Hexo released their Q2 F2021 earnings today.

Hexo CFO MacDonald will be doing and ask me anything with us Wednesday March 24, 2021 on our subReddit.  Announcement Post will be up Friday March 19, 2021, so come and ask questions.

Outlook from previous Q MDA:

• The Company expects to be Adjusted EBITDA positive for the three months ended January 31, 2021, subject to certain assumptions (outlined below) regarding store count, product output, operational improvements, cost saving initiatives and the potential economic impact of COVID-19.

By their math they got to +Adj EBITDA at +$0.2 million, by my math they are still -$1.7 million.  The difference largely lies in them not reversing Other Income of $1,685 in the EBITDA calculation.  This Other Income, which I word searched the financials, includes Truss JV and other items.  If they line itemed the Truss JV I would leave it the Adj EBITDA figure as it is operations related, but they don’t. So, I cannot tell what is Truss related and what is for example warrant liability or real estate lease related.

This Q

Pluses

• Sales increase +12% with recreational 11%.
• Gross margin remains favorable to industry peers.
• SGA control remains good with decreases as % of sales.
• Good cash balance.

Minuses

• Gross Margin fell from 41% to 34%. Once Adult Beverage JV is moved to Molson’s books this should improve.
• Sales increases in adult use were consistent each of last two Q’s at $2.8 million and $2.9 million this Q.
• Their Adjusted EBITDA includes Other Income of $1.7 million.

Some good disclosure from Hexo in MDA on segments especially on GM.

Income Statement Drivers and Breakeven Sales:

Revenue Table:

Net Sales for the Q were $33 million a +12% increase from last Q.  Adult rec was $30 million (+$2.9 million or +11%) while medical was unchanged down and wholesale was -$0.3 million. International reappeared for third consecutive Q at $2.0 million ($0.9 million) sold to Israel (24 month purchase agreement).

Note the sales increases QoQ in absolute terms in Adult use is declining.  This Q was +$2.8 million after being $3.5 million and $4.8 million the previous two Q’s.

Of the +$2.9 million in sales increase this Q:

• +$2.9 million in Relaunching Up brand
• +$0.3 million in beverages

The net selling price of Adult Use excluding beverages took a sharp turn downwards at -27% in Q1F21 to $2.17/gram but saw a rebound to $2.57/gram +195 this Q with higher priced Up brand contributing.   All in Net Average selling price is $2.16/gram versus $1.86/gram last Q, Adult rec pulling the load.

They sold 15,201 KGs -4% QoQ at a decreased per gram of $2.16/gram versus $1.86/gram last Q. The increase is the hard is Up brand relaunch.  Adult beverages consumed less KGs at higher sales, a good sign as beverages make up 10% of sales mix.

Adult Use Cannabis Revenue – Peer Trend

Hexo is 4^th in the above peer group.  Very nice trend line in the right direction.

They indicate they are the Canada leader in Hash and the market leader in beverages.    

Flower sales in Quebec have reportedly taken a hit from launch of many craft Quebec brands, but they are making headway outside Quebec. 

Medical Use Cannabis Revenue – Peer Trend

Canadian medical is a rounding error.  They did evidence a shipment to Israel of $2 million under a 24-month purchase agreement.

Income Statement Drivers and Breakeven Sales – Peers

In our Tier 1 peer group Hexo is the 5^th largest company by Revenue.  

Gross Margin: Peer and Trends

Last Q:

Their historic GM is riddled with cost based writedowns in most Q’s during F2020.  This Q they had a write up of inventory by $1.5 million.

This Q:

GM was $11.3 million for this Q versus $11.9 million last Q which included a $1.5 million write up. Gm was 34% versus 41% last Q or 35% without write up. 

GM on adult use without beverages was stable at 37%.  International carries a strong GM of 60$ despite dropping by 12% QoQ.  Beverages is at a breakeven GM.  High capital costs carry in beverages, so they need sales to pick up to get the benefits. 

