EX-99.2 3 exhibit99-2.htm EXHIBIT 99.2 HEXO Corp.: Exhibit 99.2 - Filed by newsfilecorp.com

 

  



Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of HEXO Corp.

Opinion on the Financial Statements

We have audited the accompanying consolidated statement of financial position of HEXO Corp. and its subsidiaries (together, the Company) as of July 31, 2020 and the related consolidated statements of net loss and comprehensive loss, changes in shareholders’ equity and cash flows for the year then ended, including the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of July 31, 2020 and its financial performance and its cash flows for the year then ended in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board.

We have also audited the revision to the classification of the term loan as at July 31, 2019 as described in note 37. In our opinion, such revision is appropriate and has been properly applied. We were not engaged to audit, review, or apply any procedures to the 2019 consolidated financial statements of the Company other than with respect to the revision and, accordingly, we do not express an opinion or any other form of assurance on the 2019 consolidated financial statements taken as a whole.

Change in Accounting Principle

As discussed in note 3 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2020 due to the adoption of IFRS 16, Leases.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and

 

PricewaterhouseCoopers LLP

99 Bank Street, Suite 710, Ottawa, Ontario, Canada K1P 1E4
T: +1 613 237 3702, F: +1 613 237 3963

“PwC” refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership.



disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.

Chartered Professional Accountants, Licensed Public Accountants

Ottawa, Ontario, Canada

October 29, 2020

We have served as the Company’s auditor since 2020.



Independent Auditor's Report


To the Shareholders of HEXO Corp.:

Opinion

We have audited, before the effects of the revision to the classification of the term loan as at July 31, 2019 as described in Note 37 to the consolidated financial statements, the consolidated financial statements of HEXO Corp. and its subsidiaries (the "Company"), which comprise the consolidated statement of financial position as at July 31, 2019, and the consolidated statements of net loss and comprehensive loss, changes in shareholders' equity and cash flows for the year then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies.

In our opinion, the consolidated financial statements, before the effects of the revision to the classification of the term loan as at July 31, 2019 as described in Note 37 to the consolidated financial statements, present fairly, in all material respects, the consolidated financial position of the Company as at July 31, 2019, and its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards.

Basis for Opinion

We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Other Information

Management is responsible for the other information. The other information comprises:

 Management’s Discussion and Analysis

 The information, other than the consolidated financial statements and our auditor’s report thereon, in the Annual Report

 The information, other than the consolidated financial statements and our auditor’s report thereon, in the Annual Report on Form 40-F.

Our opinion on consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon.

In connection with our audit of the consolidated financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. We obtained Management’s Discussion and Analysis, the Annual Report, and the Annual Report on Form 40-F prior to the date of this auditor’s report. If, based on the work we have performed on this other information, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard.

Responsibilities of Management and Those Charged with Governance for the Consolidated Financial Statements

Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the consolidated financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so.

Those charged with governance are responsible for overseeing the Company’s financial reporting process.



Auditor's Responsibilities for the Audit of the Consolidated Financial Statements

Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor's report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements.

As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:

 Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.

 Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control.

 Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.

 Conclude on the appropriateness of management's use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor's report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor's report. However, future events or conditions may cause the Company to cease to continue as a going concern.

 Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation.

 Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Company to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the Company audit. We remain solely responsible for our audit opinion.

We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.

 

Ottawa, Canada

Chartered Professional Accountants

December 31, 2019

Licensed Public Accountants


Table of Contents

Consolidated Statements of Financial Position 1
   
Consolidated Statements of Net Loss and Comprehensive Loss 2
   
Consolidated Statements of Changes in Shareholders' Equity 3
   
Consolidated Statements of Cash Flows 4
   
Notes to the Consolidated Financial Statements:  
   
1. Description of Business 5
2. Basis of Preparation 5
3. Significant Accounting Policies 7
4. Cash, Cash Equivalents and Short-Term Investments 15
5. Restricted Funds 15
6. Commodity Taxes Recoverable and Other Receivables 16
7. Convertible Debentures Receivable 16
8. Inventory 16
9. Biological Assets 17
10. Investments in Associates & Joint Ventures 18
11. Long-term Investments 19
12.  Property, Plant and Equipment 20
13.  Intangible Assets 21
14. Business Acquisition 22
15.  Goodwill 24
16. Warrant Liabilities 25
17. Convertible Debentures 26
18. Lease Liabilities 27
19. Term Loan (Revised) 27
20. Share Capital 28
21. Common Share Purchase Warrants 29
22. Share-based Compensation 30
23. Net Loss per Share 32
24. Financial Instruments 32
25. Selling, General and Administrative Expenses by Nature 34
26. Related Party Disclosure 34
27. Capital Management 35
28. Commitments and Contingencies 36
29. Fair Value of Financial Instruments 37
30. Non-Controlling Interest 38
31. Revenue from Sale of Goods 38
32. Segmented Information 38
33. Restructuring Provision 39
34. Operating Cash Flow 39
35. Income Taxes 40
36. Subsequent Events 40
37. Revision of Comparative Information 42

 


HEXO Corp. 2020 Consolidated Financial Statements

Consolidated Statements of Financial Position

(thousands of Canadian Dollars)

As at Note    July 31, 2020

    July 31, 2019
(Revised - Note 37)


Assets              
Current assets              
  Cash and cash equivalents 4 $ 184,173   $ 113,568  
  Restricted funds 5   8,261     22,350  
  Short-term investments 4   -     25,937  
  Trade receivables 24   19,426     19,693  
  Commodity taxes recoverable and other receivables 6   16,733     15,247  
  Convertible debentures receivable 7   -     13,354  
  Prepaid expenses - current     4,606     10,762  
  Inventory 8   64,933     83,854  
  Biological assets 9   7,571     7,371  
            305,703     312,136  
               
Non-current assets              
Property, plant and equipment 12   285,366     258,793  
Intangible assets 13   16,008     127,282  
Investment in associate and joint ventures 10   76,306     52,849  
Lease receivable 6   3,865     -  
License and prepaid royalty - HIP     1,020     1,409  
Prepaid expenses     1,392     -  
Long-term investments 11   3,209     14,277  
Goodwill 15   -     111,877  
            692,869     878,623  
Liabilities              
Current liabilities              
  Accounts payable and accrued liabilities     32,451     45,581  
  Excise taxes payable     7,121     3,494  
  Warrant liabilities 16   3,450     493  
  Lease liability - current 18   4,772     -  
  Term loan - current 19,37   29,930     33,374  
  Onerous contract 28   4,763     -  
            82,487     82,942  
Non-current liabilities              
Term loan 19   26,861     30,257  
Deferred rent liability     -     946  
Deferred tax liability 35   -     6,023  
Lease liability 18   24,344     -  
Convertible debentures 17   28,969     -  
Other long-term liabilities     393     -  
      136,193     89,911  
Shareholders' equity              
Share capital 20   1,023,788     799,706  
Share-based payment reserve 22   65,746     40,315  
Warrant reserve 21   95,617     60,433  
Contributed surplus 21,22   27,377     -  
Accumulated deficit     (659,231 )   (112,742 )
Non-controlling interest 30   3,379     1,000  
            556,676     788,712  
          $ 692,869   $ 878,623  

  Commitments and contingencies (Note 28)

Approved by the Board of Directors         

/s/  Jason Ewart, Director                                   

/s/  Michael Munzar, Director

The accompanying notes are an integral part of these consolidated financial statements.


