HEXO Corp's (HEXO) CEO Sebastien St-Louis on Q3 2019 Results - Earnings Call Transcript

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About: HEXO Corp. (HEXO)
by: SA Transcripts
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Earning Call Audio

HEXO Corp. (NYSEMKT:HEXO) Q3 2019 Earnings Conference Call June 13, 2019 8:30 AM ET

Company Participants

Jennifer Smith – Director-Investor Relations

Sebastien St-Louis – Chief Executive Officer

Conference Call Participants

Erica Eiler – Oppenheimer

Oliver Rowe – Scotiabank

Chris Carey – Bank-America

Brett Hundley – Seaport Global

Graeme Kreindler – Eight Capital

Matt Bottomley – Canaccord Genuity

Robert Fagan – GMP

David Kideckel – AltaCorp Capital

John Chu – Desjardins Capital Markets

Krishna Ruthnum – CIBC

Operator

Good morning, and welcome to HEXO Corp's Third 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. [Operator Instructions] Please note that this call is being recorded today, June 13, 2019 at 8:30 a.m. Eastern Time.

I would now like to turn the call over to Jennifer Smith, Director of Investor Relations at HEXO Corp. Ms. Smith, you may proceed.

Jennifer Smith

Good morning, everyone, and welcome to HEXO's fourth quarter earnings call. We will start with a presentation by our CEO, Sebastien St-Louis, who will recap the company's third quarter results, the recently completed acquisition of Newstrike Brands Limited and our financial outlook, 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 information that involves known and unknown risks and uncertainties and other factors that could cause actual events to differ materially from current expectations. These statements should not be read as assurances of future performance or results. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements to be materially different from those implied by such statements.

A more complete discussion of the risks and uncertainties facing the company appears in the company's annual information form and the company's management discussion and analysis for the three and nine month periods ended April 30, 2019, which are available under the company's profile on SEDAR. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of the presentation. The company 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, future events or for any other reason. Sebastien?

Sebastien St-Louis

Thank you, Jennifer. Q3 was a busy quarter. Our vision to become top three global cannabis company and top two in Canada is based on three pillars: operational scalability, product innovation and brand leadership. Our investments in our resources, technology, infrastructure and especially human capital is critical to achieving that goal and through this quarter we've made meaningful progress. Under the direction of our Chief Innovation Officer, Veronique Hamel, we're continuing to expand our R&D and innovation team with top scientists, chemists, who have extensive experience in CPG companies such as Kellogg's, Church & Dwight, Coca-Cola, Philip Morris, Campbell Soup, Smuckers that's just to name a few.

We now have 25 PhDs on staff. They're focused on developing new and innovative products for the market, best-in-class technology for our powered by HEXO experiences. Building on our innovative technology is critical in building brands. We believe that brand will be the final moat by which CPG cannabis companies are differentiated, but in the meantime, those products and that moat will be built on distribution and technology, having consistent quick on and quick off cannabis experiences that includes sleep, sport, focus, diets, sex and fun, delivered through a full range of powered by HEXO products is what we're striving to create.

Developing these experiences and partnership with Fortune 500 partners through our hub and spoke is how we're going to achieve that goal. We've added three people to the team with extensive leadership and CPG experience including our new COO, Donald Courtney, notable experience at Mars, Pepsi Bottling Group and also as the head of MedReleaf. As well we've recently welcomed Michael Monahan as our newly appointed Chief Financial Officer. Michael’s guidance will help the company to drive our global strategy moving forward based out of the U.S. and he brings his wealth of experience from privately held and public companies such as Nutrisystem, where he had a very successful exit.

We recently secured about 200,000 kilograms of hemp supply for CBD and non-THC cannabinoid extraction in fiscal 2020 and a closer term we've done a secondary supply agreement of approximately 60,000 kilograms of hemp to be supplied in the next two quarters as we prepare for the upcoming demand in edibles and concentrates pending legalization in October in Canada. Our hemp supply chain is a critical element to our strategy to be an eight U.S. states in 2020 legally through traditional non-MJ channels. We're looking forward to the following month, so that we can elaborate on that strategy.

We've signed a multi-year extraction agreement with Valens to extract a minimum of 30,000 kilograms in year one and 50,000 kilograms in cannabis and hemp biomass in year two. So this helps to smooth out our operating ramp-up and curves as we expand our production to our near-term target of 150,000 kilograms and prepare for the legalization of edibles in October. Note that our Belleville site that I'll speak about later in the call will actually be built to support the extraction using all types of extraction technologies for about 375 tons of processing capacity annually.

We're the first cannabis company to join Food and Consumer Products of Canada, which is the largest voice of the Canadian food, beverage and consumer products industry. We welcome the addition of 374 new employees, which brings our headcount to 822 employees at the end of Q3, and today, I'm very proud to say that the team has grown to 1,100 and everyone is working very hard. I thank them very much.

We continue to expand our CSR initiatives, focused on being good corporate citizens. Our support has helped to ensure that those who depend on the services of Moisson-Outaouais and the Ottawa Food Bank will continue to receive the necessary access to fresh sustainable food using environmentally sound technology. Our customers remain our focus.

To date, we have sold over 7.5 million grams of adult-use in medical cannabis to Canadians who depend on our safe reputable and high quality products. Adult-use grams and grams equivalent sold increased 9% to 2,700 from last quarter as we continue to expand our distribution across Canada.

Q3 2019, we produced approximately 9.8 tons of dried gram equivalent, so 9,800 kilograms, a 98% increase from the previous quarter. That was due mainly to our increased yields in our 250,000 square foot B6 greenhouse and also our first harvest of 1 million square foot B9 greenhouse.

First harvest, I remind everyone, that happened five quarters out from us announcing that we would build that facility, one of the fastest build-outs of a large scale modern cannabis facility on the planet.

We're preparing for Phase two of the Canadian adult-use market with the legalization of edibles and concentrates, which is expected in October 2019, although there is some timing risk to that date, we may see a delay from a regulatory perspective of up to 60 days pushing us into December. We are developing gummies, a premium vape line and a line of cannabis-infused beverages with Truss, our joint venture with Molson Coors Canada. We remain focused on delivering net revenue in fiscal 2020 of over CAD400 million and that of course excludes Truss Beverages.

