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Edited Transcript of HEXO.TO earnings conference call or presentation 30-Mar-20 12:30pm GMT

Q2 2020 Hexo Corp Earnings Call

GATINEAU Apr 3, 2020 (Thomson StreetEvents) -- Edited Transcript of Hexo Corp earnings conference call or presentation Monday, March 30, 2020 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jennifer Smith

HEXO Corp. - Manager of Financial Reporting & IR

* Sébastien G. St-Louis

HEXO Corp. - Co-Founder, President, CEO & Director

* Stephen Harry-Donald Burwash

HEXO Corp. - CFO

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Conference Call Participants

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* Aaron Thomas Grey

Alliance Global Partners, Research Division - MD & Head of Consumer Research

* Douglas Miehm

RBC Capital Markets, Research Division - Analyst

* Graeme Kreindler

Eight Capital, Research Division - Principal

* John Zamparo

CIBC Capital Markets, Research Division - Associate

* John Chu

Desjardins Securities Inc., Research Division - Analyst

* Matt Bottomley

Canaccord Genuity Corp., Research Division - Analyst

* Owen Michael Bennett

Jefferies LLC, Research Division - Equity Analyst

* Rupesh Dhinoj Parikh

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* Tamy Chen

BMO Capital Markets Equity Research - Analyst

* Venkata Velagapudi

AltaCorp Capital Inc., Research Division - Associate of Institutional Equity Research

* William Andrew Carter

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP

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Presentation

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Operator [1]

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Good morning, and welcome to HEXO Corp.'s Second Quarter Fiscal 2020 Earnings call. (Operator Instructions) Please note that this call is being recorded today, March 30, 2020, at 8:30 a.m. Eastern time.

I would now like to turn the call over to Jennifer Smith, Director of Investor Relations at HEXO Corp. Ms. Smith, you may proceed.

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Jennifer Smith, HEXO Corp. - Manager of Financial Reporting & IR [2]

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Thank you, Jessica. Good morning. I'm Jennifer Smith, Director of Investor Relations for HEXO Corp. Thank you all for joining us this morning for our 2020 Q2 earnings call. We will start with a presentation by our CEO, Sébastien St-Louis, followed by a recap of our Q2 results, by our CFO, Stephen Burwash, before opening the floor up to questions from our financial analysts.

Before we begin, I would like to remind you that today's presentation contains forward-looking statements that involve known and unknown risks and uncertainties and other factors that could cause actual events to differ materially from current expectations. The forward-looking statements are based upon and include the company's internal estimates, plans, expectations, opinions, forecasts, projections, targets, guidance or other statements that are not statements of fact. Any statements contained herein or discussed during the presentation that are not statements of historical facts may be deemed to be forward-looking statements. Such statements can often be, but not always, be identified by the use of forward-looking terminology and other similar words and expressions that are predictive or indicative of future events and future trends, including negative and grammatical variations therein of statements that certain events or conditions may or will happen or by a discussion of strategy. These statements should not be read as assurances of future performance or results. Such statements involve known and unknown risks and uncertainties and other factors that may cause actual results, performance or achievements to be materially different from those implied by such statements. Those risks or uncertainties include, but are not limited to, those relating to the company's ability to execute its business plan, renew required permits and licenses and related regulatory compliance matters, implemented growth strategies, obtain and maintain financing on acceptable terms, maintain and renew required licenses, maintain good business relationships with its customers, distributors, other strategic partners, keep pace with changing consumer preferences, protect intellectual properties, manage and integrate acquisitions, retain key personnel and relating to the company's competitive advantages, the development of new products, products formats for the company's products, changes in laws, rules, regulations in the absence of materially adverse changes in the industry or global economy. A more complete discussion of the risks and uncertainties facing the company appear in the company's annual information form and the company's management discussion and analysis for the 6-month period ended January 31, 2020, which are available under the company's profile on SEDAR.

Although the company has based forward-looking statements on assumptions that it believes are reasonable, it cautions the readers that the actual results and developments, including the company's results of operations, financial conditions, liquidity and the development of the industry in which the company operates, may differ materially from those made or suggested by the forward-looking information contained herein.

A number of factors could cause actual events, performance or results to differ materially from what is projected in the forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this presentation. The company disclaims any intention or obligation, except to the extent required by law, to update or revise any forward-looking statements as a result of the new information or future events or for any other reason. Any forward-looking statement contained herein or discussed during today's session is expressly qualified in its entirety by the above cautionary statement.

I'll now turn the floor over to Sébastien, our CEO.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [3]

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Thank you, Jennifer. Good morning, everybody. There's no way we can begin this conference call without discussing COVID-19. This virus is having an enormous impact on humanity. It will certainly have an impact on the global economy. The dramatic steps taken by our federal and provincial governments, along with most other nations of the world, over the past few weeks have presented significant challenges for all businesses, and ours is no different.