HEXO Corp. 2020 Consolidated Financial Statements

 

Consolidated Statements of Net Loss and Comprehensive Loss
(thousands of Canadian Dollars, except per share data)

  Note   July 31, 2020     July 31, 2019  
  Revenue from sale of goods 31 $ 110,149   $ 59,256  
  Excise taxes     (29,598 )   (11,914 )
  Net revenue from sale of goods     80,551     47,342  
  Ancillary revenue     233     199  
Net revenue     80,784     47,541  
                     
         Cost of goods sold 8,25   127,205     45,532  
Gross (loss)/profit before fair value adjustments     (46,421 )   2,009  
                     
  Realized fair value amounts on inventory sold 8   40,910     16,357  
  Unrealized gain on changes in fair value of biological assets 9   (29,356 )   (38,856 )
Gross (loss)/profit   $ (57,975 ) $ 24,508  
               
Operating expenses              
  Selling, general and administrative 25   52,793     45,947  
  Marketing and promotion     12,474     31,191  
  Share-based compensation 22   25,790     28,008  
  Research and development     4,639     2,822  
  Depreciation of property, plant and equipment 12   6,072     1,747  
  Amortization of intangible assets 13   3,939     1,767  
  Restructuring costs 33   4,767     -  
  Impairment of property, plant and equipment 12   79,418     -  
  Impairment of intangible assets 13   108,189     -  
  Impairment of goodwill 15   111,877     -  
  Loss on onerous contract 28   4,763     -  
  Loss on disposal of property, plant and equipment 12   3,855     -  
          $ 418,576   $ 111,482  
Loss from operations     (476,551 )   (86,974 )
               
Revaluation of financial instruments gain/(loss) 16   6,533     (3,730 )
Share of loss from investment in associate and joint ventures 10   (6,331 )   (2,964 )
Loss on induced conversion of debentures 17   (54,283 )   -  
(Realized loss)/unrealized gain on convertible debenture receivable 7   (4,806 )   1,737  
Unrealized loss on investments     (12,880 )   (315 )
Realized gain on investments     24     (215 )
Foreign exchange gain/(loss)     1,392     (78 )
Interest and financing expenses     (10,043 )   (469 )
Interest income     1,902     5,187  
Other income     2,531     -  
Loss and comprehensive loss attributable to shareholders before tax   $ (552,512 ) $ (87,821 )
Income tax recovery 35   6,023     18,213  
Net loss and comprehensive loss   $ (546,489 ) $ (69,608 )
               
Comprehensive loss attributable to:              
  Shareholders of HEXO Corp.     (546,489 )   (69,608 )
  Non-controlling interest     -     -  
    $ (546,489 ) $ (69,608 )
Net loss per share, basic and diluted   $ (1.77 ) $ (0.33 )
Weighted average number of outstanding shares              
  Basic and diluted 24   309,504,695     212,740,552  

The accompanying notes are an integral part of these consolidated financial statements.


HEXO Corp. 2020 Consolidated Financial Statements

Consolidated Statements of Changes in Shareholders' Equity

(thousands of Canadian Dollars, except share data)

      Number of
common
    Share     Share-based
payment
    Warrant     Contributed     Non-
controlling
    Accumulated     Shareholders'  
For the years ended Note   shares     capital      reserve     reserves     surplus     interest     deficit     equity  
Balance at July 31, 2018     193,629,116   $ 347,233   $ 6,139   $ 12,635   $ -   $ -   $ (43,134 ) $ 322,873  
Issuance of common shares     8,855,000     57,558     -     -     -     -     -     57,558  
Share issuance upon acquisition 14   35,394,041     322,439     -     -     -     -     -     322,439  
Issuance fees     -     (3,827 )   -     -     -     -     -     (3,827 )
Replacement stock options 22   -     -     7,134     -     -     -     -     7,134  
Replacement warrants 21   -     -     -     12,229     -     -     -     12,229  
Issuance of warrants 21   -     -     -     42,386     -     -     -     42,386  
Exercise of stock options 22   3,567,867     7,044     (2,751 )   -     -     -     -     4,293  
Exercise of warrants 21   13,619,202     61,350     -     (5,204 )   -     -     -     56,146  
Exercise of broker/finder warrants 21   1,916,527     7,909     -     (1,613 )   -     -     -     6,296  
Stock-based payments 22,25   -     -     29,793     -     -     -     -     29,793  
Non-controlling interest 30   -     -     -     -     -     1,000     -     1,000  
Net loss and comprehensive loss     -     -     -     -     -     -     (69,608 )   (69,608 )
Balance at July 31, 2019     256,981,753   $ 799,706   $ 40,315   $ 60,433   $ -   $ 1,000   $ (112,742 ) $ 788,712  
June 2020 at the market offering 20   32,942,479     33,263     -     -     -     -     -     33,263  
May 2020 underwritten offering 20   63,940,000     43,495     -     10,998     -     -     -     54,493  
April 2020 underwritten offering 20   59,800,000     22,928     -     20,182     -     -     -     43,110  
Issuance of common shares - USD$20m registered offering 20   11,976,048     21,073     -     -     -     -     -     21,073  
Issuance of common shares - USD$25m registered offering 20   14,970,062     25,229     -     -     -     -     -     25,229  
$70m private placement unsecured convertible debentures 20   -     -     -     -     23,902     -     -     23,902  
Early conversion of debentures 17, 20   37,325,000     72,005     -     13,354     (10,362 )   -     -     74,997  
Issuance fees     -     -     -     -     (27 )   -     -     (27 )
Exercise of stock options 22   116,532     223     (89 )   -     -     -     -     134  
Expiry of stock options 22   -     -     (5,983 )   -     5,983     -     -     -  
Exercise of warrants 21   4,413,874     5,866     -     (1,469 )   -     -     -     4,397  
Expiry of warrants 21   -     -     -     (7,881 )   7,881     -     -     -  
Equity-settled share-based payments 22,25   -     -     31,503     -     -     -     -     31,503  
Non-controlling interest 30   -     -     -     -     -     2,379     -     2,379  
Net loss and comprehensive loss     -     -     -     -     -     -     (546,489 )   (546,489 )
Balance at July 31, 2020     482,465,748   $ 1,023,788   $ 65,746   $ 95,617   $ 27,377   $ 3,379   $ (659,231 ) $ 556,676  

The accompanying notes are an integral part of these consolidated financial statements.