Subsequent to the end of Q3 2019, we completed the acquisition of Newstrike, providing us with the near-term increase in production to a 150,000 kilograms annually, expanding our cultivation to three campuses, giving us resiliency and redundancy and giving us access as well to nine provincial agreements, so now reaching over 95% of the Canadian population and increasing the HEXO family by approximately 250 employees.

I mentioned Bellville earlier on the call, very proud to say we are on track. Phase one was online in May as planned and we plan on having the building fully operational by the fall. That will include not only HEXO core operations in about 580,000 square feet but also the Truss, Molson Coors joint venture which we are expecting to have a full line of bottling and canning made available to be ready for October legalization should regulations allow.

A 1.5 million square foot facility will also allow future Fortune 500 partners a licensed, centrally-located facility optimized for their specific manufacturing requirements. Looking forward to sharing the future on our future partners.

It was very exciting announcement this morning. We announced that HEXO was now officially international, licensed in multiple jurisdictions with our Greece update. So, we announced that HEXO MED has received its medical cannabis installation license in Europe and that's another step towards our plan of providing regulatory access to Fortune 500 companies, so that we can use their existing distribution networks in countries such as the UK, France and all supplied from a European domicile.

Financial results. Our total gross revenue was 15.9 million for the third quarter, an increase of 11.8 times over the same quarter in the prior year. As I guided, last quarter gross adult-use revenue remained flat at 14.6 million in comparison to the same period in 2018, it increased by almost a 1,000% which included only medical sales last year. We expect revenues to double this quarter with realized sales from the first harvest from B9 and our one million square-foot facility and also as we start to shift flower outside of Quebec, which we're very excited to do.

Sales volume increased 9% to 2,700 kilograms from 2,500 kilograms in Q2. Flower and dry products, accounted for about 84% of gram and gram equivalent sold during the quarter, oils accounting for the remaining 16%.

We achieved adult-use revenues per gram of CAD5.29, a CAD0.54 decrease over last quarter, due to a shift in product mix and 94% of our sales were done in Quebec, with 9% coming from Ontario and BC, reminding everyone that we had not begun selling flower in Ontario and BC.

Cost of sales remains consistent with the prior quarter, about CAD6.6 million including the cost of dry flower and the transformation costs related to oil and value-added products. The fair value adjustment on the sale of inventory was CAD4.7 million, which has increased from CAD572,000 in Q3 2018 due to an 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 CAD20 million compared with CAD2.5 million in Q3 2018. This is due to an increase in the number of plants on hand, the result of bringing B6 and B9 fully online. So B9 is full of plants today, you can see that in a video that was publicized on Tuesday. I'd invite everyone on the call to go Google for that HEXO reel, you can see our staff hard at work and B9 full of plants. We also drove higher yields this quarter on a per plant and per square foot basis, and we expect that to continue meaningfully as we ramp through our 150-ton a year production capacity.

Our gross margin before fair value adjustment on biological assets was $6.4 million, yielding a 49% gross margin on net revenue. So holding towards the 50%, we do expect over the next 24 months as there is significant pricing compression that the flower might gradually gross margins towards the 40%. We do expect that as we introduce more and more advanced products, we'll be able to pull that gross margin back towards the 50%, but do expect some turbulence on gross margin in the short-term.

Operating expenses, our G&A increased to $10.5 million in Q3 from $2 million in Q3 2018. This reflected the growth in operations as we continue to strengthen our general, finance, administrative staff an increase of $3 million. Rental expense increased by $790,000, related to rent on the Belleville facility.

Professional listing and legal expenses increased by $900,000 as a result of corporate development initiatives, and increased financial reporting and regulatory requirements from the TSX and the New York Stock Exchange American and insurance increased $1.8 million due to an increase in property plant and equipment being covered and D&O premium increased as a result of listing on the New York Stock Exchange. G&A is expecting to trend with revenues over the remaining quarter in 2019.

On marketing and promotion, we had an increase to $5.1 million in Q3 from $2.1 million in Q3 2018. And this reflects the implementation of our adult-use marketing and promotion events to build brand recognition and establish HEXO in the adult-use market. We expect this to trend with revenues in the final quarter of 2019. Our long-term goal on our marketing spend is to be roughly around 5% of revenue and we believe we're on target looking at forward revenue of $400 million or $20 million for the year, excluding sales and operations of course, so just on pure marketing spend.

Our stock-based compensation increased to $8.1 million in Q3 2019 from $783,000 in Q3 2018. This relates to an increase in the number of options outstanding and represents our increase in headcount as a result of a significant increase in the underlying market prices of those options, granted during the period.

Net loss from operations were $2.2 million in Q3 2019 compared with a $2.7 million loss in Q3 2018 and this was offset by higher revenues and increased biological fair value adjustments as our production increases. Net loss from operations decreased 61% over last quarter, due to an increase in fair market value adjustment on biological assets, based on increased scale of operations and the additional plants in our B9 greenhouse. Other income and expense of $5.5 million loss in Q3 2019 compared with $682,000 in Q3 2018, was due to re-evaluation of financial instruments of about $1.1 million and a fair value loss on a convertible note receivable of $4.1 million.

Now I'll turn it over to our analysts on the call, looking forward to taking your questions. Thanks for being here.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Rupesh Parikh of Oppenheimer. Please go ahead.

Erica Eiler

Good morning. This is actually Erica Eiler on for Rupesh. Thanks for taking our questions. So, first I wanted to touch on the CAD400 million revenue target, we were just curious, the sensitivity and ability to hit this target if we do see the regulatory delays in advanced products. And also, maybe you could talk about some of the risks you see to potentially achieving this target?

Sebastien St-Louis

Thank you, Erica. Yes. There are two key risks to the CAD400 million. So the first one is of course the – as you pointed out, the regulatory risk. So, if we don't get the advanced products that would put – and I believe the risk of not getting it is negligible. I think the risk is really in delays. As I mentioned on the call, I think a delay to December would be prudent to expect a delay potentially in the December. But if it's further delayed that could put upwards of CAD100 million of that CAD400 million at risk as that that we're planning advanced products to be about 25% of that number.

The second risk is an execution risk, so much more in our control relating to our Belleville facility. So to achieve that CAD400 million target, we do need Belleville to be operational in the fall. And we are on track for that. But if something should happen outside of expectations, I would put that number at risk. We are confident we will deliver an operational facility in time.