As per our press release of March 24, the cannabis sector has been deemed an essential service in Québec and Ontario. While we're fortunate enough to keep operating our business, we've created a set of priorities that will guide our actions during this difficult period. Number one is to protect the health and safety of our employees. Number two, to continue to supply high-quality cannabis to our customers. And number three, our operational effectiveness strategic priority to focus on our near-term goal of EBITDA positive.

It's difficult in these early days of social distancing and self-isolation to know the long-term impact on our business. As long as we can keep our people healthy, we're confident in our ability to produce. The biggest challenge will be in our ability to forecast near- and medium-term demand as that will be impacted by the retail store environment.

Canopy has closed their corporate-owned retail stores, and many others have moved to a click-and-collect model. At the moment, demands remained strong, but the impact of significant job losses in our economy may affect the size of the market until this pandemic has abated. A key component of our expansion plans was the expected increase in retail stores in Ontario. However, that's uncertain at this time. We're vigilant in monitoring the market, but we expect uncertainty to remain present for an extended period of time. It will certainly be weeks, but it could be months.

Now I'd like to move on and discuss our financial results for the second quarter of fiscal 2020. Two quarters ago, we noted challenging conditions that were contributing to a slower rollout of the legal adult-use market. Our primary concern is centered on the delayed licensing and build-out of retail stores in both Ontario and Québec, combined with the delay in launching the 2.0 products. These issues have significantly contributed to limiting access to the consumer for Canadian-licensed producers. Our company, along with many of our peers, had built our organizations on the assumption that retail channel would be licensed and built on quicker time lines.

During the past 12 months, we've also seen a dramatic shift in the capital markets and the ability of cannabis companies to issue equity. Considering these factors, we've rationalized our operations in a number of ways. We're completing capital projects that are necessary for us to become a leader in the Canadian marketplace. We're introducing automation and implementing processes and procedures that drive efficiencies in those operations. We're using new analytical tools to produce and sell products with current consumer demand in mind, we're reducing our cash operating expenses, and we continue to drive towards adjusted EBITDA and cash flow positive operations in Canada as soon as possible.

I'm very pleased to see that we're already beginning to see the results of that hard work. In Q2, we saw our net revenue grow 17%, achieved gross margins of 33%, and we decreased our operating expenses by 21%.

As we previously stated that we were taking an aggressive stance on pricing to increase our adult-use market share in Canada through the introduction of Original Stash, the first value brand on the Canadian market, we saw a 57% increase in kilograms sold, primarily in response to the successful launch of Original Stash. We're continuing this aggressive pricing strategy across our other products to reduce product returns and drive consumer sell-through.

In order for the Canadian legal cannabis market to continue to develop, we need to continue disrupting the illicit market. Original Stash proves that we can do that and do that profitably. Several of our competitors have now entered the space with their own value lines, but we continue to believe that we will maintain a strong market share based on our operating costs and quality. We've maintained our position as the market leader in Québec commanding over 1/3 of the sales within the province. And from this position, we're looking forward to strengthening our distribution across the country and to establish ourselves as one of the top market leaders in Canada.

Aside from driving growth to our top line, we've been focused on rationalizing our operations. In October, we were one of the first companies to make the hard decision to scale back our workforce and expenditures on items such as marketing. We had scaled our operations to service a market much larger than what's currently available to us and our licensed producer peers. These reductions resulted in a decrease of operating expenses of 25% in Q1 and 21% in Q2.

Although we've made structural changes to our business, our operations continue to gain efficiencies and improve output. In Q2, we produced 22,000 kilograms of dried gram equivalent, that's a 38% improvement from previous quarter.

We've also improved the amount of dried flower we produce compared to trim from each kilo harvested. We're developing products that can consume more of that trim and alleviate the buildup of inventory. We should see the results of that work in the next few quarters.

Key to continued improvement in our cost structure and our ability to serve the market is our Belleville manufacturing facility. Using advanced automation in our manufacturing and processing supply chain will allow us to increase output while decreasing costs and will reduce our reliance on outsourcing. We've received the license for the first phase of the facility and are continuing construction on the second phase. We've submitted our edibles licensing amendment and are looking forward to beginning production at the facility upon receipt.

In the short term, we're preparing to launch our 2.0 products from our Gatineau pilot facility, which received its license in October. I'm pleased to announce, we've just shipped our first shipments of Original Stash Hash to Ontario, which should be -- which have been on store shelves and have actually sold out very quickly for shipments, and we've reloaded. We're very pleased with that. Our shipments to Québec and other provinces are following soon.

We're looking forward to announcing the release of more new products, vapes, concentrates, chocolates, gummies, over the next few months. We believe these changes to our cost structure as well as delivering products through our 3 brands and the introduction of 2.0 products will allow us to achieve long-term portfolio wide gross margins in the low 40%.

