notes and general corporate purposes. The standby agreement remains subject to negotiation and completion, and among other things, receipt of necessary regulatory and TSX approvals. Looking forward, as we've made real progress in our capital structure and balance sheet, we continue to focus on the path forward. And I'll just remind you of those five priorities. Continue to reduce manufacturing and production costs. Streamline and simplify the organization. Realize cost synergies from acquisitions and recent plant closures. Focus on revenue management, including more disciplined pricing. Accelerate growth through organic market share gains and capture missed revenue opportunities. We've already been successful in building a strong foundation for this plan by fortifying the balance sheet, strengthening the leadership team, and enhancing corporate governance. On a final note, I would also like to thank everyone at HECSO for their commitment and effort over the last year. We recognize the resilience and positive outlook of the whole team in a challenging period. We've now turned the corner, and I look forward to leveraging this team's expertise to build a robust future for HECSO. Thank you for your continued support. Operator, we would now be happy to take questions from the participants.
spk06: At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from the line of Aaron Gray from Alliance Global Partners.
spk10: Your line is open.
spk01: Hi, good morning, and thanks for the questions here, and congrats on the progress you have made on the path forward. So talking about the bright spot, you said an international. You said Zenebis double Q over Q, just any incremental color you could provide there, maybe in terms of the markets you were selling to, and also going forward, whether or not there was kind of some one-time selling or expect that level of sales to continue going forward. Thank you.
spk09: Good morning, Aaron. Thanks for the question. Val, could I ask you to take that one?
spk08: Yep, for sure. Good morning.
spk04: Yeah, so markets that we continue to sell into as we work with Cenebis are, of course, Israel, Malta, and into Europe. We have strong relationships within the international domain and expect to see continued growth.
spk10: Thanks.
spk11: And I'd also add that we're also looking at South Africa and Australia as markets as well.
spk09: Okay, great. Glad to hear that.
spk01: continue to see growth there. And the second question for me, Scott, you talked about, you know, some survey work you guys are doing right now on the consumer front to get a better understanding, obviously aligning, you know, better with demand and cultivation, and it seems like teams are communicating more now. You're talking about maybe some of the insights, you know, that you're continuing to see, you know, unfold, obviously a lot of moving parts in the marketplace in terms of consumer demands, whether it be price or THC levels. So maybe some high-level views in terms of, you know, how you view the marketplace today, you know, from your studies. and will you believe consumers are going to look for demand going forward? Thank you.
spk11: Great question. Thanks, Aaron. Again, Valerie, I'll turn that one over to you. No problem.
spk04: Yeah, so we were, again, extremely fortunate to conduct a national study of over 3,000 Canadian consumers, and within that, we were able to identify over six unique demand spaces, which really coined the understanding of usage occasions and consumption habits. And we're uniquely tailoring our overall offering to consumers to align with that. I will suggest some key findings that we have found is the importance of sleep to the Canadian consumers and how cannabis plays an important role within that. I would also suggest that, you know, your question around potency is important to Canadian consumers overall and is top of mind as we are outlining and building our product roadmap moving forward.
spk09: Okay, all right, great. Thanks so much, and I'll go ahead and pass it along.
spk10: Your next question comes from the line of Pablo Zulanek from Kantar Fitzgerald. Your line is open.
spk00: Good morning. Can you just give us an update, if it's possible, in terms of your regional coverage within Canada? I mean, the company started very strong in Quebec, right? Then it seemed to lose share there and gain in Ontario and Alberta. But just an update in terms of where you are, especially with REDECAN and the assets you acquired, in terms of regional scope, if you can break it, and then an update in terms of how much share you've lost in Quebec. I'll have a follow-up.
spk09: Thank you.
spk04: uh right so we are uh nasty president valerie i'm gonna i'm gonna turn over to you again just around the market positions in each of the uh provinces and um and the ready can roll out as well no problem we continue to maintain the number one uh share position adult records in canada uh rolling three months share of 10.3 overall we continue within large markets to continue to leverage our partners as it relates to Quebec, Ontario, Alberta, and British Columbia. I'm really excited to announce that we have seen the expansion of Redican on a national level. We've introduced Redican into Manitoba, Saskatchewan, Newfoundland, New Brunswick, and Nova Scotia and PEI. In addition, in February, we saw the introduction of Redican into the Quebec market. So continued efforts as we build out our product pipeline and continue to grow our market share with our key board partners.