Erica Eiler

Okay, great. That's very helpful. And then I just also wanted to quickly touch on market share. Is there any update on your sense of what your market share is currently?

Sebastien St-Louis

We believe that we're holding pretty strong as one of the top Canadian LPs. We're not sure exactly where, put us somewhere between top three and top five is probably a good guess. But we have some more work to do on those numbers.

Erica Eiler

Okay, great. Thank you so much.

Operator

Your next question comes from Oliver Rowe of Scotiabank. Please go ahead.

Oliver Rowe

Hey, good morning. Thanks for taking my question. When I think about Quebec, which is obviously an important market for you, you're expecting 20,000 kilograms of sales to Quebec in the first year of REC. I think we're over halfway through that year now and sales within about 5,500 kilograms to that province. So it seems to me like it could be a bit challenging for the SQDC sales to triple over the remaining five months. Do you see a risk that the SQDC doesn't need that much product, but picks it anyway and that leads to significant inventory builds and maybe even impacts demand on your year two contract?

Sebastien St-Louis

Yes. So definitely a risk, I think the demand is there in Quebec. I think the SQDC has been doing a fantastic job, but since there were inventory supply shortages on the early days from most LPs, so HEXO was delivering on its purchase orders, but the SQDC weren't getting fully supplied. They slowed their store ramps. So the original plan called for about 25 stores in Quebec by this day. And last quarter we were at about 13.

Now the good news is SQDC has now gone back to seven days of full time selling. So that adds significant demand. They've added more stores now. So we have a brand new store in Gatineau, right next to an Ottawa population center. I do think there could be some timing risk around a few of those tons – of those 20 tons. Now of course, as you pointed out, it is a take or pay contract, but we value our relationship with SQDC more than the few million dollars in revenue we could get this quarter.

So we're working very closely with them. We left our SKU mix to create more interesting products. We plan on launching a whole bunch of new products over the following couple quarters, which we think will help that but expect some timing risk whether it's an October, November, December timeline to hit the full 20 I think would be a reasonable assumption. We're confident we can completely offset that in more of course in other provinces.

Oliver Rowe

That's helpful. And just to follow-up on Quebec, I know the province recently added six more suppliers to the prior six. And I believe that you re targeting a 30% share in Quebec. So is that at risk as they increase supply or do you think 30% is a pretty sustainable number for you, no matter how many suppliers they have?

Sebastien St-Louis

It's always going to be a risk. I mean, people are going to be gunning for the top spots in Quebec. I mean, it's the second largest market in Canada and now people are finally realizing that. Thankfully, HEXO has a preferred supplier status, we have a great reputation in Quebec, our products are loved. So I think it's very feasible to defend our 30% market share. But of course we'll have to be very vigilant, we'll have to keep listening to our customers and responding to their needs.

Oliver Rowe

Great. That's helpful. Thank you.

Operator

Your next question comes from Chris Carey of Bank of America. Please go ahead. We have a question from Chris Carey.

Chris Carey

Hi. Can you hear me?

Sebastien St-Louis

Yes, thank you, Chris.

Chris Carey

Hi. So, just on your explication for the 40% gross margin in the near-term, I mean, how much of that is investment without getting kind of the requisite sales leverage and mix – and mix being flower and oils? It really – what I'm trying to get at is, what you think your capacity for a longer term margin is it is clearly expectations are for your gross margins to be a little bit higher over even the medium-term horizon. So I wonder if you could just talk to the near- and longer-term dynamics around the gross margin line.

Sebastien St-Louis

Yes, absolutely. Thank you. I think, so longer-term I think 50% is definitely doable. But that will be contingent on us building a brand more long-term. I think the 50% will be reserved to the top three or four global cannabis companies that are able to create brand pull. Otherwise, cannabis companies as a whole, not just HEXO, will be pushed towards the 30%, right, in the long-term.

I think in the short-term, the pressure is completely different. The pressure is because as we've mentioned in Quebec, new producers constantly coming online, coming to the provinces and we're talking right now about, for example, in Quebec, six new producers onlining, but remember that there's 150 companies in Canada that have licensing that want to start to sell flower. So what's going to happen in the next 18 months is that those companies are coming to the provinces saying I want to get my flower listed. These companies are not sophisticated. They're small scale. They have high cost and they need to get a listing, they need to get sales revenue.

So in turn, what we believe is going to happen is, the provinces are going to say, well, we have enough flower SKUs, we have trusted partners, we don't need your flowers. And then the smaller producers are going to have no other choice, but to drop their price. In consequence, what's going to happen is that the provinces will then call their preferred suppliers, HEXO and other major licensed producers in the country, and we'll say, well, guys, you can get to keep your listing, but you need to be competitive with these smaller guys.

What that will do is that will create a shakeup in the industry over the next 18 to 24 months. We believe there will be 80% of smaller licensed producers that will go bankrupt, because they will be unable to obtain significant listings and leverage. And as such their financing will also dry up. I think that'll be an incredible painful process and that'll put downward pressure on our ability to generate margin from flower in the short-term. That's what brings me to 40%.

Now the good news is less competition and nobody except the majors focused on advanced products and HEXO being at the top of the list as an advanced products company with great partners such as Molson Coors, we believe that we'll be able to introduce products that are in the 60% plus margin range, which helps to balance us out. So over time, as we shift from flower to advanced products, able to kind of stabilize in the 50% range.

Chris Carey

Thanks for that. And so as the market stays along flower over a longer period of time, how quickly do you think your own product mix will shift towards new product form? So you’re 84%, I think in this quarter on flower. Will it stay at that level for the next six to nine months or do you envision being able to capitalize on these opportunities in the near-term both for things like your sprays and also obviously, you have the beverage lines coming at the end of the year?

Sebastien St-Louis

Yes. And that – well, the biggest question there, Chris is going to be the regulatory risk around the legalization. So if we're live in October, which is still very possible, but at risk, so if we were live on shelves in October and HEXO is ready. So we're ready for that date, we're going -- we're ready to load in, starting in September. So we're very excited with that. The Truss products are phenomenal. They taste great. They work super fast, so we think those are going to be a home run.

