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Wednesday, Jun 29, 2022
Mugglehead Magazine
Alternative investment news based in Vancouver, B.C.

Business

Deep in debt, Hexo hemorrhages $146.66 million in Q3

From plant closures to a debt spiral that threatens to bankrupt the company – there’s not much hope left

debt
Source: potstocknews

Hexo’s (TSX.HEXO) ongoing death spiral is a thing of terrible beauty.

It would be easy to blame the present ongoing cannabis market malaise, maybe capped off with a disappointing cannabis 2.0 rollout, and accompany that with fiscal issues surrounding the COVID-19 pandemic and associated variants, but you really can’t.

This company has been shooting themselves in the foot by overpaying for go-nowhere acquisitions, accruing debt wherever they could get it in the form of fixer-upper subsidiaries, which the logic seems to be that they scan fix and swap for short term cash. Meanwhile, their workers suffer the downward pressures of its C-suite’s mismanagement in terms of plant closures and job losses.

Debt:

If there’s a bright note it’s that Hexo’s small scale convertible debt is mostly under control. The company’s convertible debt from a private placement in 2019 is coming to a close next month, as its lone remaining series of principal debentures worth $40,140. These matured back in 2020 and the company hasn’t called for their conversion yet. The interest payments on these was $273, paid in April.

Their big senior secured convertible note with HTI Investments is a different story.

Hexo entered into an agreement with Tilray Brands (nasdaq.TLRY) (TSX.TLRY) and HT Investments (HTI) for Tilray to pick up all of the senior secured convertible note owned by Hexo, which was issued on May 27, 2021. The note was originally worth of a principal of USD$360 million. The amount remaining is $185 million after various option redemption payments and a partial conversion by HTI.

That’s not an insignificant amount figuring this company’s market cap is presently $127 million.

The transaction terms set out between Hexo, Tilray and HTI after the amendment have the remainder of the note going to Tilray. Tilray will pay HTI 95% of the principal for the amended note after closing. Until then, HTI can continue to redeem the note on the previous terms, but not less than $160 million.

This came about because as of January 31, 2022, the company was in breach of the covenant to achieve positive earnings before earnings, interests, taxes and depreciation and failing to satisfy this meant default, giving HTI the right to seek immediate repayment of the debt. HTI agreed to waive it until a later date. When and if they date came, and additional waivers couldn’t be acquired, the company would not be able to make the payments under the note, and HTI would then get access to the company’s assets.

That’s when Tilray stepped in.

Here’s the amendment between Hexo, Tilray Brands and HTI, as of June 14, 2022:

  • Reduce the minimum liquidity interim covenant and closing condition from $100-million (U.S.) to $70-million (Canadian) with such amount to be determined after giving effect to a release of all conditions in any blocked accounts and restricted cash of the company and its subsidiaries and including net cash proceeds expected to be received from the company’s captive D&O (directors and officers) insurance policy;
  • Extend the outside date (as defined in the transaction agreement) from July 1, 2022, to Aug. 1, 2022, and to extend the date past which the outside date cannot be extended to Nov. 30, 2022;
  • Extend the date by which the company must use best efforts to obtain shareholder approval from June 15, 2022, to July 15, 2022;
  • Reduce the amendment share price (as defined in the transaction agreement) from 54 U.S. cents to 40 Canadian cents;
  • Amend the condition regarding Tilray’s right to appoint nominees and an observer to the company’s board of directors such that Tilray will be entitled to appoint two directors and one observer to the company’s board of directors;
  • Amend and restate the amended note to reflect a reduction in Tilray Brands’ conversion price (as defined in the amended note) from 85 cents to 40 cents;
  • Amend and restate the assignment and assumption agreement (as defined in the transaction agreement) to reflect certain changes to the purchase price and consideration (as between Tilray Brands and HTI).

Plant closures and other constrictions:

The company’s debt load is unsustainable and they’re doing what they can to unload as much of their underperforming assets as they can to lighten the load on their balance sheet. The company states that they’ve been losing revenue because of the relative price of sales and the cost of manufacturing, especially at their Belleville plant. But it doesn’t help that they’ve been forced to pay a $3,673 Health Canada cannabis fee which is recognized in the third quarter each fiscal year.