spk00: Okay, thank you. Just to follow up, Scott, maybe focusing on, it's a two-part question. One, an update in terms of the JV with Molson Coors and the relationship there. How much progress are you making in Canada and in the U.S. with JV? And the second part of the question is more about your U.S. plans. I understand, you know, you were hamstrung with the convertible debt. Now you have the agreement with Tilray. In the past, a prior CEO had talked about buying land and cultivation in California. I just want to see an update as to how you're thinking about the U.S. opportunity, or do you have too much to fix right now that you're going to be buying assets in the U.S.?
spk09: Thanks. Thank you for the question.
spk11: First, on the joint venture with Molson and Trust Beverages, I continue to be very pleased with the progress that Trust Beverages is making. It was recently announced as a result of the efforts of Trust Beverages and a number of companies in collaboration with the government that one of the restrictions around the beverage category was you can only purchase five beverages within your limit, and that's been increased to 48. So we anticipate continued progress. The innovation funnel that Trust has for 2022 is second to none. And they continue to be very consumer-focused and have very strong customer partnerships. So very pleased with that. In the U.S., continue to roll out CBD beverages and continue to have a strong commitment to that business as well in a number of new states, both in direct-to-consumer and with distributors. And on your second question around the U.S. expansion plans, we continue to absolutely look at the U.S. market with interest around operating within the legal framework. In the short term, we continue to progress the action plan around extracts of hemp-derived CBD and other minor cannabinoids as an ingredient. And as we get through the balance sheet transformation, free up cash game within that framework, we will absolutely be looking to the U.S. in the right kind of sequencing and time frame for growth and expansion. Thank you.
spk10: Our next question comes from the line of John Zampero from CIBC. Your line is open.
spk02: Thanks. Good morning. I wanted to start on the cost cutting. It's a lot of moving parts, so I just want to better understand it. I think it's $50 million in synergies from M&A last year. There's another $30 million in savings from the production network that you've identified. Subsequent to that, there's around $35 million in savings on SG&A, if you reference the 30% cut, and now $25 million in savings for your portion of the Tilray deal. So Roll all that together, you get to around 140 million. I'm trying to get a sense of ultimately how much of that falls into COGS versus SG&A.
spk09: Yeah, thanks for the question, John. Kurt, can I turn that one over to you?
spk12: Yeah, hi, John. You're right. It is a complicated set of numbers, and we have... been trying to isolate those numbers ourselves. Just in the last few weeks, we've set up a special team in a value creation office to be tracking all of those initiatives separately. And I anticipate that as we get better at tracking those things, we'll be able to offer specific details. You know, you touched on the 35 million from SG&A. That's pretty well isolated in SG&A. But the balance of it is going to be a combination of both COGS and SG&A. And we'll be sharpening that up and sharing it with you in the future.
spk02: Okay, understood. And just a clarifying question on that. Was there any progress made on the $37.5 million in targeted F-22 savings in FQ2, or is that all targeted for FQ3 and 4?
spk12: Yeah, so we did do a significant headcount reduction in February, which will certainly show up in Q3. There were some ongoing cost reductions in Q2, but I think the bulk of the $37.5 million we're going to capture in fiscal 22 is going to be in the second half of the year.
spk02: Okay, got it. And then on the revenue side, you did endure some significant organic declines, and you referenced some meaningful missed opportunities, but can you add more color on some of the other initiatives you have to retake share? It does seem like Some of your competitors have caught up to some of the products that HEXO does well in. So I'm curious what you're working on on innovation or what other initiatives you have to take back share.
spk11: Great question. Thanks for the question, Val. I'm going to turn that one over to you.
spk04: You bet. So once again, I just want to reiterate that we remain the number one LP in the adult recreational market with 10.3% market share on a rolling three-month basis. We are again working hard to launch plans to allow us to grow organically and there's tremendous opportunities with our breadth of assets that we have in the fastest growing categories overall. Over the course of the last quarter, we very much focused on mix and driving sustainable growth for our shareholders in a day in and day out basis. And we've been building our product pipeline and innovation pipeline as it relates to Canadian consumers, referencing once again the national UNA study that we conducted, which allowed us to identify unique use cases and consumption habits of Canadian consumers. You will start to see the effects of this work hit the market in early spring of this year when you start to see some of those products hitting the market. And one that I'm most excited about that I want to make sure that I highlight is the launch of our Readies Plus, which is an infused pre-roll reticence style, so the straight edge style, that will launch into the marketplace with higher THC. Again, capitalizing on the overall market moment and the key indicators from consumers in terms of their needs for potency, we leveraged this information. And again, the really, really strong Redican brand to deliver this to Canadian consumers. And you can look forward to seeing that hitting shelves, like I said, in early spring. More to come in this front as we're rolling out our innovation pipeline over the next 12 to 24 months, but this is what you can expect from HACSO on a go-forward basis. Insightful innovation that are meeting the needs of Canadian consumers.
