Mr. Charlie Bowman reports

HEXO REPORTS Q3'23 FINANCIAL RESULTS

Hexo Corp. has released its financial results for the third quarter of the 2023 fiscal year (Q3 2023). All currency amounts are stated in Canadian dollars unless otherwise noted.

"In the third quarter, we entered into a definitive arrangement agreement, whereby Tilray will acquire all outstanding shares of Hexo," said Charlie Bowman, president and chief executive officer of Hexo. "We continue to expect the transaction will be completed by June 30, 2023."

"Hexo recorded $21.6-million in net revenues in the third quarter, representing an 11-per-cent decline from the second quarter," noted Julius Ivancsits, chief financial officer of Hexo. "Our G&A expenses, excluding Health Canada cannabis fees, improved by $2.6-million compared to the second quarter, while our selling, marketing and promotion expenses were largely flat quarter over quarter. We recognized an adjusted EBITDA loss of $3.9-million, compared with a loss of $2.4-million in the second quarter."

Significant financial results:

• Total net revenues decreased 11 per cent or $2.6-million quarter over quarter, and decreased 53 per cent or $24.0-million compared with Q3 2022.
• Excluding Health Canada cannabis fees, the company's general and administrative (G&A) expenses improved by $2.6-million or 25 per cent quarter over quarter. As compared with Q3 2022, G&A expenses significantly improved by $15.7-million or 67 per cent.
• Selling, marketing and promotion expenses (SM&P) were consistent quarter over quarter, and improved by 48 per cent or $2.5-million relative to Q3 2022.
• The company made payments of cash and non-cash consideration to Tilray Brands Inc. with a fair market value of $26.3-million to obtain the waiver agreement.
• When taken as percentage of net sales, during the nine months ended April 30, 2023, the company's general, administrative, selling, marketing and promotion, and research and development costs improved by 13 per cent when compared with the same period in fiscal 2022.
• The company's only material cash generating unit (CGU) was impaired by $73.7-million.
• The company's loss from operations improved by $12.3-million or 9 per cent relative to Q3 2022.
• Operating cash flows in the three and nine months ended April 30, 2023, significantly improved by $9.6-million and $77.9-million relative to the three and nine months ended April 30, 2022, respectively.
• The company recognized an adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) loss of $3.9-million in Q3 2023, an increased loss of $1.5-million quarter over quarter. The Q3 2023 adjusted EBITDA is inclusive of the company's Health Canada cannabis fees of $2.5-million. Relative to Q3 2022 adjusted EBITDA was significantly improved by $14.4-million.

Q3 2023 total net revenue was $21.6-million, an 11-per-cent sequential decline. The decline was, among other factors, driven by lower adult-use sales in Alberta, certain supply issues and delisted products in Quebec, as well as a lower sales focus in the smaller markets of Saskatchewan and Manitoba. Also, as management noted in Q2 2023, $2,186 of net revenue associated with delayed shipments to Alberta (due to severe weather) in Q1 2023 had been recognized upon its delivery. Partially offsetting the decline was the resurgence of wholesale and international sales in the period due to the acquisition of new clients and increased purchase orders from existing clients.

Due to increased competition, net sales declined 53 per cent relative to Q3 2022 as a result of the Hexo brand's decreased market share and performance in the key provincial markets of Ontario, Alberta and Quebec. The Zenabis subsidiary (which was deconsolidated in Q4 2022 upon loss of control) contributed $8,447 of net sales in Q3 2022, which are no longer applicable to the company.

Cost of goods sold and adjusted gross margin

The attached table summarizes and reconciles the company's gross profit line items per IFRS (international financial reporting standards) to the company's selected non-IFRS financial measures adjusted cost of sales, gross profit/margin before adjustments and gross profit before fair value adjustments.

Total gross margin before adjustments declined to 43 per cent in Q3 2023 from 45 per cent in Q2 2023, in part due to the reduction in the wholesales gross margin before adjustments recognized in the period. The reduction was due to a higher sales mix of lower-margin products being sold in Q3 2023, such as extraction grade flower as well as previously impaired flower.

