HEXO Corp. (HEXO) Q3 2023 Earnings Call Transcript

HEXO Corp. (HEXO) Q3 2023 Earnings Call Transcript June 15, 2023 10:00 AM ET

Company Participants

Charlie Bowman - President and Chief Executive Officer
Julius Ivancsits - Chief Financial Officer

Conference Call Participants

Matt Bottomley - Canaccord Genuity

Operator

Welcome to HEXO Corp.'s Third Quarter 2023 Earnings Conference Call. Joining us today is Charlie Bowman, President and Chief Executive Officer of HEXO Corp.; and Julius Ivancsits, Chief Financial Officer of HEXO. Please note that all financial information is provided in Canadian dollars unless otherwise stated, and that a copy of the Q3 results can be accessed on SEDAR and EDGAR. [Operator Instructions]. Please note, this event is being recorded.

I would now like to turn the conference over to Charlie Bowman, President and CEO of HEXO. Please go ahead, sir.

Charlie Bowman

Thank you. Good morning, everyone, and thanks for joining our call. As you know, this is our last earnings call as a public company. Yesterday, shareholders voted in an overwhelming majority to approve the arrangement agreement with Tilray Brands with over 90% voting in favor.

With that in mind, before we dive into our results for the quarter, I wanted to start with a quick look back over the last 12 months. We will then detail a few of the developments from the quarter and as well we'll walk through HEXO's financial results.

First, over a little year ago, Julius and I assumed the CFO and CEO roles at HEXO. At that time, HEXO faced significant challenges, including a debt leverage, liquidity constraints, excessive inventory, excessive overhead costs, acquisitions were not integrated into the parent organization. In short, the company was grappling with a host of financials and operational issues. And I think it's fair to say we were on the verge of insolvency.

However, over the last 12 months, the organization has made remarkable progress as we have executed our strategic priorities to strengthen the balance sheet, resize the business, and position the company for long-term growth and profitability. Whilst also positioning HEXO to deliver the preferred cannabis experience to all of our cannabis consumers. Outside of the financial progress, HEXO has also made advancements on the product side to optimize its portfolio.

We refocused our portfolio to leverage our strength in premium cultivation, and we divested businesses that did not offer HEXO a real competitive advantage. Specifically, we launched a number of new products, including our new proprietary strains. We called it the TnT series, which provided -- which allowed us to pivot from generic strains that were more like a commodity to more of these specialty ingredients.

We capitalized on a high growth potential in the pre-roll segment and we expanded our capacity in our popular Straight Edge Pre-Rolls, including accelerating the Redecan ready's product to include some of the TnT series and expanding our original Stash brands. This expansion resulted in a fourfold increase in the Redecan Pre-Roll capacity and enables us now to meet the growing consumer demand across Canada.

Taken together, these efforts not only resulted in a higher quality cannabis experience for our customers, it also drove our margins higher. Our margins are now about 10% higher than they were a year ago. Julius will share a bit of the financial progress we've made over this period.

Julius Ivancsits

Thank you, Charlie. Starting with our balance sheet over the past 12 months, we have paid off more than $40 million in legacy debt and have refinanced over $235 million in high-cost debt, which combined have reduced our annual interest expense by $16 million. We also drove significant impactful improvements in our cost structure by pursuing aggressive cost-cutting strategy, which has reduced our SG&A footprint by almost $17 million on an annualized basis.

Next, we delivered improvements in our working capital management as we have reduced our working capital by $135 million versus a year ago. Inventory alone was down over $100 million as our S&OP processes were redefined and still in public philosophy, every cannabis plant is not a good plant. In short, we do not grow just to grow.

The outcome of the process and cultural changes have resulted in our cash conversion cycle improving by over 100 days, which is truly remarkable and reflective of the efforts of the entire finance and operation teams. Given these successes, HEXO has delivered positive cash flow from operations for two consecutive quarters. Charlie, back to you.

Charlie Bowman

Thanks, Julius. Now turning our developments into the third quarter. First and foremost, we entered into a definitive agreement with the Tilray Brands, whereby Tilray will acquire all outstanding shares of HEXO. This builds on the strategic partnership we established last year and reflects the significant progress we've been able to make both financially and operational since that time.

Due to the transaction, we incurred a 74 CGU impairment charge to reflect Tilray's purchase price combined with an acquisition fee of $20 million, resulting in a net income loss of $115 million for the period. In addition to the Tilray announcement, we also had a number of notable operational and product developments even as we continue to face a challenging competitive landscape and an ever-increasing uncertainty in the macro environment.

As we shared last quarter, our emphasis on bulk sales has continued to pay off. With bulk sales more than doubling from second quarter, we effectively leverage the Redecan master growers’ program as a point of differentiation for HEXO. As you may recall, this has been part of our strategy to expand our B2B sales.

Next, we saw strong momentum in our in-house developed TnT strains, which now represent over 37.5% of all flower sales. This is an incredible growth since the introduction of these TnT strains to the market just about four months ago at the end of Q1. And more importantly, we are seeing this momentum continue into Q4 as our TnT strains are now being launched across Canada. Next, we'll be launching a new hemp paper rolled readies product. This will be launched later this fall, and it will be an amazing product. Altogether, this validates our focus on growing the best strains to deliver the best consumer experience we want for our customers.

Now I'll turn it back to Julius, who will go through the financial results for the quarter.

Julius Ivancsits

Thanks, Charlie. Looking at our Q3 financial results, expense controls continue to remain our top priority, and I am pleased to share that SG&A spending improved by $2.5 million or 20% compared to the second quarter after adjusting for the annual Health candidates. This marked our four-consecutive quarter of sequential improvement in SG&A spending.