Together with our partner, Molson Coors, we've made significant progress towards launching beverages in Canada. We're looking forward to making more announcements regarding service specifics as we get closer to the launch date. Beverages will be sold under several different brands in a variety of flavors. They taste great. They include THC, CBD, and other formulations. And we look forward to bringing that to market.

Our decision on Newstrike and to curtail operations at the Niagara facility were mostly related to our opening comments on the current size of the Canadian market. A number of our licensed producer peers have also halted construction or closed certain facilities to rationalize operations. We decided to focus our attention on optimizing the operations in Gatineau, in our Masson facility, to meet current demand. And we'll revisit Niagara once the Ontario and Québec retail build-out is advanced and we need that increased production.

To summarize, HEXO's main strategic objectives, despite a very challenging global environment remain alive and well. So to summarize those, to be a market share leader in Canada is well in our focus and very achievable. In fact, we continue to dominate in the Québec market and prove out that HEXO is a top national adult-use market share player. From an operational excellence point of view, I'm thrilled with our ability to post a 33% gross margin, including onetime costs, so the normalized margin should be higher, and including Original Stash, a product that's our value brand. We've also demonstrated an ability to reduce operational expenses, and we're very confident that near term will be EBITDA positive. Our third strategic priority has been innovation and innovative products. And we've had another rousing success with Original Stash Hash, and we look forward to rolling that out nationally. The quality of HEXO products keeps being well received, and we're thrilled with the response from our customers.

With that, I'd like to hand the floor over to our CFO, Steve Burwash, to discuss our second quarter results.

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Stephen Harry-Donald Burwash, HEXO Corp. - CFO [4]

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Thank you, Sébastien. Hello, everybody. We'd like to go through our Q (sic) [second] quarter results, and I'm happy to report that there's been some positive movement for HEXO. We'll start in the revenue area.

Total gross revenue was $23.8 million for the quarter, which is an increase of 23% over Q1. Gross revenue is net of $200,000 in price concessions as we continue to assess our pricing to drive sales volumes and sell-through. A return provision of $1.2 million to provide for possible unsold inventory in the supply chain. Net revenue was up 17% to $17 million compared with $14.5 million in the last quarter.

Adult-use sales volume increased 57% to 6.5 tons from 4.2 tons in Q1. This increase was primarily driven by the expanded distribution of Original Stash during the quarter. Due to the success of Original Stash, we are continuing to expand the distribution of it, is now listed in Québec, Ontario, BC, Alberta, Nova Scotia and Newfoundland.

We achieved adult-use net revenue per gram of $2.47, a decrease of $0.77 over the prior period. The decrease is primarily the result of increased sales mix of OS. We've been making changes to the strains we are growing with a focus on the ones with THC content greater than 18%.

As more of these harvests become available for sale, that should drive increased volumes of the products sold under our HEXO and Up brands that, along with the expansion of our geographical distribution and the introduction of our new 2.0 products, result in a positive shift in the revenue per gram and gross margin over the next few quarters.

Cost of sale increased 14% to $11.3 million compared to $9.9 million in Q1 as a result of increase in the volumes sold, which was offset by a decrease in the cash cost per gram related to changes in yields, process improvements and a reduction of certain costs such as the radiation. The fair value adjustment on the sale of inventory was $5.4 million, decreased from $6.7 million in Q1. This is due to the compression of fair value of dried flower in the market, which was offset by the volume sold. The unrealized gain on changes in fair value of biological assets was negative $7.9 million compared with negative $7.1 million in Q1. This is as a result of an increase in estimate yields and production rates at the Gatineau facility as well as a reduction in the cash cost per gram, as previously mentioned. This results in a higher fair value adjustment.

The company recorded a write-down on inventory of $16.1 million in the quarter compared to $23 million in the prior quarter. $11.8 million of this impairment relates to an impairment on concentrated bulk purchase inventory. The company is currently undergoing litigation related to the supply agreement as we believe it is an onerous contract that was negotiated in that case. $3.1 million of the write-off is due to an excess supply of trim on hand when compared with our short-term demand needs. We are closely monitoring our inventory levels as well as assessing application for inventory in our 2.0 products, and we'll continue to keep you updated on a quarter-by-quarter basis regarding any future impairments that may be required.

Gross margin before fair value adjustments for Q2 2020 were $5.7 million or 33% compared with net revenue from sale of goods. This compares to $4.6 million in the prior quarter or 31%. This increase is a result of a reduction in the cost per gram as a result of significant improvement in yields at our cultivation facilities. We expect margins to improve in the long term through the launch of higher THC product, expanded Canadian distribution and the introduction of 2.0 products. Gross margin after fair value adjustments and impairment was a negative $7.9 million compared with a negative $20.9 million in Q1.