HEXO Corp. 2020 Consolidated Financial Statements

Consolidated Statements of Cash Flows

(thousands of Canadian Dollars)

For the years ended Note   July 31, 2020     July 31, 2019  
Operating activities              
  Total net loss   $ (546,489 ) $ (69,608 )
  Items not affecting cash 34   508,484     16,669  
  Changes in non-cash operating working capital items 34   (56,549 )   (71,767 )
Cash used in operating activities     (94,554 )   (124,706 )
Financing activities              
  Issuance of common shares 20   196,843     57,558  
  Issuance fees 20   (10,170 )   (3,827 )
  Proceeds from the exercise of stock options 22   134     4,293  
  Proceeds from the exercise of warrants 21   4,291     56,075  
  Acquisition of term loan 19   -     32,778  
  Payments on term loan 19   (3,500 )   -  
  Debt interest payments     (1,849 )      
  Lease payments 18   (4,341 )   -  
  Issuance of unsecured convertible debentures 7   70,000     -  
  Interest paid on unsecured convertible debentures 7   (3,205 )   -  
Cash from financing activities     248,203     146,877  
Investing activities              
  Settlement of short-term investments     25,420     119,810  
  Proceeds from sale of investments     7,871     -  
  Restricted cash     13,089     (22,350 )
  Proceeds from sale of property, plant and equipment 12   10,966     -  
  Acquisition of property, plant and equipment     (109,040 )   (138,034 )
  Purchase of intangible assets     (856 )   (3,010 )
  Investment in associate and joint ventures     (30,494 )   (13,427 )
  Net cash acquired on business acquisition 14   -     49,366  
Cash used in investing activities     (83,044 )   (7,645 )
Increase in cash and cash equivalents     70,605     14,526  
Cash and cash equivalents, beginning of year     113,568     99,042  
Cash and cash equivalents, end of year   $ 184,173   $ 113,568  

Supplemental cashflow information in Note 34

The accompanying notes are an integral part of these consolidated financial statements.


HEXO Corp. 2020 Consolidated Financial Statements

Notes to the Consolidated Financial Statements

For the years ended July 31, 2020 and 2019

(expressed in thousands of Canadian Dollars, except share amounts or where otherwise stated)

1. Description of Business 

HEXO Corp. (the "Company"), is a publicly traded corporation, incorporated in Ontario. HEXO is licensed to produce and sell cannabis and cannabis products under the Cannabis Act. Its head office is located at 3000 Solandt Road Ottawa, Canada. The Company's common shares are listed on the Toronto Stock Exchange ("TSX") and the New York Stock Exchange ("NYSE"), both under the trading symbol "HEXO".

COVID-19

In December 2019, a novel strain of coronavirus ("COVID-19") emerged in Wuhan, China. Since then, it has spread to most other countries and infections have been reported around the world. Canada confirmed its first case of COVID-19 on January 25, 2020 and its first death related to COVID-19 on March 9, 2020. On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. In response to the outbreak, governmental authorities in Canada and internationally have introduced various recommendations and measures to try to limit the pandemic, including travel restrictions, border closures, non-essential business closures, quarantines, self-isolations, shelters-in-place and social distancing. These measures remain in effect as at July 31, 2020. The COVID-19 outbreak and the response of governmental authorities to try to limit it are having a significant impact on the private sector and individuals, including unprecedented business, employment and economic disruptions. As of July 31, 2020, we have not observed material changes to our business as a direct result of the COVID-19 pandemic.

2. Basis of Preparation

Statement of Compliance

These consolidated financial statements have been prepared in compliance with the International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB") including IFRS Interpretations Committee ("IFRIC").

These consolidated financial statements were approved and authorized for issue by the Board of Directors on October 29, 2020.

Basis of Measurement

The consolidated financial statements have been prepared on an historical cost basis except for certain financial instruments and biological assets, which are carried at remeasured amounts or fair value, as detailed in the Company's accounting policies.

New and Amended Standards

The Company has applied IFRS 16 - Leases for the first time for the annual reporting period commencing August 1, 2019. Refer to Note 19 for details of the impact on adoption.

Certain new accounting standards and interpretations have been published that are not mandatory for the year ended July 31, 2020 and have not been early adopted by the Company. These standards are not expected to have a material impact on the entity in the current or future reporting periods and on foreseeable future transactions.

Functional and Presentation Currency

The consolidated financial statements are presented in Canadian dollars. Each entity within the Company determines its own functional currency based on the primary economic environment in which it operates.

Basis of Consolidation

SUBSIDIARIES

Subsidiaries are entities controlled by the Company. Control exists when the Company has the power, directly and indirectly, to govern the financial and operating policies of an entity and be exposed, or have rights to, to the variable returns from its activities. The financial statements of subsidiaries are consolidated from the date that control commences until the date that control ceases. All intercompany transactions, balances, and unrealized gains and losses are eliminated upon consolidation.

Non-controlling interest ("NCI") represents the portion of equity ownership in subsidiaries not attributable to the Company's shareholders. NCI is initially measured as the proportionate share of its interest in the acquiree's identifiable net assets as at the date of acquisition and subsequently adjusted for the proportionate share of net earnings and other comprehensive income (loss) attributable to the NCI, as well as any dividends or distributions paid to the NCI. Non-controlling interests in the results and equity of subsidiaries are shown separately in the consolidated statements of loss and comprehensive loss, statements of changes in equity and balance sheets respectively.



HEXO Corp. 2020 Consolidated Financial Statements


Principal Operating Subsidiaries

Jurisdiction

Interest Held

Principal Activity

HEXO Operations Inc. 

Ontario, Canada

100%

To produce and sell cannabis and cannabis products under the Cannabis Act.

       

HEXO USA Inc.

Delaware, USA

100%

To facilitate expansion into the US market.

 

 

 

 

Keystone Isolation

Technologies Inc. ("KIT'')

Ontario, Canada

60%

Intended to provide the Company with high quality extraction technology to facilitate an efficiently processed and consistent supply of CBD and THC to supply the Canadian and global market for cannabis derivatives

 

 

 

 

Neal Up Brands Inc.

Ontario, Canada

60%

To produce and sell cannabis and cannabis products under the Cannabis Act.

JOINT ARRANGEMENTS

Investments in joint arrangements are classified as either joint operations or joint ventures. The classification depends on the contractual rights and obligations of each investor, rather than the legal structure of the joint arrangement. The Company currently holds interests in joint ventures but has no interest in joint operations.

Joint ventures

Interests in joint ventures are accounted for using the equity method (see "Equity Method" below), after initially being recognized at cost in the consolidated balance sheet.

The following are the Company's joint ventures however, none are considered material to the Company:

Significant Joint Ventures

Jurisdiction

Interest Held

Principal Activity

HEXO MED A.E.

Athens, Greece

51%

Intended to serve as the Company's entry point into the European medical cannabis markets.

 

 

 

 

Belleville Complex Inc.

Ontario, Canada

25%

The venture was established to manage the property of Belleville facility.

Associates

Associates are all entities over which the Company has significant influence but not control or joint control. This is generally the case where the Company holds between 20% and 50% of the voting rights. Investments in associates are accounted for using the equity method of accounting (see "Equity Method" below), after initially being recognized at cost

The following associates are significant to the Company; however, only Truss Limited Partnership is considered material to the Company:

Significant Associates

Jurisdiction

Interest Held

Principal Activity

Truss Limited Partnership

("Truss LP")

Ontario, Canada

42.5%

To pursue opportunities to develop non-alcoholic, cannabis-infused beverages for the Canadian market following adult-use legalization.