This demonstrates the success of our inside our Core Walls program. In terms of revenue, net sales decreased 11% quarter-over-quarter to $21.6 million. This decline is attributable to lower adult new sales in Alberta, reduced emphasis in Saskatchewan and in Manitoba, supply chain -- I'm sorry, short-term supply issues, and delisted products in Quebec.

Growth at Q3 '22, our sales are down 53% due to increased competition, fee rationalization of lower-margin products, soft performance in key markets, Ontario, Alberta, Quebec, and the removal of product portfolios for divested benefits business, along with trust beverage.

Our gross margin increased 10% versus the prior quarter to 43%, confirming that our strategy to focus on our most profitable brands is delivering results. Moving on to adjusted EBITDA. Excluding the $2.5 million in annual Health Canada fees, we recognized an adjusted EBITDA loss of $1.4 million.

This represents an improvement of $13.2 million versus the year ago quarter. Finally, looking at cash generation. Cash is always paramount. And as I mentioned earlier, we were successful in achieving positive cash flow from operations for the second consecutive quarter and we delivered a $78 million improvement in operating cash flows versus Q3 '23 -- for Q3 '22, reflecting an aggressive cost-cutting strategy as well as balance sheet improvements we have achieved over the past year.

Before I pass it back to Charlie for his closing remarks, I would like to extend my deep thanks to the HEXO team and the Board of Directors for their ongoing commitment and efforts to make HEXO successful. I'm proud we have accomplished over the past year in an industry that is going through a significant change.

Charlie Bowman

Great. Thanks, Julius. Looking ahead, we're very excited about closing the transaction with Tilray Brands, which is on track to be completed by the end of the month. Tilray has been an excellent partner over the last year. And as a combined company, we will be better positioned to drive profitable growth, capitalize on this complementary portfolios of an industry leading with these high-growth brands.

We are confident that we are leaving the company in good hands with Irwin Simon as HEXO becomes a part of team Tilray. Before we open the floor to questions, I'd like to thank all of our employees, our partners, our customers for their continued commitment to our business and to allow HEXO to be the preferred cannabis supplier. It's been an honor to work with you over the past year. I look forward to seeing everything the future holds as a stronger company combined with Tilray.

With that, operator, we're ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question is from Matt Bottomley with Canaccord Genuity. Please go ahead.

Matt Bottomley

Good morning, everyone. Thanks for taking the question. Congrats on the vote yesterday. Just wanted to get a little more color. I know in your prepared remarks, you had mentioned some of the initiatives you've been doing with various products and in various markets. But just given that there's been double-digit sequential declines for the last couple of quarters in your adult use. Are we at sort of a trough here and you're anticipate -- what you're anticipating going into the closing and also just on the wholesale side, you sort of increased that by 2x. Just wondering if that was opportunistic or if there's an anticipated higher level of wholesale contribution going into the closing with Tilray?

Charlie Bowman

Thanks for the question. It's really good. On the B2B side, that's an area of the wholesale, if you want to call. That was an area that Julius had identified when we first came together because of some of the benefits that you could have from the standpoint of a little faster to cash on those sales. Combined with -- when we grow with strain, one of the areas you do is you wind up growing 1.2 tonnes, but you only end up someone maybe 900.

You have that extra just in case there's any issues during the growing process. And so those orphaned and stranded strains they became excellent opportunities for us to put out in the market. Now let me be really clear. None of the TnT strains, which are proprietary, none of those strains we've sold into the BNB market. Those are held within the HEXO brand.

But what you're seeing with those B2B brands, it was a strategic area to leverage this Redecan master growers’ program, which gives us some of the lowest cost, if not the lowest cost per gram in the market. It also allows us to have some of the highest level of THC and terpenes into the market, which is really what the consumers are looking for and the budtenders are looking at the point to differentiate in the retail brands.

Now going back on the retail sales, one of the areas we're seeing is when we start putting the promotional value and the consumer comes in and they buy the new TnT strains, what we're seeing is some of our older strains are now starting to kind of fade out or age out. And so, the repeat sales on the older brands are starting to slow down, while the new strains are starting to come on board. The new strains are only been available in Ontario and BC through the end of this quarter. That changes this quarter in Q4 and actually starts to go national.

And then when you add this amazing marketing and branding strength that's going to come on board with Tilray, you're going to see a whole new level of engagement and extension into the market. So, I see these trends really starting to grow. I also see an amazing area when you take a look at the bulk and combined with this incredible growth.

Julius, anything you would like to add?

Julius Ivancsits

Yes. The TnT series, and if you kind of listened to us in the past, we started out a little bit in Q1 going into Q2 and then now building momentum into Q3. And as the grow comes on, you just see that kind of pushing out the door. And so, we started off with animal runs. Now we've got Valico, Automic Hour Hays and Ghost Gelato that are all gaining significant traction. So, we're really, really pleased with how that is being accepted by the marketplace.

Charlie Bowman

It's a really good question.

Operator

[Operator Instructions]. Showing no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Charlie Bowman for any closing remarks.

Charlie Bowman

Thank you. Again, everyone, I want to thank you. It was a tough year. But at the same time, it was a very rewarding year, and I want to thank everybody again at the HEXO organization, all of our customers. I want to thank the Tilray team. Irwin has been great from the standpoint of working together and putting this -- the businesses and really the synergies that are going to come through. I really believe this is going to be an incredible company as it goes forward, and I can't wait to see the progress that's going to be made -- so thanks, everyone. Have an outstanding day and have a great Thursday. Bye-bye, everyone.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.