Inventory write-offs, impairments and net realizable value adjustments were incurred due to the aging out of inventory, as well as obsolescence and other accounting adjustments.

Reductions to inventory write-offs, impairments and net realizable value adjustments were recognized relative to Q3 2022, as management continues to focus on aligning cultivation to demand and mitigate the risk of aged out and unsellable stock. Additionally, the crystallization of fair value from business combinations was fully realized in Q4 2022 and therefore did not factor into fiscal year 2023 results.

During the three months ended April 30, 2023, the unrealized gain on changes in fair value of biological assets decreased 30 per cent quarter over quarter. The reduction was due to lower average selling prices. Relative to Q3 2022, the unrealized gain on changes in fair value of biological assets decreased 93 per cent as the result of lower plants on hand due to the reorganization of the businesses operations (less cultivation facilities and capacity), lower weighted average selling prices and the change in estimated trim value, which is now valued at nil.

In Q3 2023, the realized fair value adjustment on inventory sold fell by 45 per cent quarter over quarter. This decrease was the result of substantially lower weighted average selling prices and lower volumes sold. The realized fair value adjustment on inventory sold during the period decreased 68 per cent relative to Q3 2022 due to the deconsolidation of the Zenabis subsidiary in Q4 2022, lower volumes sold and certain accounting adjustments.

Total operating expenses in Q3 2023 increased by $87,591 from Q2 2023. The increase was driven by an impairment charge to the company's only significant CGU, the Canadian operations CGU. Due to the presence of certain indicators of impairment at April 30, 2023, the company performed a quantitative assessment and concluded the CGU was impaired by $73,689. As the result of this exercise, the company allocated the CGUs impairment on a weighted average basis between plant, property and equipment, and intangible assets, amounting to $54,914 and $18,775, respectively. Also in the period, an increase in acquisition and transaction fees was recognized due to certain consideration paid to execute the waiver and amendment agreement with Tilray, as well as the accrual of Health Canada cannabis fees, which are recognized in the third quarter of every fiscal year.

Operating expenses in Q3 2023 decreased by $16,342 or 13 per cent, compared with Q3 2022. This was largely due to a net reduction in impairment charges. In Q2 2022, the company recognized impairment losses associated with the closure of its Belleville manufacturing facility. Also contributing to the significant improvement was the execution of managements cost savings initiatives, which collectively reduced general, administrative, selling, marketing, promotional, and research and development (R&D) expenses by $19.9-million.

Finance income (expense), net improved by $800,000 quarter over quarter, driven by the repayment of the $40.1-million convertible debentures on Dec. 5, 2022, resulting in lower quarterly interest expenses. Year over year, the improvement of $5.0-million is driven by the principal repayment of the $40.1-million convertible debentures on Dec. 5, 2022, and the deconsolidation of the former subsidiary, Zenabis, and its interest-bearing note in Q4 2022.

Total non-operating expenses of $9.0-million were recognized in Q3 2023, compared with the non-operating income of $34.2-million in Q2 2023. The decrease is the result of a fair value loss being recognized in the current period as opposed to the $31.8-million gain on the senior secured convertible note recognized in Q2 2023, due to the relative unfavourable exchange rate and credit spread movement quarter over quarter. Additionally, unfavourable foreign exchange losses of $2.8-million were recorded in Q3 2023, compared with favourable gains of $3.7-million in Q2 2023, primarily pertaining to the company's U.S.-dollar-denominated senior secured convertible note and a $6.2-million write-off for the company's capitalized ELOC costs. Offsetting the above was $5.0-million in other income realized from the receipt of funds held in escrow since the acquisition of Redecan on Aug. 30, 2021. The funds were a part of the original consideration to acquire the business based on preliminary working capital figures and were ultimately mutually released by both Hexo and seller of the Redecan and received during the period.