So if we launch in October, to your question on six or nine months, absolutely, I think that's going to move the needle. I don't expect the needle to move from 84% flower to 20% flower. It's not going to be that kind of seismic shift. It's going to be a month by month. People are going to try these new products. There will be some excitement, but look for a gradual move where flower takes less and less and less of our total sales.

Flower will not go away, and I believe that even long-term flower will remain about 35% of the total addressable cannabis market. And we plan on maintaining that position in Canada. I think for us to get there, if you look to Colorado, historicals could take about five years. So if you take us from 84% flower now and find a straight line down to 35% in five years, I think that’s a reasonable guess, taking into account certain regulatory risks. So if I don’t get my advanced products before December, for example, then I think expect flower to remain in the 80% plus range for six to nine months.

Chris Carey

Okay. Thank you. If I could squeeze in one more, I appreciate it. How quickly can you enter the U.S., and just any flavor on that launch? Thank you.

Sebastien St-Louis

We’re very excited about the U.S. So I’ve committed to be in the U.S. in 2020. I think we can do multiple states, so the number I mentioned is eight. I think we could do those states legally with powered by HEXO non-THC based experiences, so that’d be focused sport and sleep to start. We think we can enter with our Fortune 500 partners in our hub and spoke strategy. We think we can lever their existing distribution and go through traditional non-marijuana channels.

So I think this is going to be a key advantage for us as we use our hemp supply and the farm bill and our extraction technology to clean outdoor field hemp. I think we can use all that in our formulation technology and are powered by HEXO team to gain -- to essentially leapfrog the multi-state operators. So instead of being limited to say 60 in individual retail stores, our strategy is to go with non-THC experiences at first through traditional retail where we could get a listing in a traditional retail like our Walgreens or CBS thereby getting thousand plus stores at once. So that’s a -- watch for them in 2020. And of course, if we’re able to do that a bit faster, you’ll see it in the news right away.

Chris Carey

Thank you.

Operator

Our next question comes from Brett Hundley of Seaport Global. Please go ahead.

Brett Hundley

Hi, good morning, Sebastien. Thank you for all this detail around near-term revenue and margin. It’s really helpful. If I can go a step further and think about your specific route to the new 2.0 market, as we get beyond fiscal Q4 and maybe look at the early part of fiscal 2020. What parameters might you put in place for us thinking about revenue performance in Q1 into Q2 as you potentially short the flower market and get product ready for the 2.0 market?

Sebastien St-Louis

Yes. So we haven’t provided guidance spread on specific ramps for the CAD400 million, but you can expect that it will be an incremental step function, so try to -- I think if your model is a linear model, it will get pretty close. If -- and that’s probably a good place to start.

Brett Hundley

Okay. I appreciate that. And then I wanted to go back to a comment you just made on entering the U.S., because I think what you’re saying does make some sense insofar as competing well with the MSOs, if in fact you’re able to get product into traditional markets, traditional channels rather and leverage some of these hub and spoke partners. And it gets back to a question that I wanted to ask you broadly just about hub and spoke trends. We personally were hoping to see more in the way of strategic tie-up at this point in time.

And it’s at least my understanding that maybe big CPG and big pharma are looking a little bit away from marijuana and maybe towards hemp and bio synthesis insofar as getting cannabis into their branded products sooner or rather than later, and I’m clearly here focusing more on the U.S. market. Can you just talk a little bit about your own discussions with hub and spoke partners? And what you think they’re looking for at this point in time? And whether or not that’s changed relative to six or nine months ago? I’d really appreciate it.

Sebastien St-Louis

Yes. Thanks. I think you’re absolutely bang on that hemp is a key part of the strategy. So one thing that hasn’t changed for the Fortune 500s, I mean, we’re talking to over 60 of them right now in the funnel, obviously talking to more than that, about 60 in various stages of discussion. So we remain on track for our plan, kind of one a year over the next five years to round out a wheel.

The hemp strategy is key, because if you want to operate legally in the U.S., and of course not pseudo legally on a state by state basis, but legally at all levels of government with FDA and DEA, no contest, you’d need the source from hemp. And so that’s why HEXO has put in place these hemp relationships. That’s why we already now have 260 tons of hemp biomass secured under contract. That’s why we’ve invested heavily in specific extraction technology to be able to clean out those real hemp.

I think one of the things that the Fortune 500 companies, and you’ve seen this from a few of them, some of them are taking a strategy of saying, we don’t need the marijuana companies, we don’t need LPs, we’re going to go at our own, and then they take a hemp strategy. And then they come up with a product that perhaps doesn’t taste as great as what they would normally have. That doesn’t have the right actives, that doesn’t work fast enough and quite frankly becomes a sub-par offering.

Now just going with the pure hemp product, like we’re doing with a hemp oil, much easier alternatives that go in with a complex formulation something that we’re trying to achieve with powered by HEXO. So I think the discussions are still very lively. We’re still very excited about delivering kind of our one year spoke partner. In the meantime, Truss, our existing spoke partner is performing very well. We’re developing that business plan and the drinks are going to be absolutely dynamite, we believe, in traditional retail channels, so working away at that.

Brett Hundley

That’s really helpful. Thank you for going through that. Just lastly for me. Do you guys have a target for reaching profitability on the EBITDA line? We can all do the math given your commentary over the near-term, but have you disclosed any target as far as profitability on that line?

Sebastien St-Louis

No, we haven’t guided that. But I do – I am happy to share with you that 2020, we’re going to make some money. I mean obviously, CAD400 million at the kind of margin we’re throwing off, it would be a little foolish not to. So we’re going to do that, but this we are in growth mode. So the reason I don’t want to guide EBITDA is because I’m ramping up my R&D team and nobody is investing in marijuana today for the EBITDA I’m going to generate next year. If we were all investing in marijuana for that reason, none of these companies should be worth what they are worth.

What we’re building, our global branded companies, what we’re building is a sustainable moats around not only that brand but the technology and the powered by HEXO experiences, and that takes significant investments. With these top PhD scientists we’ve hired, I mean, the team of 25 obviously, there’s significant cost to that but I don’t want to stop there. 25 is not enough. We plan on having 100 PhDs on staff. We believe that that will actually create a human capital moat as well beyond just the pure technology and IP.