Operating expenses were $281.5 million in Q2. However, these included a number of nonrecurring expenses that came about as a result of changes in conditions of the Canadian market. For that reason, we look at our operating expenses in 2 segments, core and nonrecurring. For our core operating expenses, we saw a decrease of about 21% to $28.1 million in Q2 from $35.1 million in Q1. As noted earlier, we have proactively worked to reduce our cash operating expenses. We have started to see demonstratable reductions in these overhead costs. Our OpEx cash cost decreased to $16 million in Q2 from $24 million in Q1, that's a 33% decrease.

In our G&A, we decreased to $14.4 million from $16 million in Q1. This is the result of reduced payroll and travel costs. In marketing and promotion, we decreased to $0.4 million from $6.2 million in Q1 2020. This is a direct result for a decision to reduce our promotional spending and headcount. There was also an over accrual based on a contract that we renegotiated in Q2 to allow us to reverse that accrual.

Research and development decreased to $1.2 million from $1.7 million in Q1 as a result of a reduction in headcount and consulting fees.

Now a look at our nonrecurring expenses. There was an additional $300,000 in restructuring costs related to the rightsizing we began in Q1. Secondly, there was impairments of property, plant and equipment as well as intangible assets of $138.3 million, which came about after we completed the strategic review of our cultivation assets and deciding a focus on driving operational improvements and yields at our Gatineau facility to reduce costs and to list Niagara for sale; an impairment of goodwill, $111.9 million, after performing an indicator impairment test; and an additional $3 million realization of an onerous contract related to a supply agreement that is currently the subject of litigation.

Losses from operations. In Q2, our losses from operations were $289.4 million compared with $60.6 million in Q1 2020. The increase is primarily related to the nonrecurring expenses I mentioned, which is offset by a decrease in operating expense of $7 million combined with a decrease in the impairment loss and write-off of inventory and biological assets of $11 million. We are still focusing on reducing operating expenses and streamlining operations with a focus on becoming adjusted EBITDA positive.

At the end of Q2 2020, we had $81.4 million in cash, cash equivalents, and short-term investments. We will require additional capitalization in order to meet the company's obligations, commitments and budgeted expenditures through January 31, 2021. We are considering a number of options, and we hope to launch an at-the-market financing in the near future.

Thank you very much, and I will now turn the call back over to Jennifer.

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Jennifer Smith, HEXO Corp. - Manager of Financial Reporting & IR [5]

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We will now take questions from analysts. Due to a large number of analysts joining us today, I would ask you to limit your questions to 2 at a time. You're welcome to rejoin the queue after that. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from David Kideckel with AltaCorp.

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Venkata Velagapudi, AltaCorp Capital Inc., Research Division - Associate of Institutional Equity Research [2]

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This is on Ven, pinch-hitting on behalf of David. First of all, congrats on the quarter. Just wanted to know more about your positive EBITDA guidance for 2021. For instance, it would be useful to know your estimated percentage of revenue coming from cannabis derivatives in 2021 and the range of gross margins you are expecting to achieve this.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [3]

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Thank you. We are expecting to improve the amount of products that are coming from 2.0 and derivatives, and that's the fundamental problem for all -- for our whole industry right now, how much revenue can we generate from trim, which is effectively a byproduct of production in order to get the best portfolio margin available. So we're not giving specific numbers in our forecast. We can tell you it will be improving. In terms of a portfolio gross margin, we're targeting 40%.

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Operator [4]

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Our next question comes from Aaron Grey with Alliance Global Partners.

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Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [5]

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First, I just want to touch back again on gross margin. It's nice to see that you have sequential improvement during the quarter. Can you talk a little bit more what -- in terms of what drove that? I know you mentioned the change in yields, but also, I heard you mentioned a onetime cost that should go away. So is there any way you could kind of quantify that?

And then also going forward in terms of once the Belleville license is received, how that helps to improve the gross margin as well in terms of like improved automation as well. So just any kind of color in to help quantify the onetime hit during the quarter and how that should be normalized.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [6]

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Thanks, Aaron. So the -- so it's not just yields. It's across the organization. We've taken -- funnily enough, we found opportunity amidst this COVID thing. We've had a renewed focus on health and safety, which has really driven efficiencies. So that's been a huge success. When I say onetime costs, I mean the purchases in the quarter, some onerous contracts, et cetera. So if you normalize and if we only had sold in the quarter or it only needed to take into account current costs of our product -- current manufacturing cost, we can see the 40% right now. And I remind everybody on the call that's including Original Stash, which accounts for a large portion of our sales. So very, very bullish on our ability to drive long-term portfolio margin at 40% once we get these onetime issues out of the way.