COGS & GM Table:

GM per gram sold increased by $0.11 to $0.77/ gram prior to any write offs/ups and impairments.

Cost per gram did increase QoQ to $1.40/gram from $1.21/gram, but this was offset by increases in revenue per gram.

GM, netted for impairments, improved by $1.3 million with Adult rec +$1.0 million and International +$0.6 million, offset by wholesale and medical decreasing a combined $0.3 million. It will be interesting to see what happens when Truss GM and SGA move to Molson’s.

Gross Margin Larger Peer Group

Hexo is to #2 in this peer group.  Note: CGC, APHA, and TLRY have considerable non cannabis revenue which distorts GM%.

SGA and SBC: Trend Analysis

NOTE: I have moved restructuring and impairments to Other Income/Expenses to maintain peer comparability.

Selling and marketing increased marginally QoQ to $2.1 million ($0.1 million) and are 6.5% of sales.  The dollar amount is consistent with Q3F20 pre beverage launch.

G&A increased $0.4 million to $12.3 million QoQ and in line with Q3-Q4 F2020. At 37% of sales it is the lowest on record.

They indicate they want SGA to be 25% of sales as a target to reach for.  They will need some SGA to move to Molson’s and sales to increase to get there.

SBC is at $5.3 million a increase from $2.9 million QoQ as share price has been increasing.

R&D was $1.1 million up from $1.0 million last Q.

Depreciation and Amortization was $2.0 million versus $1.3 million last Q.

Total Opex was $22 million an increase from $19 million last Q.  This was first increase in Opex in six Q’s.  last q we noted the decreases were getting smaller.  I guess they hit “bone”.

SGA and SBC: Peer Analysis

Hexo is 4th best in Peer Group. 

Implied Breakeven Sales to +Net Operating Profit divided by Current Q Sales:

Using current GM% and Opex$’s Hexo requires incremental sales of 102% to evidence +NOP.

NOP for the Q net of IFRS was negative $11.6 million versus negative $7.4 million last Q. The lack of an write up this Q, coupled with increase in Opex being the reason for the swing.

Other Income and Expenses aggregated negative $16.6 million versus negative $3.0 million last Q. Of note:

• Revaluation of financial instruments was $9.9 million versus a small credit last Q
• Share loss in JV swung $2.6 million from $1.1 million.
• Unrealized investment swung from $0.6 million loss to $1.2 million gain
• Interest expenses grew to $2.8 million from $2.3 million
• Other Income from truss and other items was stable at $1.7 million.
• Loss on disposal of long lived assets increased to $1.3 million from $0.1 million

Net Income net of IFRS on Bio Assets and Inventory rang in at negative $28 million a versus negative $10.5 million last Q.  Most of the swing is in other expenses as the NOP swing was only -$4.2 million.

Implied Breakeven Sales to +EBITDA divided by Current Q Sales:

At current GM% and cash Opex$, Hexo requires 15% increase in incremental revenue to reach +EBITDA.

EBITDA Trend and Peer:

My figure of -$1.7 million differs from theirs of +$0.2 million as they do not back out Other income and they back out SBC embedded in CoGS of $0.3 million.  Problem is their SBC on their cash flow statement balances to what is in Opex, so I only deducted what was in the cashflow statement. And Other Income… I cannot find a reason to not back it out as I cannot tell how much is operational in nature.

This is an improvement from last Q of -$2.2 million or an improvement of +$0.6 million

Balance Sheet Items of Note:

Cash:

Cash and restricted cash decreased by $13 million QoQ to $168 million.  Cash is in good condition, but it has come at huge dilution and before the recent run up in cannabis stock prices.  Speaking with their CFO, he indicates they would like to only raise cash if there is an opportunity to add assets as they believe their burn rate has decreased sufficiently to get them to a positive cash flow.