There’s not a thousand of these top food scientists on the planet and HEXO is continuously attracting top talent. So we believe that over time that erects the technology moat over the next three years and then that gives you one more reason to go back to the Fortune 500s and say, well our technology is fundamentally better, you can do it on your own and spend hundreds of millions of dollars to try to develop a product that will be sub-par or you can solve it immediately, global supply chain, already solved in the U.S. and eight states in the UK, in France and then we also solve the technology piece. So I think that, yes, absolutely, able to be profitable next year but the number will be modulated given our investments back into R&D.

Brett Hundley

Thanks, Sebastien.

Operator

Your next question comes from Graeme Kreindler of Eight Capital. Please go ahead.

Graeme Kreindler

Hi, good morning and thank you for taking my questions here. Just first off, as a matter of housekeeping, you are mentioning in the press release this morning about revenues doubling in the next quarter, I just want to confirm that that the doubling there would not include anything on the Newstrike side of things, that would be strictly from the number reported on the HEXO side this quarter?

Sebastien St-Louis

So the doubling of revenue would include the Newstrike numbers, which are expected to be consolidated in next quarter, yes.

Graeme Kreindler

Okay. Understood. Thank you. I wanted to just elaborate a little bit on the U.S. strategy and understanding that you have supply agreements signed for 2020 to source the biomass there. But, when you think about that strategy how capital-intensive does that get for you? We’ve seen some other of your peers looking to invest a significant amount of capital on the processing manufacturing side. So, how does HEXO look at the U.S. opportunity and how capital-light or capital-intensive would that be?

Sebastien St-Louis

Yes. So the – well, the U.S., I mean, at a very broad level, right, when I look at our world wide plan, when I talk about becoming a top three global cannabis player, if I look at what it took to becoming top three Canadian player, that was about $400 million, right, deployed often down between CapEx operations. And I was pretty efficiently deployed. So if I looked at Europe, that's five times the size of the Canadian market that will be 400 times five gets you to $2 billion in investment required for Europe, the U.S. is about 10 times the size. So you're looking at $4 billion.

So look at the total capital deployment of about $6 billion. Now that's not all going to come from treasury in the form of capital raises. I think there's significant M&A opportunity in the U.S. And so the exact mix of what's going to be done through M&A out of that $6 billion and what's going to be done through capital -- future capital raises is yet to be determined. So whether that's 40-60 or 50-50 we're not sure yet.

We believe that that level of investment fundamentally long term will be required in the U.S. And then of course, that'll break down between your capital, your R&D and then your marketing spend as we get the traditional channels and we lever the ability to build brands in the U.S., which is very exciting, because that's going to unlock our potential. And as you see in that marketing video we put out on our B9 greenhouse on Tuesday, the HEXO marketing team is doing a great job and putting some exciting material out there.

So that gives you a high level idea, where kind of the next five to 10 years of $6 billion requirement to become a top three global player. And of course, HEXO will continue to manage its capital responsibly continuing to rely on our great finance team and calculating our IRR making sure we return a good return on capital and continuing to penetrate in new markets.

Graeme Kreindler

Okay. Understood. Appreciate the color there. Just to follow-up, with respect to the entrance into the U.S. market, is that something where you would lead in with the HEXO brand or would this be leading in through the Truss JV?

Sebastien St-Louis

So leading in with the Truss suite of products, so we're really excited for Truss to come out and have a conference call with Brett later next week and we're excited to be able to start to plan that rollout. Obviously, a lot of questions around what the brands are going to be. They are very exciting. We're touching over 85% of consumer occasions and the marketing team at Truss has done an absolutely dynamite job. But I'll let him take that thunder. The exciting piece is that, we're going to have powered by HEXO marks on every single product going out.

So the idea of course is to build a long-term brand around powered by HEXO, think and tell inside, think the draw where someone can walk into a store know that powered by HEXO sleep has worked very well in the brief format, but then know that if they need to go take a plane the next morning, they can also find a face cream by a trusted cosmetics brand that has powered by HEXO sleep as well. So that's our long-term build on the HEXO brand itself. And of course, in Canada, we'll continue to have HEXO as core products.

Graeme Kreindler

Got it. Thank you. And finally, with respect to the eight states, is there any additional color you can provide at this time in terms of which markets are at the top of the priority list?

Sebastien St-Louis

We're keeping that as a bit of a competitive advantage, figuring out all the regulatory work around how to operate legally in the U.S. is a key strategic advantage. Our regulatory team is absolutely phenomenal under the direction of our General Counsel, Roch Vaillancourt. He's built an amazing legal team, which I really think that if you look 10 years out, those are going to be the two core functions at HEXO. It is going to be R&D and innovation and our legal and regulatory team. So we're really making great inroads there. So I'm not disclosing a whole bunch of color on where we're going to be, but what I can tell you is, we will be legal at all levels of government and we will have no contest from both the DEA and FDA.

Graeme Kreindler

Okay, thank you very much, appreciate that. That's it for me.

Operator

Your next question comes from Matt Bottomley of Canaccord Genuity. Please go ahead.

Matt Bottomley

Good morning, Sebastien. Thanks for taking all these questions. Just wanted to touch back on something Graeme mentioned with respect to what we're expecting for next quarter on that top line. So maybe it has to do with the dynamics of the production ramp up versus getting everything packaged and labeled and excise tax into the wholesale channels, but considering you are producing close to 10,000 kilograms as of this reported quarter versus sales of 3,000, I would have anticipated that that double next quarter would be facilitated just from the HEXO side of things independent of Newstrike, so can you just comment on the dynamics of how that shapes out?

Sebastien St-Louis

Yeah. Happy to Matt, and thanks for the question. So it all boils back down to infrastructure. So I think last quarter I had mentioned that we'd be flat this quarter, we'd double in Q4. And I pointed that the key reason for that is that our infrastructure to package what we were growing was still ramping up, right. And now that infrastructure, this particular quarter has caught up and that's what's leading to the double.

So your insight is right. The infrastructure that’s allowing us to package everything is really from HEXO – from the HEXO side leading to that double. Obviously, we’re going to grow much more, right. Our yields continue to go up every day. We’re going to add the Newstrike yields, which is going to be great. But fundamentally, to truly unlock our infrastructure requirements, I need my Belleville facility. So I need the facility that’s going to have processing capacity for 375 tons per year. And that kicks in, in the fall. So that’s why we’re going to double and not much more immediately, as you pointed out, because we’re catching up our infrastructure in two phases. Phase one now complete, and Belleville in the fall.