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Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [7]

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Great. That's helpful. And then just second one would just be just touching on in terms of market share for Québec. You mentioned the strong share again during the quarter. Just maybe you could help kind of quantify the market share and how it's kind of compared quarter-over-quarter for Québec. And then just anything you've seen kind of quarter-to-date just with kind of the [hoarding of product] that people took an anticipation of moving in isolation with COVID-19. And then also, just any color you could provide in Ontario where you also did launch an Original Stash and what you've seen in terms of market share trends there as well.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [8]

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We're still completely dominant in Québec. We've chosen to share the 33% number as we think that's a good, sustainable, conservative number.

Some of the monthly data just blew that out of the water, quite frankly, but we're waiting for that to normalize. In any consumer packaged goods business, it's highly unlikely, almost impossible that any brand will maintain above a 40% market share. And so we're being conservative there, but we're definitely #1 and not going anywhere. In terms of Ontario, the introduction of some new products have worked very well, but we've really focused in our attention on servicing the Québec market fully. The other markets in Canada, we're really focused on 2.0 until we can properly service them with flower, so as a full line offering. So in terms of the total national market share, we're amongst the top. If you look at adult-use market share, you compare us to any of the top 5 names, we're right in striking distance. And we're quite pleased with those results, and we anticipate that to continue.

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Operator [9]

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Your next question comes from Rupesh Parikh with Oppenheimer.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [10]

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So I guess first, Sébastien, getting back to the comments on getting to a positive EBITDA near term, any more granularity you can provide in terms of the timing of achieving that target?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [11]

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Right now, we're still -- we're shooting for within the next couple of quarters. But in terms of giving a precise window given all the uncertainty in the market, no, Rupesh, we're not giving more appropriate guidance there. What I can tell you is that at a -- with continuing increase in sales quarter-over-quarter and with a 40% gross margin and an ability to reduce OpEx, it gets very certain pretty soon.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [12]

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Okay, great. And then on the operating expense front, is there any more color you can provide in terms of how you guys are thinking about G&A sequentially in marketing, I guess, Q3 and Q4? And I just want to get a sense of what type of dollars we should be thinking about going forward.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [13]

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Absolutely. I think one of the biggest successes to come out of our acquisition of Newstrike -- we certainly had our challenges, and you saw this quarter with the impairments. But one of the greatest successes was the Up brand. And we've come up with new marketing initiatives that are actually quite low cost. And so we're very confident in our ability to keep those costs under control go forward while continuing to deploy those brands nationally in getting resonance. The brand will always rely on 2 things: distribution first and then product innovation second. That's what's going to build, I believe, a long-term brand success. And so on top of that, we have great banners like Original Stash, Up and HEXO to put this technology under, and we're having great success in that with things like launch of our Original Hash.

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Operator [14]

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Next question comes from Tamy Chen with BMO Capital Markets.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [15]

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First question is -- so I just wanted to touch back on the growth and the volumes sold seen this quarter. So my understanding is most of it came from sequential growth in Québec with Original Stash. I think the sell-in of Original Stash to some of the other provinces this quarter was a bit less than what I thought. I just wanted to understand, is that function of just timing for when you launch into those provinces? And at this point now, are these other provinces, are they now meaningfully increasing their ordering of Original Stash?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [16]

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Well, one of the challenges outside Québec -- and I want to congratulate the SQDC for how they've managed their supplier relationships, so they're one of the few that don't have this issue. But one of the issues is as LPs sell into retail networks, so into other provinces outside of Québec, as those provinces load up the retail channel, some -- the -- if there's any price adjustment or concessions need to be made or margin concession need to be made in the future, those concessions don't flow through to the retailer and don't flow through to the consumer. So what that ends up doing is it ends up jamming the store with a bunch of inventory and then we can't reload. So in certain cases, we have retail stores choosing to take a different manufacturer-suggested retail price. So instead of taking the HEXO-suggested price for Original Stash, they're taking prices that affect the velocity. And then in turn, when we go to adjust, then the province itself will prevent the price adjustment. So we are getting better on those things, and we are learning more, but that's causing the slowdown outside of Québec.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [17]

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Okay. So will this be a continued bit of a challenge for the next couple of quarters? Or is this something that can be addressed. And so I just want to...

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [18]

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I think it's an industry -- yes, it's -- I think it's an industry-wide challenge for the next couple of months at least, but we are seeing meaningful improvement in all provinces.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [19]

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Okay. And my second question is, I think you adjusted some of the covenants in your term loan. One of the ones mentioned was there's some EBITDA-related criteria within the covenants. Just want to understand if that has changed because I think in the prior credit agreement, there were certain covenants related to EBITDA that were going to come in at a certain point. So I just wanted to understand if you could kind of clarify if these EBITDA covenants, if they've changed and what they are in the new covenant agreement.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [20]

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We're in full compliance of all our bank covenants, and we're working very closely with our banking partners. They're super supportive. Both CIBC and BMO have been fantastic to work with.

