Q2 2023 Hexo Corp Earnings Call

Good morning, I'd like to welcome everyone to XO Corp, second quarter 2023 conference call.

Joining us today is Charlie Bowman, President and Chief Executive Officer of types of Corp, and Julius I thinks its chief financial officer of Texel.

As a reminder, this conference is being recorded please.

Please note that all financial information is provided in Canadian dollars, unless otherwise stated that a copy of the Q2 results can be accessed on SEDAR and Edgar.

To open the call Charlie and Julia supervisor, a commentary on the quarter, followed by a question and answer session.

To ensure that we get to as many questions as possible.

Last participants to limit limit themselves to one question.

With that I'll now pass the call over to Charlie Bowman, President and CEO of <unk> Corp.

Yeah.

Thanks, and good morning, everyone.

I am pleased to review our results in the quarter ending January 31 2023.

I will begin by detailing some of our financial accomplishments highlight.

Highlight a few of our key products and operational achievements that happened this quarter.

I'll just take you along the journey to a leaner operation.

On the quality of near term profitability afterwards, Joyce who'll walk us through Hexose financial results first before I start.

About nine months ago, I had an opportunity to sit down with a number of the original shareholders, none of whom have sold a single share of stock.

Your advice to me was once we reset the balance sheet is to take off my corporate tie and to focus on the key consumer elements of why people purchase campus high THC pricing Turpin.

The best strains to deliver this consumer experience at the lowest price we can.

That's what we've been doing.

So let's address this legacy balance sheet.

Which was my first priority.

Over the past six months, our aggressive cost cutting strategy has reduced taxes overall debt.

Austin, improving our balance sheet, we repaid a total outstanding principal of 40.700 million, which was matured on December the fifth 2020.

Listen all in crude and unpaid interest. This was the first major step of strengthening our balance sheet next we focused on strengthening our margins with a higher value product mix leveraging a series of intense cost reductions and pricing disciplines, we focused on quality measured by Pharmacopeia.

Test methodology procedures with.

Focused on the critical items and improved our first past success rate all in our team decreased our operation expenses and significantly reduced our trade receivables.

Now turning to our product and operational developments, we've streamlined our recreational cannabis portfolio focusing on delivering the best consumer experience.

We expanded our health and wellness portfolio by addressing unmet consumer needs, but only cannabis can address featured on already can medical platform.

We signed a long term agreement with entourage health securing a multiple channel distribution network into the medical cannabis market over the next three years. This partnership is key to expanding our health and wellness portfolio and accelerates our ability to grow the business and deliver premium cannabis products to more Canadians.

But to especially our bedrooms.

In the recreational market, we are focused on creating and a unique sensory experience by highlighting some amazing TERP teens in high THC strains from our in house developed TNT strange.

We launched three new <unk> branded products.

Two new original stash products.

All using the new TNT Strange. These strange were released after about 20 months of research and development, which reinforces our belief that properly balanced hurricanes dramatically enhance the candidate experience in fact consumers validated our commitment to this unique cannabis experience.

Our first <unk> launch animal rock sold out within 24 hours of its release replenishment summed up in two days and the third order sold out in less than a week the fourth orders in the process of packaging this week.

If not the fastest selling strain, Ontario, Canada full history.

The good news Violet Borg is next.

As we move towards a leaner portfolio, our long standing commitment to education remains strong.

So those next generation of products from our internal genetics program highlights total Cabana boys high THC percentage with a wide range of turbines is this continued pursuit to deliver the highest quality cannabis that allows our premium strains to where the crown on the ready can brand we produce some of the industry's highest THC percentage.

Without a doubt, but total cannabinoid content.

With an incredible breadth of turbines and flavonoids, it's an outstanding consumer experience.

Furthermore, these new cultivars gives us a high production build with greater margins and the industry's leading hurricanes THC percentage in total carnival. It's in fact, that's TNT.

Lastly, our team is committed to the ongoing cost efficiency by reducing the overall footprint, we've deployed resources into our profitable segments and eliminated unprofitable business brands. For example, we saw the high growth potential in the pre roll segment, specifically in the infused provable area.

We expanded our capacity and our popular straight edge pre rolls facility and Fenwick, Ontario at the end of this quarter. This increase.

Four fold of readiness straight edge.

Yeah.

Okay.

Capacity and expands our product offering and capabilities. It enables <unk> to deliver the preferred candidate experience to all of our red can and original stash customers and with that I will turn the conversation over to join us to discuss our financial results.

Thank you Charlie and good morning, everyone I'd like to remind you that all numbers I shared today are in Canadian dollars unless.

Unless otherwise stated before diving into the financial results I'd like to comment on one of our biggest financial challenges cleaning up the balance sheet, our strategic redeployment over the last two quarters has included a thorough review of our underperforming assets and taking a strong action to repair the balance sheet. The early financial results.

Some of our physical year demonstrate a prudent path towards long term profitability as Charlie noted the debt repayment has help delever our balance sheet positioning <unk> for long term financial success I would also like to note that despite difficult market conditions, and intensifying competition, which has put significant pressure on price.