Matt Bottomley

Great, that’s helpful, makes sense. And then just on the guidance, again I know this was for 2020, touched on a little bit already. But you gave some good color there that about 25% relates to derivative products, and obviously, there’s some timing there that, that is within your control base than what the government puts out. Can you give any other sort of slicing of that number with respect to just the domestic contribution in Canada between Quebec and other markets? Obviously, it’s about 90% plus, now listing Quebec on a trailing basis. So of that 400, how much of that would be just Canada? And then what would sort of the goalpost be between Quebec and ex-Quebec?

Sebastien St-Louis

Yes, well you can work back to our five year contract with the province of Quebec, year two 35 ton commitment there. So that gives you a good sense of where that should round out. Expect that Ontario will be pretty close as a large market. Alberta certainly doing a great job with their rollout, so we’re excited to be in market there. And so it’s fundamentally all going to wash out to kind of population base with HEXO being overweight in Quebec. So that gives you a good sense, but we’re still working through the exact numbers before we share those.

Matt Bottomley

No. That’s understood. And then just on the Quebec side of things. So given that there was six more LPs entering that market, I know initially when you announced the five-year deal and I understand there’s assumptions that go into this number, but sort of that headline CAD1 billion five-year contract, did that contemplate other entrants coming into the market? And would you still classify at that quantum over a five-year period?

Sebastien St-Louis

I think we still – I still think the potential with that contract is absolutely to hit CAD1 billion in five years, yes.

Matt Bottomley

Okay, great. I’ll flip one more in, and apologies, I know Brett was talking about the hemp side of things in the US, you know, I was pulled out of my office for a second. But can you comment if you would anticipate that an execution strategy in the US similar to what you’re doing on the parameters with Truss or maybe you partner with cosmoceutical, nutraceutical, I know healthcare is becoming more and more topical right now into entities outside of HEXO as part of that rollout? Or are you expecting it to be completely in the economics of your current entity.

Sebastien St-Louis

No, we’re absolutely planning on using our Fortune 500 partners. So in Canada, HEXO has all the distribution. We’re listed now in nine provinces, touch 95% of the population. So we actually provide the marijuana distribution to our partners like Truss and Molson, and our other spoke partners. So when we add cosmetics, when we add health and wellness, when we add edibles, when we add vapes. So in the other markets, we’re going to rely on their distribution. So we’re actually getting their international distribution. So in the U.S. obviously, Molson very strong with a top four position in beverages, top two in the UK. But, as we add more spoke partners that gives us all that more opportunity.

So as we’re focused on the technology and supply chain piece, those partners are bringing a deep understanding, a consumer occasion, the international distribution piece. And of course, the base product, which is very important. Because there’s really two parts to creating awesome cannabis products, it has to work and it has to work better than the rest. And so HEXO has got that covered. But I do think one risk that most cannabis companies are ignoring is that, it will be very difficult for a cannabis company to make a better chocolate than the Nestle, to make a better face cream than L’Oreal and a better beer than a Molson. So that’s why I think our strategy fundamentally leads to better products, which will lead to better success in market.

Matt Bottomley

Great. Thanks, Sebastien.

Operator

Your next question comes from Robert Fagan of GMP. Please go ahead.

Robert Fagan

Hey, Sebastien. Thanks for taking the questions. Just wanted to ask about on the ramp up of capacity at B9. Obviously, we saw in the video, how it seems to be already quite filled up with plants and just wondering if you can give us kind of a cadence of how much of the overall capacity of that facility is already ramped up and what’s left to ramp up?

Sebastien St-Louis

Yes, absolutely. Thanks, Rob. So the facility is full. So as you’ve seen in the video, there’s plants – the entire million feet is full of plants. So with the first harvest out of greenhouse, there’s always dialing in. And you’ll see, if you look at our historical numbers for B6, so our 250,000 square feet greenhouse, that will give you a really good idea of how we’re dialing the environmental with the new greenhouse, how we start to improve yields quarter-over-quarter. I think to get to our 150 ton ramp, reasonable to see is, early 2020 to be at that number on a run rate basis. And so that’ll really reflect incremental yield improvements. But the facility is full and now it’s just a question of you should see meaningful improvement every quarter.

Robert Fagan

Great. That’s quite impressive. Is there any potential delays from beginning sales from that facility around licensing in any kind of way, does that create any type of hurdle to actually get sales generation from that facility?

Sebastien St-Louis

Rob, we have our sales license. We just didn’t think it was a big deal. It’s kind of order of operations these days. So now we’re selling from that facility, I’d say, really we’ve begun. And so, you know that facility is fully licensed, so no worries there.

Robert Fagan

Excellent. Just shifting to extraction now. In light of your agreement with Valens and in the context of Belleville, hoping to be able to accommodate 375 tons of the input material for extraction. How do you see the kind of margin evolution from your cannabis 2.0 products as a result of perhaps a shift in capacity from third-party to your own for the production of those products? And then if you can just give us maybe a bit of insight on how you intend to go about extraction operations in the U.S. with that hemp biomass being secured?

Sebastien St-Louis

Yes, I think from a long-term strategy perspective, if we get a third-party extractor, that can match or beat; a, our capacity; two, our quality, three, our technology. We’d conceptually be happy to work through a third-party operator, which is why we’ve been working with Valens and they’ve been great so far. From a – remember that 10 years out, if HEXO were to look like a team of lawyers and a team of scientists and a great brand Powered by HEXO in hundreds of different Fortune 500 products, that’s what we’re striving for. In the meantime, we have to make sure that we can deliver certain products and that means having enough capacity for HEXO’s scale, which is shooting to be a top three global player.

And quite frankly, there’s nobody else whether that’s the extractors, other LPs that have shot for the level of scale that we’re putting in. We are preparing for the possibility that we could shoot not just for a 20% share in Canada, but actually grow that. So, we are preparing ourselves, and let’s say, we were to say this is a 1,000 ton market with 375 tons of potential processing power and 150 ton to grow, the idea is we’re already starting to prepare to have less grow in the supply chain, so 150 tons moves through our manufacturing and extraction and formulation stage, which has 375 tons supplemented by hemp in the short-term, in the medium term, perhaps supplemented by other forward contracts with other licensed producers or imports from overseas, and then moving on eventually to the final phase, where we’re simply an IP and technology company.