The Restricted cash of $38 million is Hexo self-insuring on Directors Insurance which save a $10 million a year as per their CC…. but ONLY if there is no claim. Not like there have been many class action lawsuits in the industry. /s

“Waterfall- Trend”: Projected Yield Bio Assets, Harvest, Sold, Delta in KGs

Their KG sold decreased to 15,201 KGs (-605 KGs) and increased their harvest to 25,608 (+8,146 KGs) for a net add to inventory of 10,407 KG.  From MDA:

• The Company’s realized its highest harvested kg in history, increasing 47% quarter over quarter. The increase is the result of moving out of historically lower harvests that are experienced in the first quarter of the fiscal year as a result of harvesting the lots produced during the warmer summer months and into the higher yielding lots due to optimal climate.

Interesting take.

“Waterfall- Peer”: Projected Yield Bio Assets, Harvest, Sold, Delta in KGs

Harvesting only below Aurora and Aphria. Canopy stopped disclosing.

“Gas in the Tank”: Trend Analysis

Hexo does not break out WIP and Finished Goods, so we only have an inventory delta

Biological Assets increased to $0.2 million to $10.9 million and are at their highest since April 2019.

Inventories increase $7.6 million to $82 million. The biggest increase was in dried cannabis of $7.9 million and Oils of $2.6 million.  With addition of Zenabis they will need to ensure they are not over building again.  This will be something to keep an eye on.

Inventory to Sales: Peer and Trend

Total inventory increased to $82 million or 2.50X sales.  Inventory impairments at bay for now.  Only Aurora is lower in Inventory to Sales. Cronos is a GAAP measure of Inventory to CoGS as is CGC.

Sold vs Harvest KGs and Sales vs Inventory $’s

They increased inventory by $7.6 million as they added KGs to inventory this Q.

On liability side only the $9.9 million increase in warrant liability to $13 million is of note.  Hopefully, it drops into Equity at some point.

What I said last Q:

A small sales increase and it looks like they are losing market share in Quebec.  The declining QoQ $ sales increase is something to keep an eye on.  Hexo will need to focus on growing Ontario revenue as store counts increase.

They were able to maintain gross margin in their overall portfolio with the improvement in Beverage GM in the Q. Without the improvement in beverage GM, they would have slid backwards in $’s.

This was a progress quarter but less than the previous one.  EBITDA remains negative and they have $2.3 million in interest expense quarterly plus a further $7.9 million in Current Portion of debt and leases.

Cash position finally looks to be in a place where dilution will not be an issue for a few Q’s.  Couple that with inventory looking to be in control and their new CFO seems to have addressed some of the concerns within his control. 

I would suggest investors keep an eye on Quebec retail sales in relation to Hexo sales growth.  This is still their main driver of growth.  No other LP would benefit as much from the Quebec government acting like Alberta and Ontario and opening up retail stores than Hexo.

This Q:

Hexo has been hanging multiple progress quarters together.  They are not huge PROGRESS, but they are gaining ground.  Rec sales have been on an upward trajectory that many LP’s would love to have.  The increase has been in $2.8 million range each of last two Q’s.

Gross Margin has settled in to a 35% range.  They are not getting any GM from beverages and would need the sales to swing considerably higher to generate a mediocre GM.  International GM, which is bulk shipped, has been strong. 

SGA finally moved upwards after five Q’s of decrease. 

EBITDA is moving in the right direction. 

Cash balance is reasonable.

Continue headway in adult recreational is the lever Hexo needs to lean on.  With the addition of Zenabis they are buying sales.  Will they shutter any of Zena’s grows.  The memory of purchasing HIP and writing it off five months later is still fresh.

Still only one spoke in the “Powered by Hexo” wheel, but they continue to mention dialogues with CPG. I’ll caveat that CPG is likely talking to numerous players.

The preceding is the opinion of the author and is in no way intended to be a recommendation to buy or sell any security or derivative. The author has no position in HEXO and does not plan on entering in the next five days.