We haven't made the decision to maintain our fair pricing as part of taking a sustainable approach and our commitment to quality now I will discuss Q2 results. This quarter. The company has hit two important milestones first positive net income in the second positive cash flow from operations.

This is attributable to an 11% reduction in SG&A spending from the prior quarter, along with a 20% reduction in trade.

Our accounts receivable.

Revenue did however, slow in the quarter with a 26% decline to $24 2 million when compared to Q1 'twenty three of $35 8 million. The decline can be attributed to a number of different factors.

Price reductions by our competitors in our biggest markets, Ontario, Alberta, Quebec, and British Columbia, leading to XO market share declines also the revenue was impacted by returns of seasonal products due to low velocity on available supply for certain demanded products and specific product.

Is being placed on hold due to due to pricing reductions in key Ontario markets.

Lastly, we ceased recognition of cannabis infused revenue as the result of the Trust Trust operationally operationalize them Theyre, Canada selling license.

At the same time, our net sales declined 54% relative to Q2 'twenty two due to increased competition and diminished performance of XO brands in key markets of Ontario, Alberta, and Quebec, along with the removal of product portfolios from the divested 48 North business ends ended this brands.

Looking at our adjusted EBITDA in the quarter, we saw a loss of $2 4 million, which is an increase of $1 8 million from the prior quarter Q1 'twenty three on.

On the positive note the <unk> branded sales did increase 9% from Q2 'twenty two as a result of the increased after newness on the Alberta market. Furthermore, our increase in gross margins confirmed that we're on track to profitability on a final note I would like to thank anyone everyone at <unk> for their ongoing commitment and positive.

Look we look forward to leveraging this team's experience to become the standard of excellence in the industry.

You for continued support now I turn the conversation back to Charlie.

Thanks Darius.

Before we open the floor to questions I'd like to Echo that the successes we achieved in the second quarter resulted from our strategic alignment which include Ling.

Tackling the legacy balance sheet stripping all nonproductive processes capitalizing on our strengths. These adjustments will continue to create a more profitable entity to the balance of the year.

Finally, I'd like to thank all my fellow Kennewick, Cayuga Masan grow sites and all of our employees and partners for their continued commitment to our business and customers. This transition has not been simple or easy, but I can't thank my teammates more for their efforts.

Efforts in making <unk> a success with that we will continue our remarks and open the floor to questions.

Thank you if you would like to ask a question. Please press Star then one on your telephone keypad.

The first question is from Matt Bottomley with Canaccord Genuity. Your line is open.

Hey, good morning, everyone and thank you for the question I just wanted to get a little bit more color on what you believe the you know the sustainability is in the let's call. It medium term for the strategy of you know, maybe we're giving some revenues to protect profitability.

Do you kind of look around some of the dispensaries in just the restrictive nature of the regulations.

Increasingly difficult for any L P to kind of get differentiation.

On Matt with respect to.

Branded products or things that are more.

Characteristics of the product themselves as opposed to pricing. So I'm, just curious not try to tease guidance out or anything like that but just where are you sort of think the the top line erosion could go proportionately from where you are today given the dynamics in this sector.

Thank you Matt that's an outstanding question, we took a hard look at when the price War began last quarter, a little before the last quarter.

And measured out what would be the impact to us if we actually participated maintain that volume revenue number volume and revenue and what that would impact into our net income as it would come down and it was significant.

Anywhere from $5 million to $8 million loss and it just wasn't something that we wanted to entertain at the same time, we were in the process of getting ready to launch our Tnt's series and with that to your point.

Right now cannabis cannabis and so the key point of differentiation is that consumer experience. The consumer experience comes from THC. It becomes from a total <unk> of boys and it comes from turbines and so our points of differentiation was to launch. These these high teen.

The AC high Turpin strains and place them in across the different parts of Canada. So in some parts, we have animal ronson violet fog and other parts of the market. We have ghost Gelato sex Panther Haas. The board, we have the CBD push which is more of a medical brand and fitness and well being.

And so the goal here was to get the strains out and allow those strains to start to differentiate in addition to our straight edge, we recognize the the the growth of the infused pre roll and we have launched our atomic sour haze into this area and we've got a series of other products coming on.

So for US was to reset the balance sheet to reset the operations. So that we could not provide me too products into the market, but to have truly differentiated cannabis products with standing experience from the consumer side.

And Thats and Thats, what we focused and that's a great question.

I appreciate that and then just one more quick one for me just on the <unk>.

Cash flow generation profile, so but are you guys.

In fact, it into positive territory from operations it looks like though when you look at the.

The dynamics Theres pretty big swing still in working capital that are causing you know for some of the volatility. So I'm just wondering how you see that smoothing smoothing out over the next little while and if you think the inflection into positive territory is sustainable within the next couple of quarters.

Yes, I can take that one a large alerts chunk of it is if you just look at trade AAR from quarter to quarter.