 

 

 

 

Truss CBD USA LLC

("Truss CBD US")

Colorado, USA

42.5%

To explore opportunities for non-alcohol hemp-derived CBD beverages in the State of Colorado.

EQUITY METHOD

Under the equity method of accounting, the investments are initially recognized at cost and adjusted thereafter to recognize the Company's share of the post-acquisition profits or losses of the investee in profit or loss, and the Company's share of movements in other comprehensive income of the investee in other comprehensive income. Dividends received or receivable from associates and joint ventures are recognized as a reduction in the carrying amount of the investment.

Where the Company's share of losses in an equity-accounted investment equals or exceeds its interest in the entity, including any other unsecured long-term receivables, the Company does not recognize further losses, unless it has incurred obligations or made payments on behalf of the other entity.

Unrealized gains on transactions between the Company and its associates and joint ventures are eliminated to the extent of the Company's interest in these entities. Unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of equity-accounted investees have been changed where necessary to ensure consistency with the policies adopted by the Company.


HEXO Corp. 2020 Consolidated Financial Statements

The carrying amount of equity-accounted investments is tested for impairment in accordance with the policy described herein.

OPERATING SEGMENTS

An operating segment is a component of the Company for which discrete financial information is available and whose operating results are regularly reviewed by the entity's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and that engages in business activities from which it may earn revenue and incur expenses. The Company only has one operating segment.

3. Significant Accounting Policies 

CASH AND CASH EQUIVALENTS

Cash and cash equivalents are comprised of cash and highly liquid investments that are readily convertibles into known amounts of cash with original maturities of three months or less.

RESTRICTED FUNDS

Restricted funds represent cash that is pledged as collateral or guarantees for certain of the Company's projects, obligations, and agreements.

SHORT TERM INVESTMENTS

Short term investments are comprised of liquid investments with maturities between 3 and 12 months. Short term investments are measured at amortized cost using the effective interest method, less loss allowance.

TRADE RECEIVABLES

Trade receivables are recognized initially at the amount of consideration that is unconditional, unless they contain significant financing components when they are recognized at fair value. Trade receivables are subsequently measured at amortized cost using the effective interest method, less loss allowance.

COMMODITY TAX RECOVERIES & OTHER RECEIVABLES

The Company measures commodity tax recoveries and other receivables at fair value fair value and subsequently measured at amortized cost, less any provisions for impairment.

BIOLOGICAL ASSETS

The Company measures biological assets consisting of cannabis plants using the income approach at fair value less costs to sell up to the point of harvest, which becomes the basis for the cost of related inventories after harvest. The Company capitalizes all the direct and indirect costs as incurred related to the biological transformation of the biological assets between the point of initial recognition and the point of harvest including labour related costs (including share based compensation), grow consumables, materials, utilities, facilities costs, depreciation, overhead, quality and testing costs. The identified capitalized direct and indirect costs of biological assets are subsequently recorded within the line item 'costs of goods sold' on the statement of loss and comprehensive loss in the period that the related product is sold. Unrealized gains or losses arising from changes in fair value less cost to sell during the period are included in the results of operations and presented on a separate line of statement of comprehensive loss of the related period.

INVENTORY

Inventory is valued at the lower of cost and net realizable value. Cost is determined using the weighted average method. Inventories of harvested cannabis are transferred from biological assets at their fair value at harvest, which becomes the initial deemed cost of the inventory. Any subsequent post-harvest costs are capitalized to inventory to the extent that cost is less than net realizable value. Subsequent costs include materials, overhead, depreciation, amortization, and labor related costs (including share-based compensation) involved in packaging and quality assurance. The identified capitalized direct and indirect costs related to inventory are subsequently recorded within 'cost of goods sold' on the statement of loss and comprehensive loss at the time the product is sold, with the exclusion of realized fair value amounts included in inventory sold which are recorded as a separate line within gross profit. Net realizable value is determined as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. Packaging and supplies are initially valued at cost and subsequently at the lower of cost and net realizable value.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment is measured at cost less accumulated depreciation and impairment losses. Cost includes expenditure that is directly attributable to the acquisition of the items.

Subsequent costs are included in the asset's carrying amount or recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the group and the cost of the item can be measured reliably. The carrying amount of any component accounted for as a separate asset is derecognized when replaced. All other repairs and maintenance are charged to profit or loss during the reporting period in which they are incurred.

Construction in progress is transferred to a depreciable asset class property, plant and equipment when the assets are available for use and depreciation of the assets commences at that point.


HEXO Corp. 2020 Consolidated Financial Statements

Depreciation is provided using the following terms and methods:

Land Not depreciated No term
Buildings Straight line 5 to 20 years
Leasehold improvements    Straight line lease term
Furniture and equipment Straight line 5 years
Cultivation and production equipment Straight line 5 to 20 years
Vehicles Straight line 5 years
Computers Straight line 3 years
Construction in progress    Not depreciated  No term

                      

An asset's residual value and useful life are reviewed at each reporting date and adjusted if appropriate. When parts of an item of equipment have different useful lives, they are accounted for as separate items (major components) of property, plant and equipment.

Gains and losses on disposal of an item of equipment are determined by comparing the proceeds from disposal with the carrying amount of the equipment and are recognized in profit or loss.

FINITE LIFE INTANGIBLE ASSETS

Finite life intangible assets are measured at cost less accumulated amortization and accumulated impairment losses. Amortization is provided on a straight-line basis over the following terms:

Domain names

Straight line

    10 years

Health Canada licenses

Straight line

    20 years

Software 

Straight line

3 to 5 years

Patents  

Straight line

20 years

The estimated useful life is reviewed at the end of each reporting period, with the effect of any changes in estimate being accounted for on a prospective basis.

Research expenditure and development expenditure that do not meet the recognition criteria for intangible assets are recognized as an expense as incurred. Development costs previously recognized as an expense are not recognized as an asset in a subsequent period.

INDEFINITE LIFE INTANGIBLE ASSETS

Indefinite intangible assets are deemed to have no foreseeable limit over which the asset is expected to generate net cash inflows. Following initial recognition, intangible assets with indefinite useful lives are carried at cost less any accumulated impairment losses and are tested annually for impairment, or more frequently if events or changes in circumstances indicate that they might be impaired. The Company intends to utilize the brand indefinitely. The capitalized brand consists of the Company's premium Up brand, which was recognized upon the acquisition of Newstrike (Note 14).

Brand

Not amortized

Indefinite

GOODWILL

Goodwill is not amortized but it is tested for impairment annually, or more frequently if events or changes in circumstances indicate that it might be impaired and is carried at cost less accumulated impairment losses.

Goodwill is allocated to cash-generating units for the purpose of impairment testing. The allocation is made to those cash-generating units or groups of cash-generating units that are expected to benefit from the business combination in which the goodwill arose. The units or groups of units are identified at the lowest level at which goodwill is monitored for internal management purposes, being the Company's single operating segment.