Total net non-operating expenses of $14.8-million in Q3 2022 was the result of the $15.1-million unfavourable fair valuation and amortized day 1 losses under the original senior secured convertible notes structure and a slightly unfavourable Canadian-dollar/U.S.-dollar foreign exchange loss. Offsetting the previous losses was a $3.1-million gain on revaluation of warrant liabilities due to favourable movement in the company's share price.

Liquidity risk

During the three and nine months ended April 30, 2023, the company reported operating losses of $120,716 and $190,984, respectively, cash outflows from operating activities of $23,144 in the nine months ended April 30, 2023, and an accumulated deficit of $2,014,326, and has yet to generate positive cash flows or earnings. The company had a working capital deficiency of $140,500 and held cash and cash equivalents of $20,000 as at April 30, 2023 ($83,238 at July 31, 2022).

On April 10, 2023, the company entered into a definitive arrangement agreement with Tilray, whereby Tilray will acquire all of the issued and outstanding common shares of the company subject to shareholder approval and the satisfaction of or waiver of the closing conditions under the arrangement agreement. Under the proposed arrangement agreement, Tilray will acquire all of the issued and outstanding common shares of the company, whereby each Hexo shareholder will receive 0.4352 of a share of Tilray common stock in exchange for each Hexo share implying a purchase price of $1.25 (U.S.) per Hexo share based on the volume weighted average price of Tilray shares on the Nasdaq Stock Market for the 60-day period ended on April 5, 2023.

The company and Tilray also entered into a letter agreement on April 10, 2023, which, among other things, provides for a waiver by Tilray of, and the amendment to, certain covenants under the amended and restated senior secured convertible note due May, 2026, issued by the company and held by Tilray to mitigate the risk of covenant breaches by the company until the consummation of the arrangement and to allow the company to use existing cash resources to satisfy the company's continuing payment and contractual obligations and operate its business.

The amendments to certain financial covenants were as follows. Tilray has agreed to waive the requirement under the note that Hexo achieve a positive adjusted EBITDA for the three months ending April 30, 2023, and for subsequent quarters, and to amend the financial covenant set out under the note to reduce the minimum liquidity threshold from $20-million (U.S.) to $4-million (U.S.). On April 30, 2023, the company was compliant with the amended minimum liquidity covenant.

Subsequent to the end of the period, on June 1, 2023, the company and Tilray amended the arrangement agreement in order to satisfy a condition precedent of a private placement of Series 1 preferred shares, a first tranche of which was also completed with the issuance of $11.5-million (U.S.) in Series 1 preferred shares on June 1, 2023. See the company's Q3 2023 interim condensed consolidated financial statements for a detailed description of the private placement and the amendments to the arrangement agreement, as well as other concurrent agreements and transactions. Upon execution of the private placement, the amended minimum liquidity covenant was reduced from $4-million (U.S.) to $1 (U.S.).

In the event the arrangement is not consummated, there is a significant probability of the company not being able to meet its obligations as they come due within the 12 months following April 30, 2023, and, accordingly, there would be significant doubt about the appropriateness of the going concern assumption and use of accounting principles applicable to a going concern.

There can be no assurances that the arrangement will be consummated. If the arrangement is not completed, the company will be confronted with default under one or more covenants under the note, either within the near term or in the next 12-month period. As such, these circumstances create material uncertainties that lend substantial doubt as to the ability of the company to meet its obligations as they come due and, accordingly, there are material uncertainties that cast significant doubt about the appropriateness of the going concern assumption.

About Hexo Corp.

Hexo is an award-winning licensed producer of premium products for the global cannabis market. Hexo delivers a thoughtfully curated portfolio of both recreational and therapeutic cannabis products that inspire customer loyalty. Hexo's brands include Hexo, Redecan, Original Stash, Bake Sale and T 2.0, as well as medical cannabis products.

Hexo's world-class Canadian grow sites are unmatched in size, technological advantage and yield of high-quality cannabis, driving innovation through every step of the process. Hexo operates three major grow sites in Ontario and Quebec, including one of the largest facilities in North America. Hexo is a publicly traded company under the ticker HEXO.

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