You see a significant drop while was flat from Q4 to Q1, and so we very aggressively.

Improved our cash collection efforts, and then changed our invoicing procedures a bit to basically move up those payment cycles does that coupled along with if you look at our SG&A footprint and just overall footprint those expenses are down.

Quite quite significantly so we're happy on how that is how that is how that is trending in the business hopefully that answers your question.

Got it alright, thanks, a lot guys.

Okay.

Again, Thats star one if you'd like to ask a question. The next question is from Frederico Gomez with <unk> capital markets. Your line is open.

Sure.

Hi, Good morning, Charlie you just thank you for taking my question.

In terms of your balance sheet.

Our capital needs you mention your ATM is there any specific reason why you have decided not to start using that yet just given that you seem pretty close to breaching our covenant there and second part here is just if you decide to use that ATM going forward or just some sort of other equity raise.

How would that impact the conversion price of the senior notes held by Q right. Thank you.

Yeah.

Yes. This is Charlie Thank you Fred Rico AR for the.

The ATM one of the reasons that we've taken a look right now are not tapping into the ATM was during this price.

More that was going on for lack of better words, we needed to establish what the new baseline was going to be as we look through to to what the our cash consumption would be and also how low we could take our our cash burn from a standpoint of our cost takeout and our savings. In addition, with the new the velocity of the new <unk>.

Trains coming on it really does reset what the balance in the business was looking like we've been really fortunate with both are our primary debt holder, which is til ray.

But then all of our partners that we work with about supporting US as we go through from a standpoint of.

What we would need from cash what we would need from a standpoint of working together.

To ensure that we have enough cash to run the operations and then I think most importantly is when you look at like til right Theyre not only an investor in US there also a primary customer for us too and so there's lots of ways that we can work together to address this capital needs at the ATM is clearly one of them we've had a number of <unk>.

Banks that we've that we've had discussions about for investment. So the good news is we have a number of options. The goal here was is to live within our means right now and as I said, a number of quarters ago. The goal for our operations has always been to be self sustained.

So that's kind of still of the mindset that we have right now Joyce any color you want to add.

We're continuously working with our board and internal management to evaluate all strategic financing opportunities. So whether that's the ATM, whether thats a lock or other means that's always on the table and under evaluation.

Thank you I'll hop back in queue.

Okay.

Yes.

The next question is from Aaron Grey with Alliance Global Partners. Your line is open.

Hi, good morning, and thank you for the questions.

First one for me just wanted to get some context of what you think the impact might be of some of the changes that <unk> is making.

And whether or not that impact might be more so for the retailers and some of it might flow through to you guys as they look to reduce the margin that they're taking and then whether or not any of that give back Mike just flow right down to continued pricing pressure or do you think that might end up falling due to your guys' profitability as well thanks.

That's a great question them from a standpoint of all the boards have been really active about reaching out to us.

Anybody was.

I don't think anybody was surprised with the price war in the magnitude that went on in the last five months I think the damage that can occur to the industry is significant because no one wins in a price war and so I think one of the areas with the Ocs, taking a lower margin and resetting is clearly to help quite a bit.

The retailers.

A lot of the especially smaller independent retailers are bleeding from the standpoint of just the plethora of retailers that are on the market right now and undercutting one another I think I think from a standpoint of the how this tanks on what we look at it is I can't say on the industry and the other.

But we look at the discipline of the business as the business should be profitable the business should have a point of differentiation in every product line that it brings to the market and you should charge a fair value that doesn't mean I charge. The premium the highest it also means I'm not the lowest in the industry, but it should be fair our products.

They're all priced in a good spot where we're in a fair area of fair.

Fair price point as far as our margins go.

We've done an incredible job within the operations of getting cost out to where I feel very comfortable.

With the statement that if we're not the we're one of the lowest cost operators in the industry as such it allows you to take that volatility.

When people do selling us like to get into a price war and they should be more disciplined in that.

Back side of that is if there is additional margin that comes out by the by the board by the governments, what it should allow us to take away from the illicit market.

Was the illicit market had a fantastic growth this past year and as a result, they have plowed it in throughout the country and it has taken away some quite a bit of the growth. So that's one of the key things that we work with and hopefully the government continues to take on is to curb this illicit market. Its a good question.

Thank you.

Okay, great no. Thanks, very much of that do you have answered that's helpful. I'll jump back in the queue.

Thank you.

Again as a reminder, the star one if you'd like to ask a question.

And it looks like we have no further questions at this time I will turn it back over to Charlie Bowman for any closing remarks.

Yeah.

Just wanted to say thank you to everybody in the time it was a dynamic.

Nine months that we've gone through and from a standpoint of walking us.

The opportunity to go through what our quarter. Two results are I just wanted to say thank you.

And I know from time to time, we have analyst calls that are scheduled up any additional questions. They have will be more than willing to take on thank you very much and I hope everybody has a fantastic Friday.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating.

You may now disconnect.

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