During that whole journey, as I mentioned, in the very short-term, we’ll see some margin compression, especially as our sales on flower come in. But that margin should start to dilate back up. The nice thing is as we scale up; our costs are coming down significantly. And I think a testament to the team has been the supporters, you see our revenue per gram of course has dipped, but we’ve managed to hold our gross margin relatively stable. So, we’re recovering the costs. Unfortunately, I do think that in the face of lowering costs, you will have continued selling pressure. So, it will be difficult to translate those costs to additional gross margin until those advanced products come online.

Robert Fagan

Okay, great. Thanks for that color. So, as an – last quick one, if you could maybe – I don’t know if you can give us an idea of the mix in terms of the new products in Canada. You mentioned the gummies, vape and beverages; can you give us an order of magnitude of the split there? What would be the biggest drivers?

Sebastien St-Louis

So, our top priority is our beverage launch followed by our vape launch and then gummies is one that we think from an edible’s perspective, will be very interesting. So, they’re in that order. I think steady state in the future as I mentioned on the call that, at steady state, this market will be about 35% flower, 65% advanced products. Of the advanced products, we think that beverage and vape could easily be a third each with other categories such as edibles, which gummies is the largest part of the edible segment, which would be less. I had started to give you a bit of an idea of how we see that well.

Robert Fagan

Great. Thanks a lot.

Operator

Your next question comes from David Kideckel of AltaCorp Capital. Please go ahead.

David Kideckel

Hi, good morning. Congrats on the results and thanks for taking my call. I just wanted to go back to the U.S. and with you – Truss, the JV, in particular. So, when we’re talking about in the press release and we’ve talked about this morning so far, when you are looking to enter into eight states in 2020, just to clarify for housekeeping here. Does this only – and you also mentioned, Sebastien that you want to lead into the U.S. with Truss. But do these initial eight states; is this only going to be including the Truss products?

Sebastien St-Louis

No. So, it will be including Truss. Well and specifically, I should clarify. So, Truss is a Canadian joint venture. So, it’s Canadian-only. So, most likely, the exact form of entity we haven’t revealed exactly how we’re doing this with MCBC yet. So, MCBC and HEXO will be doing a joint release at some point in the future to explain exactly how under which brands. Of course, Truss and all the work that’s been done will be leveraged on the marketing side. So that’s one piece. The other piece is we’re going to have our other spoke partners. So, I’ve said one a year. So, you could assume that in 2020, we have two at this point. Late 2020, maybe three. And, yes, the idea is to enter the U.S. using our spoke partners not to go direct with HEXO core products in the short-term.

David Kideckel

Okay, thanks. That’s helpful. And to clarify as well, then you mentioned that the Truss beverages are great. And so there’s a lot of progress that has been made. So, can we assume that the development in the R&D, all the innovation behind the actual beverages, are those nailed down now or are they still being tweaked?

Sebastien St-Louis

Our 1.0 is nailed down and our 1.0 is amazing. It's better than anything, that's in the U.S. today. I am having that, but I think our 1.0 has a lot of room to grow. What I'm excited about is the future, right, if I'm excited about a two minute onset, I'm excited about a 45 minute onset, I'm excited about diet experiences, a sparkling water where it reduce your appetite using the ingredients in cannabis that are non-psychoactive. These are all things that R&D teams are working on and I think that's going to provide really exciting roadmap for the next five years. Today, our starting lineup is best-in-class, it's better than anything that exists on the planet that I've seen and so I'm tremendously excited about that.

David Kideckel

Okay. So then just to confirm then, so the Truss product – beverages are ready to go subject to, I guess number one, Canadian, the derivative legalization and then also with your – eventual in near term strategy in the U.S.?

Sebastien St-Louis

Yes, we have technology. We have a level of technology in product quality right now, that puts us in our own class. I expect that at launched, you will probably – we'll see how we're performing against the other top LP. Obviously, Canopy with the Constellation partnership, I'm sure are getting coming out with something pretty impressive as well. But I haven't seen anything else in the industry right now that compares to what we have today. So what we have from the technology perspective today is absolutely phenomenal. The team's done a great job.

And now the question is going to be the ramp up in infrastructure, and that ramp up in infrastructure is dependent on our Belleville facility rollout and the Truss rollout. Within that Belleville facility, which we are scheduled to deliver for the fall, but that is the risk to [indiscernible] that full roll out and obviously for the 2020 plan in the U.S., there's some infrastructure in U.S., which is why we formed HEXO USA, our corp. in Delaware, to have that corporate structure to start acquiring assets in doing infrastructure build out in the U.S.

David Kideckel

Okay, great. Thank you for that. Another question, I have a couple more here quick ones. I know Sebastien, you mentioned sort of capital deployment over time around the $6 billion mark, which could include both M&A and capital raises, is there any, just to tweak this down a little bit over the next say 12 months or six months to 12 months, can you provide any CapEx guidance for HEXO?

Sebastien St-Louis

We're not going to provide the CapEx guidance is just yet, but thanks for asking. We'll see what we can do over the following quarters in terms of thinking about that. But I want to make sure we nailed down our numbers and again, we don't give up exactly of how we're entering the U.S., just yet. I'd rather do it and then tell you guys about that, if that's all right.

David Kideckel

Understood. That's great. My last question, Sebastien, actually, I think it was brought up by another analyst before passing around bio-synthetic s. I'm just wondering in all of your discussions with Fortune 500 partners, I mean it's apparent, I think from a lot of our due diligence that a lot of the Fortune 500 partners, especially when considering cannabis, they really pride their final product with consistency, purity and potentially low cost as well.

So on that note with bio-synthetic s, can you maybe – is there any color you can give to your discussions with the Fortune 500s around any sort of bio-synthetic discussion that’s relevance for them, and how that could impact your strategy if you decide to move into the area of bio-synthetic s as well?