Significant financial results and events

  • On April 12, 2022, Hexo entered into definitive agreements with Tilray Brands Inc. to restructure the terms of the senior secured convertible note. Amongst other amendments, the notes maturity will be extended by three years and the equity condition clause will be removed, relieving the company from the punitive dilution pressure under the notes current structure.
  • Concurrent with the definitive agreements, Hexo entered into a definitive equity purchase agreement with an affiliate of KAOS Capital Inc., which when completed, will provide Hexo access to an aggregate $180-million over a 36-month period.
  • During the quarter, management announced the closure of the centralized processing and manufacturing facility in Belleville, Ont. The decommissioning and phase out process is expected to be finalized by the end of July, 2022. The company has begun to transition these operations to other existing sites to further streamline operations and capitalize on production efficiencies.
  • Net sales decreased 14 per cent, quarter over quarter, led by a reduction of international and adult-use sales.
  • Total impairment losses of $83,171 were recognized in Q3 2022, pertaining to the company’s property, plant and equipment, due to the above Belleville closure and due to new estimated recoverable amounts of certain redundant assets.
  • Loss from operations improvement of 80 per cent, quarter over quarter, as the result of the Q2 2022 realignment of the balance sheet and the $616-million of previously recognized impairments to goodwill, intangible assets and property, plant and equipment.
  • Total senior secured note redemptions for $34,924 occurred during the quarter, resulting in the issuance of 72,257,022 common shares.
  • The loss on the company’s senior secured note was reduced by $61,556 due to less volatility in the valuation approach. The senior secured note continues to be valuated at the default demand amount of 115 per cent of the outstanding principal.
  • The company’s total assets held for sale increased to $22,450 from $13,404 from the previous quarter as the result of closing operations of certain, previously announced, cultivation and research facilities as well as a manufacturing facility.
  • Subsequent to the quarter-end and concurrent with a transformation of the company’s management structure, Hexo appointed Joelle Maurais, former assistant general counsel who joined the organization in April, 2018, as general counsel and corporate secretary, effective June 15, 2022. The company would like to thank departing general counsel Roch Vaillancourt for his contributions and dedication to Hexo through this pivotal period. Mr. Vaillancourt will remain with the company in an advisory role through to July 1, 2022, to facilitate a smooth transition.

The Numbers

What the revenues aren’t saying here is that the Zenabis Global acquisition came with hefty debt, and that the numbers they brought in—roughly revenues around $11 million—are the functional equivalent of getting two minimum wage jobs to finance your $50,000 student loan. Now that it has Sundial Growers (Nasdaq: SNDL) skulking about in search of picking Zenabis bones clean post-bankruptcy, even that’s up in the air.

Net revenues:

  • Q3 2022 net revenues have doubled when compared with Q3 2021 as the result of the accretive sales contributed by the acquisitions of Zenabis Global Inc. and Redecan (acquired Q4 2021 and Q1 2022, respectively).

Cost of sales and adjusted gross margin:

  • Total non-beverage related adjusted gross margins decreased to 24 per cent from 28 per cent, when compared with Q3 2021 as the result of a lower average price per gram and unfavorable production variances.
  • Increase of biological asset and inventory write-offs, destruction, and adjustments to net realizable value of $14,620 from Q3 2021 due to aged-out stock and the write-off of trim.
  • Crystallization of fair value from business combinations amounted to $4,396 compared with nil in Q3 2021.

Operating expenses:

  • Operating expenses before impairments and restructuring costs increased 70 per cent from Q3 2021, again as the result of the increased size and scale of the consolidated entity.
  • Consistent with the company’s policy established in FY21, the company fully recognized its Health Canada cannabis fee of $3,673 (a 2.3-per-cent levy based upon the company’s total cannabis sales from the period of April 1, 2021, to March 31, 2022, net of shipping and purchased cannabis costs).
  • Restructuring costs increased $2,468 from the comparative period Q3 2021 as the result of management planned closures of certain facilities and turnover of executive management.

Other income and losses:

  • The Q3 2022 revaluation on financial instruments gain of $3,147 was the result of the decreased United States warrant liability stemming from a drop in the company’s quarter-over-quarter share price. No material movement existed in the comparative period.
  • The fair value loss on the senior secured note, which was acquired in Q4 2021, amounted to $15,110.

The only hope shareholders have right now is that Hexo can’t pay their debt, Tilray absorbs it and puts it out its misery.

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