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Operator [21]

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Your next question comes from Owen Bennett with Jefferies.

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Owen Michael Bennett, Jefferies LLC, Research Division - Equity Analyst [22]

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First question is just on the requirement for additional funding over the next 12 months. I was just hoping you could give a bit more specifics around that, assuming you hit your time line for EBITDA positive, how much cash you think you're actually going to need. And then the second one is just around HEXO, those brands. Could you give any kind of color on the sales or market share trends we're seeing for those 2 brands specifically?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [23]

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Thanks, Owen. From a cash-need perspective, we certainly know what our wish list is versus the hard requirement. From a wish list perspective, you'll recall, I used to talk about for a global cannabis company -- global cannabis dominance would require billions of dollars of capital. HEXO is now solely focused on being profitable in Canada first and driving profitable operations here. And to dominate in Canada and be one of the top layers, a wish list number is about $150 million. The bare-bones requirement could be quite a bit less than that, significantly less. So we're waiting to see how the markets are going to respond, how our ATM performs, et cetera. And in the short term, there is no cash pressure. So we're in good shape in the very short term. So we have a lot of options as well as strong supporting shareholders.

From a brand perspective, we're not breaking down the success of specific brands. What I can say right now is Original Stash working very well, and we're working on an upper relaunch that we're super excited about. That will tie into introducing more higher margin product, but also more advanced 2.0 products into market. And of course, HEXO keeps doing very, very well in Québec.

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Operator [24]

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Your next question comes from Matt Bottomley with Canaccord.

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Matt Bottomley, Canaccord Genuity Corp., Research Division - Analyst [25]

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Sébastien, maybe just if you could provide a little more color on any sensitivity in pricing that you might have, given that it seems like a lot of your peers are also starting to target this value brand segment. I know you guys were first to do it. But just as your recreational pricing seems to be offsetting overall market penetration growth, is there sort of a bottom line price that you guys have set that would be of concern, given where the market is going? Or is the overall OpEx leverage and overall growth in your facility infrastructure expected to absorb a lot of that pressure?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [26]

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Thanks, Matt. I think that HEXO's assets are some of the best in the world, quite frankly. I've seen most of what's around. And I think we can rely on that on our processes and our methods that, given a set quality, I really don't think most of our competitors can compete at the same price.

So we're going to continue to drive up gross margin. We're going to continue to drive down OpEx. And as we do that, I want to keep flowing through that value to our customers and our consumers. And so as long as we maintain a portfolio gross margin above 40%, we are quite comfortable in continuing to lower prices. I think that the overall price in the industry is starting to stabilize because we've achieved with Original Stash at HEXO the disruption of the black market. And that has been a fundamental change in how people consume product. And so I think we'll start to see that stabilization on value, and I only think there's HEXO and maybe 1 or 2 other license producers that can compete in that segment because they have the asset base and cost structure to do so.

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Matt Bottomley, Canaccord Genuity Corp., Research Division - Analyst [27]

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Appreciate that. And just a second follow-up question. Just with respect to your sales and marketing, that basically came down to 0 this quarter over last, I think about $6 million. So can you frame how much of that might have been upfront investment during the launch of maybe cannabis 2.0 versus any sort of change in strategy and how you allocate dollars to marketing?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [28]

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Yes, there was a big change in strategy in terms of how we're doing a portfolio marketing. So we were marketing brands before really at the -- from a top-level, from a corporate level. We've stopped all those activities, and now we're taking product launches on a project-by-project basis and being very selective in how we go to market. And that's been very successful. Original Stash is one of the best-performing product -- cannabis products of all time across all license producers, and that was done on a shoestring marketing budget. So we're -- the marketing team is doing a fantastic job in doing more with less.

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Operator [29]

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Your next question comes from John Chu with Desjardins Capital Markets.

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John Chu, Desjardins Securities Inc., Research Division - Analyst [30]

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Just first question would be just on the positive EBITDA. Now previously, you had mentioned 800 store -- retail stores is kind of the benchmark for being able to reach that. I believe we're over that number now across Canada. So the question is, is the current retail infrastructure enough for you to reach positive EBITDA? Or do you need more stores open in Ontario and other provinces to get to that -- to get to positive EBITDA?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [31]

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Well, John, we'll certainly take more stores, it'll make it easier. I think the distribution of stores need some rightsizing. We're still probably overloaded a bit in Alberta and light in Ontario. So that needs to be adjusted a little bit, given the third pillar really that could balance out the store count is the competitive pressure. So as we start to see more and more license producers outside of HEXO force filing for bankruptcy and failing, that's creating less competition, which then allows us to gain more share and more sales. And so given that continued trend, confident that with or without more stores, we can get positive. Now with that in mind, we do need more stores for the market and for consumers to be properly serviced in this country.