Sebastien St-Louis

Yes. I think bio-synthetic certainly have a lot to offer but they also have a lot to prove. And so from our perspective, we’re waiting to see who will emerge as the bio-synthetic winners, before making significant investments in that space. And to us, the winners are not only the ones that will solve scale, but also the ones that will solve intellectual property and especially when it comes to rare cannabinoids that would be relevant to a specific powered by HEXO experience. So those are the really ones that are going to keep our attention. We have great relationships with quite a few of the bio-synthetics companies. We’re keeping an eye on them. We’re tracking their progress and I think from the Fortune 500 perspective, they’re leveraging our maturity in market and understanding of all that to kind of sort it out. The Fortune 500s today, from my perspective are not taking bets on technology to come, they need to solve the market access now and that’s something that HEXO is doing today from plants.

In the future, of course, I’ve talked about the HEXO team being lawyers and scientists that could very well mean that our supply chain is sourced from greenhouses in Canada for the flower, hemp fields in the U.S. for 80% of our cannabinoids and then a few bio-synthetic providers for rare specific cannabinoids as cost depends. But I don’t plan on marrying myself now to a cost structure. I think we can pivot in the future depending on which solution becomes best. And I think that the reason of Fortune 500 would need HEXO as a partner, it’s because to figure all this out in a relatively effective way, it takes a lot of energy and expertise which they simply don’t have on their team. So that’s why our powered by HEXO, a partnership model has resonated very well with Molson and is resonating very well with a number of companies in our funnel.

David Kideckel

That’s a really great insight, Sebastien, thank you. That’s it for me.

Operator

Your next question comes from John Chu of Desjardins Capital Markets. Please go ahead.

John Chu

Hi. Good morning. Just a couple of quick questions. On the U.S. strategy, the $400 million in revenue guidance for 2020, is that including any revenue generated from the U.S.? And then second one, I just...

Sebastien St-Louis

No, it doesn’t, John, and let me clarify. So the 400 million guidance is for fiscal ending July. When I say 2020 U.S., I’m talking to December calendar. So there’s some offset, but the nuance to consider as well is that our current spoke partner, Truss, so with Molson and depending on how the future ones will be structured, the revenue itself does not consolidate up to HEXO. We’re going to see our 42.5% share of the net income or loss. So you will see it post bottom line, so obviously, show up on our financials, but you wouldn’t see the revenue and so that’s the primary reason that’s not in the guidance.

John Chu

Right. Okay. And then to what extent does FDA approval on the CBD side come into play in terms of your entry into the U.S.?

Sebastien St-Louis

Yes, we’re watching the FDA very closely, because how they will decide to treat overall CBD treatment relative to the pharmaceutical, nutraceutical, et cetera will obviously have an impact on how we’re operating. But we’re currently following a path where we believe we’ll have no contest from FDA. So very confident at this point in our strategy.

John Chu

Okay. And then just lastly, you mentioned in terms of shipping flower to Ontario, BC and in other provinces, are you going to ship that officially right now and what's the update on Alberta? That's a pretty big market and it doesn't seem you're having much exposure there at this point in time?

Sebastien St-Louis

Yes. So when you look at the – you look at our throughput of course, Quebec remains – has remained a huge market. But that has not been demand constrained. That has been supply constraint to-date. As we double this quarter and as we go of course, and we start to ramp from there into our 400 million next year, as I mentioned, the infrastructure block goes away largely by fall. So you have more and more capacity to supply into these markets. And we want to make sure that we are not only a preferred supplier in Quebec, but that we're a top supplier in all other provinces. So we want to make sure when we go into these provinces that we respect our commitments, we make sure that whatever is on the shelf is always available and that we really provide a great customer experience.

So not so much demand cap, and that's why you haven't seen anything in Alberta yet, but expect to see more and more things in other provinces as the months go by.

John Chu

Okay, that's it for me. Thank you.

Operator

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

Krishna Ruthnum

Hi. This is actually Krishna Ruthnum on for John. My first question is on pricing. And my apologies, I missed part of the prepared remarks that there's a meaningful decline quarter-over-quarter in your pricing. I just wanted to understand whether that was simply due to lower oil sales, a greater focus on Quebec or maybe what you alluded to earlier, which was constraints on the packaging size?

Sebastien St-Louis

Yes. Thank you. I think a little bit on oil, but it's really – we're starting – so earlier in the call, I'm not sure you got the point, but I was talking about how we're going to go into a period of price compression around flower as you have these 150 smaller LPs that vie for market share and that really have very little ability to go to market, right. So we're already seeing that price compression in the market begin, so that has started. And I think that it's prudent that we all expect that to continue for a certain period of time.

And I think that it's been prudent to have a bet on companies like HEXO that will have to scale in operational expertise and cost control to survive their margins in that price compression. So as you've seen, despite the price compression we've held our margins, so I'm not too worried about it. But the smaller producers over time will not be able to because they won't have the economy of scale.

Krishna Ruthnum

Okay. Thanks for that. I also had another question just around the 260 tons of hemp supply that you announced. Are there any terms or is there any additional color that you can give us just sort of around that supply?

Sebastien St-Louis

So we're not disclosing the terms, but you can kind of look at how we operate. We always operate from a kind of a fundable supply, globally approved supply chain perspective. So when we look at our cost per milligram, we track everything. And then there's – so there's two things to look at. Where do you need the supply to come from and how is that supply relevant to specific jurisdictions? So in the US, you need hemp to participate, but then two, whether it's bio-synthesis, hemp or marijuana, we are continuously evaluating our cost per milligram of all cannabinoids in formulation and flower and then searching the most cost effective alternative. So you can assume that our hemp transformation will be at a good price.

Krishna Ruthnum

Okay. Thanks for that. And one last question just on your guidance for Q4, just given where we are in the quarter, just wondering if you can give us some comments on the trend to date as well as your – the pace and sort of your confidence of reaching that target?

Sebastien St-Louis

We're going to reach the target. I mean, I'd ask you and I continuously, I welcome a challenge as I think that the analyst community is doing a phenomenal job in our space. I welcome more transparency in our space. I welcome a broader discussion for investors. If you ever hear me say something and not deliver, you have to call me out. And in reverse, I would tell you today, nobody has ever called me out on anything because HEXO has always delivered what we said we would. We're delivering a double this quarter.

Krishna Ruthnum

Thank you.

Operator

[Operator Instructions] There are no further questions at this time. Please proceed.

Sebastien St-Louis

Thank you very much, everybody, for your time and the great questions. Look forward to speaking with you during the following months and of course at our next earnings call.

Operator

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