IMPAIRMENT OF NON-FINANCIAL ASSETS

Goodwill and intangible assets that have an indefinite useful life are not subject to amortisation and are tested annually for impairment, or more frequently if events or changes in circumstances indicate that they might be impaired. Other assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset's carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset's fair value less costs of disposal and value in use. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash inflows which are largely independent of the cash inflows from other assets or groups of assets (cash-generating units). Non-financial assets other than goodwill that suffered an impairment are reviewed for possible reversal of the impairment at the end of each reporting period.

A CGU's recoverable amount is the higher of its fair value less costs of disposal ("FVLCD") and its value in use ("VIU"). In assessing the VIU, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money to the Company and the risks specific to the asset. In determining FVLCD an appropriate valuation model is used. Where the carrying amount of a CGU exceeds its recoverable amount, the CGU is considered impaired and is written down to its recoverable amount. Any impairment loss is recorded in earnings and previously recognized impairment losses are reversed or partially reversed only if there has been a change in the assumptions used to determine the asset's recoverable amount since the last impairment loss was recognized. In which case, the carrying amount of the asset is increased to its recoverable amount. The new carrying amount cannot exceed the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognized.


HEXO Corp. 2020 Consolidated Financial Statements

BUSINESS ACQUISITION

The acquisition method of accounting is used to account for all business combinations, regardless of whether equity instruments or other assets are acquired. The consideration transferred for the acquisition of a subsidiary comprises the:

  • fair values of the assets transferred
  • liabilities incurred to the former owners of the acquired business
  • equity interests issued by the Company
  • fair value of any asset or liability resulting from a contingent consideration arrangement, and
  • fair value of any pre-existing equity interest in the subsidiary.

Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are, with limited exceptions, measured initially at their fair values at the acquisition date. The Company recognises any non-controlling interest in the acquired entity on an acquisition-by-acquisition basis either at fair value or at the non-controlling interest's proportionate share of the acquired entity's net identifiable assets.

Acquisition-related costs are expensed as incurred.

The excess of the:

  • consideration transferred,
  • amount of any non-controlling interest in the acquired entity, and
  • acquisition-date fair value of any previous equity interest in the acquired entity

over the fair value of the net identifiable assets acquired is recorded as goodwill. If those amounts are less than the fair value of the net identifiable assets of the business acquired, the difference is recognised directly in profit or loss as a bargain purchase.

Where settlement of any part of cash consideration is deferred, the amounts payable in the future are discounted to their present value as at the date of exchange. The discount rate used is the entity's incremental borrowing rate, being the rate at which a similar borrowing could be obtained from an independent financier under comparable terms and conditions.

Contingent consideration is classified either as equity or a financial liability. Amounts classified as a financial liability are subsequently remeasured to fair value, with changes in fair value recognised in profit or loss.

If the business combination is achieved in stages, the acquisition date carrying value of the acquirer's previously held equity interest in the acquiree is remeasured to fair value at the acquisition date. Any gains or losses arising from such remeasurement are recognised in profit or loss.

NON-CURRENT ASSETS (OR DISPOSAL GROUPS) HELD FOR SALE

Non-current assets (or disposal groups) are classified as held for sale if their carrying amount will be recovered principally through a sale transaction rather than through continuing use and a sale is considered highly probable. They are measured at the lower of their carrying amount and fair value less costs to sell, except for assets such as deferred tax assets, assets arising from employee benefits, financial assets and investment property that are carried at fair value and contractual rights under insurance contracts, which are specifically exempt from this requirement.

An impairment loss is recognised for any initial or subsequent write-down of the asset (or disposal group) to fair value less costs to sell. A gain is recognised for any subsequent increases in fair value less costs to sell of an asset (or disposal group), but not in excess of any cumulative impairment loss previously recognised. A gain or loss not previously recognised by the date of the sale of the non-current asset (or disposal group) is recognised at the date of derecognition.

Non-current assets (including those part of a disposal group) are not depreciated or amortised while they are classified as held for sale. Interest and other expenses attributable to the liabilities of a disposal group classified as held for sale continue to be recognised.

Non-current assets classified as held for sale are presented separately from the other assets in the balance sheet. The liabilities of a disposal group classified as held for sale are presented separately from other liabilities in the balance sheet.

ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities represent liabilities for goods and services provided to the Company prior to the end of the financial year which are unpaid. The amounts are unsecured and are usually paid within 30 days of recognition. Trade and other payables are presented as current liabilities unless payment is not due within 12 months after the reporting period. Accounts payable and accrued liabilities are recognized initially at their fair value and subsequently measured at amortized cost using the effective interest method.

REVENUE RECOGNITION


HEXO Corp. 2020 Consolidated Financial Statements

Revenue from the direct sale of cannabis to customers for a fixed price is recognized when the Company transfers the control of the good(s) to the customer upon delivery and acceptance by the customer. The Company recognizes revenue in an amount that reflects the consideration which the Company expects to receive taking into account the impact which may arise from any rights of return on sales, price concessions or similar obligations. Net revenue is presented net of taxes, estimated returns, allowances and discounts.  

Canada Revenue Agency ("CRA") levies excise taxes on the sale of medical and adult-us cannabis products. The Company becomes liable for these excise duties when cannabis products are delivered to the customer. The excise taxes payable is the higher of (i) a flat-rate duty which is imposed when a cannabis product is packaged, and (ii) an advalorem duty that is imposed when a cannabis product is delivered to the customer.

Effective May 1, 2019, excise tax calculated on edible cannabis products, cannabis extracts and cannabis topicals will prospectively be calculated as a flat rate based on the quantity of total tetrahydrocannabinol (THC) contained in the final product. There were no changes in the legislation in calculating excise taxes for fresh cannabis, dried cannabis, seeds and plants. Net revenue from sale of goods, as presented on the consolidated statements of comprehensive (loss) income, represents revenue from the sale of goods less applicable excise taxes.

COST OF GOODS SOLD

Cost of goods sold includes cost of inventory expensed, packaging costs, shipping costs and related labor.

INCOME TAXES

The income tax expense or recovery for the period is the tax payable on the current period's taxable income, based on the applicable income tax rate for each jurisdiction, adjusted by changes in deferred tax assets and liabilities attributable to temporary differences and to unused tax losses.

The current income tax expense or recovery is calculated on the basis of the tax laws enacted or substantively enacted at the end of the reporting period in the countries where the Company and its subsidiaries and associates operate and generate taxable income. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation and considers whether it is probable that a taxation authority will accept an uncertain tax treatment. The Company measures its tax balances either based on the most likely amount or the expected value, depending on which method provides a better prediction of the resolution of the uncertainty.

Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, deferred tax liabilities are not recognized if they arise from the initial recognition of goodwill. Deferred income tax is also not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that, at the time of the transaction, affects neither accounting nor taxable profit or loss. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the end of the reporting period and are expected to apply when the related deferred income tax asset is realized or the deferred income tax liability is settled.

Deferred tax assets are recognized only if it is probable that future taxable amounts will be available to utilize those temporary differences and losses.

Deferred tax assets and liabilities are offset where there is a legally enforceable right to offset current tax assets and liabilities and where the deferred tax balances relate to the same taxation authority. Current tax assets and tax liabilities are offset where the entity has a legally enforceable right to offset and intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously.

