Hexo Corp (HEXO) reports second quarter fiscal 2020 financial results

Key Operating Highlights

• Net Revenue increased 17% to $17.0M from $14.5M in Q1
• Adult-use grams and gram equivalents sold increased 57% to 6,579 kg compared to prior quarter
• Production levels increased to 22,305 kg from 16,107 kg in the previous quarter.
• Expanded Original Stash market distribution to Ontario, British Columbia and Alberta
• Obtained Phase 1 licence for Belleville facility
• Obtained sale of cannabis topicals, extracts, edibles and beverages licence for Gatineau facility, and a research licence for the Company
• Closed a $70M private placement of 8% unsecured convertible debentures, including key management and board participation of over 10%
• Closed two registered direct offerings totalling USD$45 Million

OTTAWA, March 30, 2020 (GLOBE NEWSWIRE) — HEXO Corp. (TSX: HEXO; NYSE: HEXO) (“HEXO” or the “Company”) today reported its financial results for the second quarter fiscal 2020 ended January 31, 2020. All amounts are expressed in Canadian dollars unless otherwise noted.

“We have continued our focus on improving our operations and expanding distribution across Canada.  Our strategy with Original Stash has demonstrated that we can directly compete with the black market,” said Sebastien St-Louis, CEO and co-founder of HEXO Corp. “The industry continues to see challenges ahead, and following a strategic review of the Company’s core and non-core assets we believe we have positioned HEXO to meet these challenges head on.”

Operational and Financial Highlights 

Second Quarter 2020 Highlights

Gross revenue increased 23% to $23.8M from $19.3M in Q1’20.  Net revenue increased 17% to $17.0M from $14.5M in Q1’20.

Adult-use cannabis shipped revenue in Q2’20 increased 21% to $24.4M from $20.2M in Q1’20.  Net adult use revenue increased 20% to $16.3M from $13.6M in Q1’20. The primary driver of the increase in sales during the quarter was the launch of Original Stash in Ontario, British Columbia and Alberta during the quarter, and the increase volume sold in Quebec.  Adult use sales volume in Q2’20 increased 57% to 6,579 kg from 4,196 kg sold in the prior quarter.

Gross adult-use revenue per gram equivalent decreased to $3.49 in Q2’20 from $4.35 in Q1’20, reflecting the impact of the increasing portfolio share of Original Stash, the Company’s value brand.  The adult-use net revenue per gram equivalent decreased to $2.47 in Q2’20 from $3.24 in Q1’20.

Gross margin before fair value adjustments for Q2’20 was $5.7M or 33% of net revenue from sale of goods, compared to $4.6M and 31% in the prior quarter.

The Company incurred an write down on inventory of $16.1M during Q2’20 compared with $23.0M during Q1’20. The write down was realized on the Company’s inventory in comprised of the following;

• Write down of surplus cannabis trim (trim is primarily used for extraction purposes) and milled products in the amount of $3.1M due to an excess of stock relative to the Company’s short-term demand for cannabis distillate production; and
• Write down of concentrated bulk purchase of $11.8M, in part to an oversupply in the bulk product market, of which lowered the value when compared to the contracted price.  The bulk product was acquired through a supply agreement, which is currently the subject of litigation and is alleged to be void as it was negotiated in bad faith at prices well in excess of market.
• Write down in the amount of $1.2M was recognized due to sunk costs related to packaging reconfiguration.

Operating expenses increased to $281.5M compared with $39.5M in Q1’20.  Included in operating expenses, are certain expenses which management believes are expenses that are non-recurring or non-cash and related to significant changes in market conditions.   Included in these expenses are:

• Restructuring costs – During the quarter the Company incurred restructuring costs in the amount of $0.3M associated to the rightsizing of operations that took place in Q1’20.
• Impairments of property, plant and equipment and intangible assets – Subsequent to the end of the quarter, after completing a strategic review of its cultivation capacity, the Company made the decision to list the Niagara facility for sale.  As a result of the decision to sell, the Company undertook impairment testing of the facility, its property, plant and equipment, and the intangible assets acquired from Newstrike Brands Ltd.  The Company determined that an impairment loss of $138.3M was required.
• Impairment of goodwill – As at January 31, 2020, the carrying amount of the Company’s total net assets significantly exceeded the Company’s market capitalization. In addition, slower than expected retail store roll outs in Canada and delays in government approval for cannabis derivative products resulted in a constrained distribution channels which have adversely affected overall market sales and profitability. As a result of these factors, management performed an indicator-based impairment test of goodwill as at January 31, 2020.  As a result of this assessment, the Company recorded an impairment in goodwill of $111.9M.
• Realization of onerous contract – The Company recorded a $3.0M realization as the result of an onerous contract which is currently the subject of litigation.

When normalized for these non-recurring or non-cash expenses related to significant changes in market conditions, the company reports normalized operating expenses of $28.1M, compared with $35.1M in Q1’20. A 21% decrease as the result of a decrease in marketing expenditures and headcount, as the Company continues to reduce previous spending levels to refocus operations on becoming adjusted EBITDA positive. When normalized for other non-cash expenses the company reports normalized operating expenses of $16.1M, compared to $23.9M in Q1’20.

Loss from operations for the quarter was ($289.4M), compared with ($60.6M) in the prior period. Excluding non-cash write downs and impairment charges in Q2’20, adjusted net loss was ($23.2M) compared with ($34.0M) in Q1’20.

During Q2’20, the Company’s calculated adjusted EBITDA results were ($10.3M), compared with ($19.4M). This represents a 47% decrease.

Financial Position

As at January 31, 2020, the Company held cash, cash equivalents and short-term investments of $81.4M.

Management estimates that the working capital as at January 31, 2020 and forecasted cash flows will require additional capitalization in order to meet the Company’s obligations, commitments and budgeted expenditures through January 31, 2021.  Please see the financial statements for more detail.

COVID-19 UPDATE

HEXO is also carefully monitoring and assessing the evolving situation related to COVID-19 and the potential impact to its business, employees and customers. HEXO is working diligently to protect the health and safety of its employees and to ensure that there is no disruption to its supply of medical and adult-use cannabis. As of today, manufacturing facilities remain open, with additional measures in place to allow the Company to maintain the capacity needed to fulfil orders. Additional measures include: temporary restriction of visitors to facilities; work from home policy and support for employees who can do so; employees who feel unwell or have travelled are asked to stay home; hosting all meetings via digital tools; significant investment into additional sanitation measures; consistent communication to employees with reminders and instructions on practicing good personal hygiene, including proper handwashing; and operational measures to support social distancing, such as staggered break schedules and workstations.