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John Chu, Desjardins Securities Inc., Research Division - Analyst [32]

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Okay. And then has COVID-19 impacted the progress of Belleville in terms of construction and bringing in equipment and everything else? And did I hear you right that Gatineau is now going to actually producing 2.0 products for sale now? Because I thought that was really for more testing purposes than producing for distribution.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [33]

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Yes. So we are pilot scale in Gatineau. And so what we did is, we took our testing purpose facility and we're going to market with certain products. Now it's a more limited offering that what we can do with our full-scale in Belleville. The intention is to manufacture everything from Belleville eventually. And right now, construction is substantially complete, which is why we've been able also to reduce our CapEx ongoing and go forward.

But the Belleville facility has been affected by COVID just in terms of timing, of inspections, et cetera. So Health Canada, of course, completely occupied with coronavirus and completely understand, but we're working closely with them to see how we can adjust that for licensing time lines, et cetera, and we're quite happy to see that they're still doing their good work.

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Operator [34]

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Your next question comes from Douglas Miehm with RBC Capital Markets.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [35]

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Just wanted to go back to the stores for a second. When you look at your EBITDA guidance with respect to, say, Ontario, I know that Ontario talked about 250 stores. We thought that was going to be a challenge to begin with. But given the current setting, can you maybe tell us what your EBITDA positive outlook is based on? Is it based on the $250 million? And let's say if it were half of that, would you still be able to meet your EBITDA outlook?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [36]

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Yes, Doug. I think Ontario is still going to have a lot of challenges getting to that number. They need to fundamentally fix the distribution center. Distribution center can't really support more than 40 or 50 stores at the end of the day. So that needs to be fundamentally upgraded. It's not just a question of store count. You also have the reduced throughput of stores given the capital environment, so which reduces that count. So I think it's prudent to expect a slow rollout. And that, of course, all in the context of COVID, so which is deprioritizing store openings for the Ontario government for the moment.

So in terms of EBITDA positive, as I've said, I don't think the store count is the only factor you need to look at. You need to look at the total competitive environment. You need the market share of our new value offerings and our entrants into the higher end segments with our Up brands. That should contribute meaningfully. And so I'm not overly worried. We don't need to get to a 250 store count.

In terms of a specific store number, we're not disclosing our specific plan and we'll -- everything is moving so quickly that we are adapting in real time.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [37]

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Okay. That's fair. My other question just has to do -- you mentioned that you're having a real impact finally on the illicit market, especially in Québec. Can you expand on that to give us a bit more details, maybe with respect to pricing, what type of market share you're taking from the illicit market? I think that would be very helpful. And I'll leave it there.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [38]

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Thanks for that. We're really seeing new consumers come in. Where it comes down to in our conversations with SQDC, we're seeing consumers that have never shopped at SQDC start to walk in, in a significant amount. And they're walking in, asking for Original Stash and HEXO products. And so that's really where the first success comes from.

From a pricing perspective, everything we do with the Original Stash line revolves around attacking the black market pricing. So we'll go out and we'll look at what the cost per gram is on dried flower. We'll go look at what the cost per gram is on Hash, for example, and we make sure to come in excise tax in with very competitive products. Anecdotally, I get calls from -- with the launch of Original Stash, I got calls from black market dealers for the first time, saying, what are you doing to our business? And so that's when I knew we were succeeding.

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Operator [39]

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(Operator Instructions) Your next question comes from Graeme Kreindler of Eight Capital.

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Graeme Kreindler, Eight Capital, Research Division - Principal [40]

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I just had a follow-up question regarding the ongoing capital needs as well as the covenants. I noticed some language in the financial statements about an additional covenant that was put in about the need for $40 million raised on or before April 30. So I was just wondering if that covenant in the language in there, that includes the activities that were done towards the end of fiscal Q2 or if that's sort of within the next 30 days here?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [41]

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Steve?

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Stephen Harry-Donald Burwash, HEXO Corp. - CFO [42]

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Yes. Thanks for the question. Yes. So that $40 million is something that's required new money before the end of April. The fundraising and capital raise as we did in Q1 of -- I think it was about $130 million is outside of that, and this is going to be new money.

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Graeme Kreindler, Eight Capital, Research Division - Principal [43]

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Okay. Thank you for the clarification there. And then just another question here. Sébastien, you mentioned earlier on the call, the significant increase, 22,000-kilogram equivalent in Q2. I was just wondering if you could provide the breakdown of what the flower versus the other equivalents were in that number?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [44]

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Yes. So really excited about that actually. So this -- and this is what's really signaling to me the bottom of the trough is that we're now over half flower, and that trend continues. So you'll see a continued improvement in our next quarter, I believe. And so that -- you have a number of factors here. Sales increasing, gross margin increasing at the same time that we can get additional penetration with a value product and our fundamental problem of flower versus trim is getting fixed. The guys in operations are doing a great job. So all those things put together, coupled with the launch of new products, is really giving me confidence here.