spk11: Yeah, and Val, I'd add, you know, the Readies Plus, very excited about that as well, and it took a lot of technical know-how to bring that to market. It's launched at a premium price, and as you say, that's what can be expected as we continue to leverage those consumer insights and and our capability to bring unique and compelling products to market.
spk09: Okay, I appreciate the call. Thank you very much.
spk06: Again, if you would like to ask a question, press star to the number one in your telephone keypad. Your next question comes from the line of Federico Gomez from ATB Capital Market. Your line is open.
spk07: Hi, good morning, and thanks for taking my question. Maybe... Could you give more color on the issues you're seeing with Ratican? I know you mentioned competition, the pre-roll market specifically in Ontario. So just curious on what you're seeing in other provinces as well as other product categories in terms of competition and potentially pricing pressure.
spk11: Thank you. Thanks, Federico. Valerie, over to you.
spk04: Yeah, sure. I would suggest that we have a unique opportunity as it relates to our breadth of brands, including Redican, and our unique position to leverage our value continuum allows us to address price points and specific needs of consumers across the spectrum of cannabis needs and allows us to balance both our overall volume and our profitability for our business overall. For sure, there's a lot of competition as it relates to the pre-roll category, but but again, we are in a good position from our productive capabilities, our strong brand positions as it relates to Redican, and the deep innovation pipeline that we're building. So we're feeling very, very confident in our position as it relates to the market across all categories and all markets.
spk08: Scott, is there anything else you'd like to add there?
spk09: Nope. Great answer. Thanks, Sal.
spk07: Okay, thank you. And then just on your capital position right now, you still have some months until the deal with DeRay closes. So I know that you have some assets for sale on the balance sheet. How are you seeing that? Do you need to raise any more capital or are you going to rely on those asset sales? How comfortable are you with your cash position right now?
spk09: Kurt, do you want to speak to that?
spk12: Yeah, sure. Federico, hi. Cash position is something that we track very, very closely. And we do a rolling receipts and disbursements forecast going out 13 weeks and then out to 26 weeks as well. And so we manage that cash position pretty carefully. We do have asset sales coming up. That cash, we anticipate, will be going into the restricted cash. Nevertheless, you know, we believe that we've got adequate liquidity to get through to the conclusion of the Tilray deal in the middle of May.
spk09: Thank you. That's helpful. Thank you. Your next question.
spk10: comes from the line of Syl Thingra from RBC Capital Markets. Your line is open.
spk05: Hi. Hi. Good morning. Good morning. I just wanted to get back on the Radican revenues. So you noted in the MD&A that there was a 29% quarter-on-quarter decline on a pro-rated basis, and it was due to logistical issues and competition. Could you please split the proportion from both of these? And finally, I wanted to confirm that the logistical issues are now resolved.
spk09: Thanks for the question. Valerie?
spk04: Yeah, as it relates to Redican in the last quarter, there were a number of administrative and logistics issues that were unique events that we entered in within the quarter and it was around amalgamation and relisting with provinces. In addition to that, we shifted our overall zero product of the readies from a 0.35 grams to 0.4, which enabled us to actually sell through all of the inventory before restocking in the marketplace overall. So there were some integration challenges that we had to overcome over the time period of the second quarter. However, demand remained strong, and we're seeing that rebound now.
spk09: Okay. Thank you. That's a
spk10: And there are no further questions at this time. Mr. Scott Cooper, I turn the call back over to you for some closing comments.
spk09: Thank you, everyone.
spk11: Thank you, everyone, once again for joining us this morning. I am pleased that we can now, as a result of our recently announced proposed strategic partnership with Tilray, continue to position ourselves to retain and grow our significant market share. We'll become a cash flow positive business for the next four quarters. I have full confidence in the path forward, and again, appreciate everyone joining us this morning. Thank you.
spk06: This concludes today's conference call. Thank you for your participation.
spk10: You may now.
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