You think our quarter was bad? Wait until you see everyone else hit the wall over the next 12 months.
That was the gist of HEXO Corp. chief executive Sebastien St-Louis’ argument on an earnings call Tuesday morning. HEXO reported a fourth quarter net loss of $56.7-million on sales of $15.4-million.
The “first bubble” in Canadian cannabis has popped, Mr. St-Louis’ said, and only companies with low operating costs and scale will survive the coming year. Where will HEXO be after the shake-out? Well, the company’s decision to cut costs – including laying off 200 employees – and its current market share, “tells a much stronger story than the quarterly revenue numbers,” Mr. St-Louis said.
Mr. St-Louis and new CFO Steve Burwash, laboured to give the results an optimistic tone – no small feat given recent layoffs at HEXO, the shuttering of facilities, the retraction of the company’s 2020 revenue guidance, inventory write downs and expectations of a slow roll-out of Cannabis 2.0 products.
Here are some takeaways from the call.
At the core of HEXO’s $56.7-million loss was a $16.9-million writedown of inventory. Expecting higher demand from retail consumers, the company bought a considerable amount of cannabis from other LPs on a wholesale basis. As the price of cannabis dropped, HEXO was left holding product that it could no longer sell at a profit. “The [original] cost is now exceeding its net realizable value” the company said in its MD&A.
“Purchasing that product was before we had full visibility on store count, and so quite frankly, in hindsight, purchasing that product was a mistake,” Mr. St-Louis said.
Revenues hit by returns
HEXO shocked the market earlier this month when it cut its quarterly revenue guidance by 40 per cent. Its reported net revenue of $15.4-million was largely in line with that reduced forecast.
The lower-than-expected revenues were due largely to returns: $2.9-million worth of wholesale product was returned, and HEXO recorded an additional $3.8-million impairment charge because it believes additional product will be returned.
"To further complicate matters, our sell through was a bit lower than anticipated, and we expected to generate a fair amount of wholesale revenue, that did not materialize,” said Mr. St. Louis.
Gross margin declined 16 per cent from the previous quarter, to 33 per cent from 49 per cent.
The company is not expecting sales to improve much in Q1 2020. It is forecasting net revenue of between $14-million and $18-million.
"The reason for the range is it could be subject to retroactive pricing adjustments, as we continue to reevaluate our pricing strategy across the country,” said Steve Burwash, who took over as CFO following the abrupt resignation of Michael Monahan earlier this month after only four months on the job.
Slow launch of 2.0 products
The company announced on Monday that Health Canada has given a research licence to its large processing facility in Belleville, Ont. However, HEXO is still waiting on a processing and sales license for the facility, which will delay its roll-out of Cannabis 2.0 products.
Mr. St. Louis said that HEXO wants to have a “a national portfolio launch” for its 2.0 products, “which means waiting for Belleville to be fully online before launching our 2.0 products.”
HEXO’s initial 2.0 products will be on shelves "within the first six months of calendar 2020, though there's still some regulatory risk associated with that date," he said.
The company will initially focus on vapes and beverages, via its partnership with Molson Coors. It is delaying the launch of other edible products.
"Our gummies line has been down scaled, so we’re going to do that as a proof of concept for our next Fortune 500 partner. When we do the full international and national roll-out for edibles, we’re expecting to do that with a partner. We may do some pilot stuff with gummies, and gummies obviously is not allowed in Quebec, so it will be more challenging from a revenue perspective,” Mr. St. Louis said.
Cut back on facilities
Along with the lay-offs, HEXO is also trying to cut costs by taking facilities offline. The company will shutter its Niagara-area greenhouse, which it acquired only six months ago from Newstrike, and close 200,000 square feet of operating space in its main facility in Gatineau.
“Additional cultivation space is not currently required to supply the Canadian market today... When market conditions improve, we can bring these suspended facilities back online as required," Mr. St-Louis said.
Slower entrance into the U.S.
HEXO still plans to enter the U.S. in 2020, Mr. St-Louis said, but the company will take “a more concentrated” approach. HEXO had planned to launch products in eight states, but will slow its U.S. roll-out to save money. Mr. St-Louis did not say how many states HEXO will launch in.
Alongside the $70-million convertible debenture raise HEXO announced last week, the company plans to launch an At The Market (ATM) offering, allowing it to sell shares on an ongoing basis.
"The ATM is really about building additional capital reserves and it's going to gauge how fast we can do international expansion,” Mr. St-Louis said.
While HEXO touted its 33 per cent market share in Quebec, the company did not come close to its promised shipments to the Société québécoise du cannabis for fiscal 2019. HEXO had been contracted to sell 20 tons of cannabis to the SQDC in the first year of legalization, but only shipped 10 tons.
The 33 per cent market share in Quebec is a “blended number” that encompasses HEXO’s market share over the past year, including the early months of adult-use sales when HEXO was one of only two LPs shipping to the SQDC, Mr. St-Louis said.
Adjusted EBITDA positive by 2020
Mr. St-Louis said that his company would-be adjusted EBITDA positive some time in fiscal 2020, due to a combination of cost-cutting and revenue growth as more retail stores come online. Mr. St-Louis expects 43 stores will be open in Quebec by March and more than 700 stores will be open across the country by the end of next year.
Beyond expressing hope about more stores, Mr. St-Louis and Mr. Burwash gave few clues about how the company would shift to profitability, dodging several direct questions from analysts asking for more detail.
“These are estimates based on the assumptions we have today regarding store count, operational improvements and cost savings,” Mr. Burwash said.