SHARE-BASED COMPENSATION

The Company has an employee stock option plan. The Company measures equity settled share-based payments based on their fair value at the grant date and recognizes compensation expense over the vesting period based on the Company's estimate of equity instruments that will eventually vest. Forfeitures are adjusted for on an actual basis. The impact of the revision of the original estimate is recognized in profit or loss such that the cumulative expense reflects the revised estimate. For stock options granted to non-employees the compensation expense is measured at the fair value of goods and services received except where the fair value cannot be estimated, in which case it is measured at the fair value of the equity instruments granted. Consideration paid by employees or non-employees on the exercise of stock options is recorded as share capital and the related share-based compensation is transferred from share-based payment reserve to share capital.

RESTRICTED SHARE UNITS ("RSU's")

RSUs are cash or equity settled share-based payments granted to certain employees, directors and executives within the Company. RSUs are measured at their initial fair value on the date of the grant utilizing the Black-Scholes Merton model. The fair value of cash-settled RSUs is revalued at each period end and is recognized as share-based compensation expense over the vesting period with a corresponding adjustment to the liability. Upon the settlement of cash based RSUs, which are valued at the market value at the time of exercise, the related liability is transferred to share capital. The fair value of equity-settled RSUs are recognized in the share-based reserve at the grant date. Upon the settlement of equity-based payments, RSUs are settled in the form of common shares and the related share-based reserve is transferred to share capital.


HEXO Corp. 2020 Consolidated Financial Statements

Amounts recorded for forfeited RSUs are transferred to the accumulated deficit in the year of forfeiture or expiry.

LOSS PER SHARE

Loss per common share represents loss for the period attributable to common shareholders divided by the weighted average number of common shares outstanding during the year. Diluted loss per common share is calculated by dividing the applicable loss for the year by the sum of the weighted average number of common shares outstanding and all additional common shares that would have been outstanding if potentially dilutive common shares had been issued during the year. The calculation of diluted loss per share excludes the effects of various conversions and exercise of options and warrants that would be anti-dilutive.

BORROWING COSTS

Borrowing costs directly attributable to the acquisition, construction or production of qualifying assets, which are assets that necessarily take a substantial period of time to get ready for their intended use or sale, are added to the cost of those assets, until such time as the assets are substantially ready for their intended use or sale.

All other borrowing costs are recognized in profit or loss in the period which they are incurred.

FINANCIAL INSTRUMENTS

Financial assets and liabilities are recognized when the Company becomes a party to the contractual provision of the respective instrument.

The Company classifies its financial assets in the following measurement categories:

 

 those to be measured subsequently at fair value (either through OCI or through profit or loss), and

 those to be measured at amortized cost.

 

The classification depends on the entity's business model for managing the financial assets and the contractual terms of the cash flows.

The Company has made the following classifications:

 

IFRS 9 Classification

Financial assets

 

Cash and cash equivalents

Amortized cost

Restricted funds

Amortized cost

Short-term investments

Amortized cost

Trade receivables

Amortized cost

Convertible debenture receivable

FVTPL

Long term investments

FVTPL

Financial liabilities

 

Accounts payable and accrued liabilities

Amortized cost

Warrant liabilities

FVTPL

Deferred rent liability

Amortized cost

Convertible debentures

Amortized cost

Lease liabilities

Amortized cost

Term loan

Amortized cost

Fair Value Through Profit or Loss ("FVTPL") Financial Assets

Financial assets classified and measured at FVTPL are those assets that do not meet the criteria to be classified at amortized cost or at FVTOCI. This category includes debt instruments whose cash flow characteristics are not solely payments of principal and interest ("SPPI") or are not held within a business model whose objective is either to collect contractual cash flows, or to both collect contractual cash flows and sell the financial asset.

Amortized Cost Financial Assets

Financial assets at amortized cost are non-derivative financial assets which are held within a business model whose objective is to hold assets to collect contractual cash flows and its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. An amortized cost financial asset is initially measured at fair value, including transaction costs and subsequently at amortized cost using the effective interest rate.

Impairment of Financial Assets

Financial assets, other than those classified at fair value through profit and loss, are assessed for indicators of impairment at the end of each reporting period. Financial assets are considered to be impaired when there is objective evidence that, as a result of one or more events that occurred after the initial recognition of the financial asset, the estimated future cash flows of the investment have been affected.


HEXO Corp. 2020 Consolidated Financial Statements

Financial Liabilities and Other Financial Liabilities

Financial liabilities are classified as either financial liabilities at FVTPL or other financial liabilities. Financial liabilities at FVTPL are stated at fair value, with changes being recognized through the consolidated statements of income. Other financial liabilities are initially measured at fair value, net of transaction costs, and are subsequently measured at amortized cost using the effective interest method.

Derivatives

Derivatives are initially measured at fair value in conjunction with the host contract; no bifurcation is performed, and any directly attributable transaction costs are recognised in profit or loss as incurred. Subsequent to initial recognition, the entire instrument, including the embedded derivative is measured at fair value and changes therein are recognised in profit or loss. The Company has a convertible loan receivable whereby the balance can be converted into equity. See Note 15 for transaction and valuation details.

Compound Instruments

The component parts of compound instruments (convertible debentures) issued by the Company are classified separately as financial liabilities and equity in accordance with the substance of the contractual arrangements and the definitions of a financial liability and an equity instrument. A conversion option that will be settled by the exchange of a fixed amount of cash or another financial asset for a fixed number of the Company's own equity instruments is an equity instrument.

At the date of issue, the fair value of the liability component is estimated using the prevailing market interest rate for similar non-convertible instruments. This amount is recorded as a liability on an amortized cost basis using the effective interest rate method until extinguished upon conversion or at the instrument's maturity date.

The conversion option classified as equity is determined by deducting the amount of the liability component from the fair value of the compound instrument as a whole. This is recognized and included in equity and is not subsequently remeasured. In addition, the conversion option classified as equity will remain in equity. No gain or loss is recognized in profit or loss upon conversion or expiration of the conversion option.

Transaction costs that relate to the issue of the convertible debentures are allocated to the liability and equity components in proportion to the allocation of the gross proceeds. Transaction costs relating to the equity component are recognized directly in equity. Transaction costs relating to the liability component are included in the carrying amount of the liability component and are amortized over the term of the convertible debentures using the effective interest method.

For compound instruments with non-equity derivatives, the fair value of the embedded derivative is determined first based on the contractual terms, and the initial carrying amount of the host instrument is the residual amount after separating the embedded derivative.

Transaction Costs

Transaction costs that are directly attributable to the acquisition or issue of financial assets and financial liabilities (other than financial assets and financial liabilities at fair value through profit or loss) are added to or deducted from the fair value of the financial assets or financial liabilities, as appropriate, on initial recognition. Transaction costs directly attributable to the acquisition of financial assets or financial liabilities at fair value through profit or loss are recognized immediately in profit or loss.

FOREIGN CURRENCY TRANSLATION

Foreign currency transactions are translated into Canadian dollars at exchange rates in effect on the date of the transactions. Monetary assets and liabilities denominated in foreign currencies at the consolidated statement of financial position date are translated to Canadian dollars at the foreign exchange rate applicable at that date. Realized and unrealized exchange gains and losses are recognized through profit or loss.

Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction.

CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS

The preparation of the consolidated financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected.

Critical Accounting Judgements

CGU Impairment

CGUs are defined as the lowest level of integrated assets for which there are separately identifiable cash flows that are largely independent of cash flows from other assets or groups of assets. The classification of assets and the allocation of assets into respective CGUs require significant judgment, assumption and interpretations. Areas of judgement in the classification process, include the manner in which management reviews and makes decisions about its operations. The recoverability of assets are assessed at the CGU level and therefore could have a significant impact on impairment losses.

Revenue - Principal versus Agent

The Company evaluates whether it is the principal (reports on gross basis) or agent (reports on a net basis) for revenues generated by the direct sale of cannabis infused beverages ("CIB's). The Company control's the CIB's prior to the sale to its customers as regulated and mandated under the Cannabis Act and Health Canada legislation. The Company's control is evidenced by our sole ability to possess the CIB's once the cannabis distillate has been added and thus establishing the inventory as a cannabis product requiring to be held a licensed producer. It is further evidenced by the Company possessing the sole ability to monetize the sale of CIB's through the held sales agreements and purchase orders with customers. The Company presents the revenues from the sale of CIBs on a gross basis.

Critical Accounting Estimates

Valuation of Biological Assets


HEXO Corp. 2020 Consolidated Financial Statements

In calculating the fair value less costs to sell of the Company's biological assets, management is required to make a number of estimates, including estimating the stage of growth of the cannabis, harvesting costs, selling costs, sales price and expected yields for the cannabis plant.

Observable market selling prices of cannabis derived products less costs to sell are used to estimate the sales prices which are an input in the fair value less costs to sell calculation.

Valuation of Inventory

In calculating the net realizable value (NRV) of inventory, management determines the selling prices based on prevalent sales prices, selling costs, and includes an estimate of spoiled or expired inventory based on the most reliable evidence available at the time, to record inventory at the lower of cost or net realizable value.

Impairment of Property, Plant and Equipment and Intangible Assets, including Goodwill

The assessment of any impairment of these assets is dependent upon estimates of recoverable amounts that take into account factors such as economic and market conditions and the useful lives of assets. The impairment is the amount by which the carrying amount of the asset or CGU exceeds its recoverable amount. The recoverable amount is the higher of the fair value less costs of disposal and its value in use. Management exercises judgement in the determination of the Company's CGUs.

Provisions

Provisions are recognized when the Company has a present obligation, legal or constructive as a result of a previous event, if it is probable that the Company will be required to settle the obligation and a reliable estimate can be made of the obligation. The amount recognized is the best estimate of the expenditure required to settle the present obligation at the end of the reporting period, taking into account the risks and uncertainties surrounding the obligations. Provisions are reviewed at the end of each reporting period and adjusted to reflect the current best estimate of the expected future cash flows.

Allocation of Purchase Price

In determining the allocation of the purchase price, estimates are used based on market research and appraisal values.

Business Acquisitions

In determining the fair value of all identifiable assets acquired and liabilities assumed, the most significant estimates relate to private investments and intangible assets acquired. Management exercises judgment in estimating the probability and timing of when cash flows are expected to be achieved, which is used as the basis for estimating fair value.

Identified intangible assets are fair valued using appropriate valuation techniques which are generally based on a forecast of the total expected future net cash flows of the acquiree. Valuations are highly dependent on the inputs used and assumptions made by management regarding the future performance of these assets and any changes in the discount rate applied.

Acquisitions that do not meet the definition of a business combination are accounted for as asset acquisitions. Consideration paid for an asset acquisition is allocated to the individual identifiable assets acquired and liabilities assumed based on their relative fair values. Asset acquisitions do not give rise to goodwill.

Convertible Debentures

Convertible debentures are financial instruments which are accounted for separately dependent on the nature of their components: a financial liability and an equity instrument. The identification of such components embedded within a convertible debenture requires significant judgments including; discount rates and future cash flows. The conversion option has a fixed conversion rate thus the financial liability, which represents the obligation to pay coupon interest on the convertible debentures in the future, is initially measured at its fair value and subsequently measured at amortized cost. The residual balance, or conversion feature is accounted for as equity at issuance. Transaction costs are apportioned to the debt liability and equity component in proportion to the allocation of proceeds.


HEXO Corp. 2020 Consolidated Financial Statements

Newly Adopted Accounting Policies Effective August 1, 2019

IFRS 16, LEASES

The Company adopted IFRS 16 Leases on August 1, 2019, which introduces a new approach to lease accounting. The Company adopted the standard using the modified retrospective approach, which does not require restatement of prior period financial information, as it recognizes the cumulative impact on the opening balance sheet and applies the standard prospectively. Accordingly, the comparative information has not been restated.

At the inception of a contract, the Company assesses whether the contract is, or contains, a lease based on whether the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. This policy is applied to contracts entered into, or modified, on or after August 1, 2019.

Practical expedients

Effective August 1, 2019, the IFRS 16 transition date, the Company elected to use the following practical expedients under the modified retrospective transition approach:

  • Leases with lease terms of less than twelve months (short-term leases) and leases of low-value assets (less than $5,000 U.S. dollars) (low-value leases) that have been identified at transition were not recognized in the consolidated statement of financial position;
  • Right-of-use assets on transition were measured at the amount equal to the lease liabilities at transition, adjusted by the amount of any prepaid or accrued lease payments;
  • For certain leases having associated initial direct costs, the Company, at initial measurement on transition, excluded these directs costs from the measurement of the right-of-use assets;
  • Application of a single discount rate to portfolios of leases with similar characteristics on transition; and
  • Any provision for onerous lease contracts previously recognized at the date of adoption of IFRS 16 has been applied to the associated right-of-use asset recognized upon transition.

The Company as a lessee

Where the Company is a lessee, a right-of-use asset representing the right to use the underlying asset with a corresponding lease liability is recognized when the leased asset becomes available for use by the Company.

The right-of-use asset is recognized at cost and is depreciated on a straight-line basis over the shorter of the estimated useful life of the asset and the lease term. The cost of the right-of-use asset is based on the following:

  • the amount of initial recognition of related lease liability;
  • adjusted by any lease payments made on or before inception of the lease;
  • increased by any initial direct costs incurred; and
  • decreased by lease incentives received and any costs to dismantle the leased asset.

The lease term includes consideration of an option to extend or to terminate if the Company is reasonably certain to exercise that option. In addition, the right-of-use asset is periodically reduced by impairment losses, if any, and adjusted for certain remeasurements of the lease liability.

Lease liabilities are initially recognized at the present value of the lease payments. The lease payments are discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, the Company's incremental borrowing rate. Generally, the Company uses its incremental borrowing rate as the discount rate. Subsequent to recognition, lease liabilities are measured at amortized cost using the effective interest rate method. Lease liabilities are remeasured when there is a change in future lease payments arising mainly from a change in an index or rate, if there is a change in the Company's estimate of the amount expected to be payable under a residual value guarantee, or if the Company changes its assessment of whether it will exercise a purchase, renewal or termination option.