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Operator [45]

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Your next question comes from John Zamparo with CIBC.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [46]

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I wanted to touch on your upcoming 2.0 launch. I mean the majority of your flower sales come from Québec, but of course, the province isn't allowing for most of the derivatives portfolio. So how do you think about capturing market share with your brands in other provinces?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [47]

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So our brand strategy essentially is our Original Stash to displace black market, and that's going -- that's a national strategy. But as you've seen, our launch in Ontario with Hash, so we're taking products that can be made with other products and flower. Québec is consuming most of the flower we produce, and so we're maintaining that share. We're going to add markets one at a time from a flower perspective on top of that. And then our 2.0 strategy is going to roll up into the UP brand outside of Québec, which is going to have a full premium offering. It's how we're planning on attacking that. So you should see that within the next 2 to 3 quarters from a full rollout perspective, the full portfolio rollout.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [48]

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Okay. And my other question is on Truss. Your level of cash injections expanded pretty significantly in the quarter. Can you give us an update on where Truss is in terms of financing, how much more it might need, and also just how it's progressing on the operations side and when we might see those products launch nationally?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [49]

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Yes, Truss -- the Truss facility is absolutely amazing. It is the largest, as far as I know, beverage facility in the world and most advanced from an oxygen control perspective, which is critical when you talk about the quality control of your cannabinoids. So the beverages taste fantastic. There's no added preservatives, which makes them even more appealing, we believe, to consumers. From a cash perspective, Truss has been funded with about $90 million so far. It's fully funded from both a CapEx and OpEx perspective for the next while. And that has been -- of course, those contributions came 57% from Molson Coors, which remain very actively engaged in Truss. So we're all very excited about what that's going to bring. From a product launch portfolio, we have multiple brands going out. So definitely, in this calendar year, you'll have a full product launch, but expect some select launches of select brands in the meantime.

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Operator [50]

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Your next question comes from Andrew Carter with Stifel.

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William Andrew Carter, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP [51]

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I wanted to ask, we've all seen the anecdotal evidence suggesting the surge of demand in Canada and then a significant increase where we had the visibility here in the U.S. markets. But could you give us a sense of how the provinces are and retailers are managing inventories? Are you kind of seeing a commensurate increase in orders from the provinces? Are they kind of taking a wait and see approach to the new environment?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [52]

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So the new environment, especially with COVID, has resulted in the provinces asking for bigger load-ins. I think the provinces are being cautious as to their supply chain, given this uncertain environment. And -- but the demand is real.

So when we look at the till sales, we're seeing meaningful throughput. HEXO has been managing our provincial partners very closely because we have learned our lessons of not stuffing the channel. And we are making sure to feed these stores with what they need and what they can sell through before necessarily responding to the aggregate purchase orders that are coming in. So really focused on what sells through versus sell it.

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William Andrew Carter, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP [53]

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And then kind of a second question, now that you've kind of transitioned to doing some of your second-generation products from Gatineau, you obviously made that change a couple of months ago, kind of targeting a stronger kind of gross margin profile. Is this -- is leaning on this versus waiting on Belleville going to be a drag on that 40% gross margin target? Or could we expect that the incremental launches here will be significantly increased -- accretive to your gross margin profile?

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [54]

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Yes. It's not a drag. So Belleville actually -- should -- when it first comes on, there's going to be a couple of months of a negative hit to gross margin when Belleville first turns on because we're going to have to take on all that amortization, but then it rapidly correct. Belleville is upside to our margin profile. It's all automated facilities. It's built for manufacturing. It's inline processing. To give you an idea of the supply chain, I mean today, our products get made in Masson, go to Montréal for radiation, go to Belleville for some package and go back to Masson and then ship up to Québec. So it's a 5-point supply chain. Once Belleville is fully licensed, we actually in-house -- so it's not a radiation. We in-house other inoculation techniques. And so the product is grown in Masson, sent to Belleville, shipped to customers. So a 3-point supply chain. So we're going to realize significant cost savings there.

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Operator [55]

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We have no further questions at this time. Please proceed.

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Sébastien G. St-Louis, HEXO Corp. - Co-Founder, President, CEO & Director [56]

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Okay. Well, thanks, everybody, for joining the call. Going to end again by wishing you and your families the best of health. Keep staying safe and washing your hands as best as possible. In the meantime, HEXO will continue to focus on our market share, our operational effectiveness and our product innovation and look forward to talking to you next quarter.

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Operator [57]

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Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.