The payments related to short-term leases and low-value leases are recognized as other expenses over the lease term in the statement of loss and comprehensive loss.

Significant accounting estimates and assumptions

In the situation where the implicit interest rate in the lease is not readily determined, the Company uses judgment to estimate the incremental borrowing rate for discounting the lease payments. The Company's incremental borrowing rate generally reflects the interest rate that the Company would have to pay to borrow a similar amount at a similar term and with a similar security. On adoption of IFRS 16, the Company has determined a single IBR as the discount rate across all administrative real estate leases due to the leases containing similar characteristics. A separate IBR was used for the discounting of the Company's production real estate property. The IBRs utilized for administrative real estate and production real estate were 8% and 12%, respectively.


HEXO Corp. 2020 Consolidated Financial Statements

The Company estimates the lease term by considering the facts and circumstances that create an economic incentive to exercise an extension or termination option. Certain qualitative and quantitative assumptions are used when evaluating these incentives.

 

The Company as a lessor

The Company's consolidated financial statements were not impacted by the adoption of IFRS 16 Leases in relation to lessor accounting. Lessors will continue with the dual classification model for recognized leases with the resultant accounting remaining unchanged from IAS 17, Leases.

Impact of Change in Accounting Policy

On August 1, 2019, the Company recognized $21,360 of right-of-use assets and $21,360 of operating lease liabilities. The Company applied its weighted average incremental borrowing rate as at August 1, 2019 to determine the amount of lease liabilities. The effect of the adjustment to the amounts recognized in the Company's consolidated statement of financial position at August 1, 2019 is shown below.

     
August 1, 2019,
as previously reported
    IFRS 16 remeasurement
adjustments on
August 1, 2019
    As reported under
IFRS 16
August 1, 2019
 
Assets                  
Non-current                  
  Property, plant and equipment $ 258,793   $ 21,360   $ 280,153  
Total Assets $ 258,793   $ 21,360   $ 280,153  
                   
Liabilities                  
Current liabilities                  
  Lease liabilities   -     3,556     3,556  
                   
Non-current liabilities                  
  Lease liabilities   -     17,804     17,804  
Total Liabilities $ -   $ 21,360   $ 21,360  

Total commitments as at July 31, 2019 were $192,230, which included certain contractual financial obligations related to service agreements, purchase agreements, operating lease agreements, and construction contracts. Of this total, $101,741 is related to operating lease commitments. The following is a reconciliation of total operating lease commitments as at July 31, 2019 to the lease liabilities recognised as at August 1, 2019:

Total operating leases commitments as at July 31, 2019

$              101,741

Less: Variable components of operating leases

(49,330)

Less: Low value and/or short-term lease

 

(88)

Operating lease liability before discounting

 

52,323

Adjustment to reflect discounting of operating lease commitments at August 1,  2019, using the incremental borrowing rate

 

                (30,963)

Total lease liabilities recognized under IFRS 16 as at August 1, 2019 (Note 18)

 

$              21,360 

4. Cash, Cash Equivalents and Short-Term Investments

  Interest rate     July 31, 2020     July 31, 2019  
Operating cash           -   $ 70,318   $ 5,993  
High interest savings accounts       0.70%     113,855     107,575  
Cash and cash equivalents     $ 184,173   $ 113,568  
                 
Term deposits & GIC 2.85%-4.25% maturity of 3 to 12 months $ -   $ 25,937  
Short-term investments     $ -   $ 25,937  

5. Restricted Funds

          July 31, 2020     July 31, 2019  
Capital contribution held in trust $ -   $ 4,076  
Debt service reserve account - term loan (Note 19)   8,191     9,200  
Neal Up Brands Inc. (Note 30)     -     2,500  
Letters of credit, collateral and guarantees for purchases   70     6,574  
Total   $ 8,261   $ 22,350  

HEXO Corp. 2020 Consolidated Financial Statements

6. Commodity Taxes Recoverable and Other Receivables

    July 31, 2020     July 31, 2019  
Commodity taxes recoverable $ 12,821   $ 14,415  
Accrued interest income   -     570  
Lease receivable - current (1)   630     -  
Other receivables   3,282     262  
Total $ 16,733   $ 15,247  

(1) A related party capital lease receivable related to Truss Limited Partnership (Note 26).

7. Convertible Debentures Receivable 

    July 31, 2020     July 31, 2019  
12% Convertible debentures $ -   $ 12,024  
Zero interest convertible debentures   -     1,330  
Total $ -   $ 13,354  

12% CONVERTIBLE DEBENTURES

On July 26, 2018, the Company purchased $10,000 in the form of unsecured and subordinated convertible debentures to an unrelated entity, Fire and Flower ("FAF"). The convertible debentures bore interest at 8%, which was paid semi-annually and matured July 31, 2020. The convertible debentures included a conversion feature which allowed for the conversion of the debenture into common shares of FAF at the lower of $1.15 and the share price as defined within the agreement. The Company obtained the debenture as a part of a strategic investment into the private retail cannabis market. The convertible debentures are measured using a level 2 valuation methodology under the fair value hierarchy.

The debentures had the option of being converted into common shares or a loan on July 31, 2020, which bore interest at 12%, at the holder's option.

On January 23, 2020, $3,000 of debentures were converted using a conversion rate of $1.15 into 2,608,695 common shares of FAF. The Company then fully disposed of these shares on January 27, 2020 at an average market price of $1.0541 for total proceeds of $2,724, net of commission expenses amounting to $26.

On February 11, 2020, the remaining $7,000 of debentures were converted using a conversion rate of $1.15 into 6,086,956, common shares of FAF. The Company fully disposed of these shares on February 18, 2020 at an average market price of $0.75 for total proceeds of $4,504 net of commission expenses amounting to $61. The accrued and unpaid interest on February 11, 2020, was $367 which was settled through the issuance of 319,377 common shares of FAF to the Company (Note 11).

The realized loss for the year ended July 31, 2020 was $4,396.

ZERO INTEREST CONVERTIBLE DEBENTURES

On May 24, 2019, the Company obtained $800 of unsecured and subordinated convertible debentures from FAF as a result of the acquisition of Newstrike (Note 14). On May 24, 2019, the debentures carried an initial fair value of $1,220. The convertible debenture bore zero interest and matured on November 30, 2019. On maturity, the debentures converted into 1,000,000 common shares of FAF, at a conversion rate of $0.80, as set out in the agreement (Note 11). The realized loss for the year ended July 31, 2020 was $410.

8. Inventory 

    As at July 31, 2020  
    Capitalized     Biological asset fair        
    cost     value adjustment     Total  
Dried cannabis $ 29,702   $ 16,981   $ 46,683  
Purchased dried cannabis   1,956     -     1,956  
Oils   10,805     385     11,190  
Hemp derived distillate   566     -     566  
Packaging and supplies   4,538     -     4,538  
  $ 47,567   $ 17,366   $ 64,933  

    As at July 31, 2019  
    Capitalized     Biological asset fair        
    cost     value adjustment     Total  
Dried cannabis $ 28,996   $ 19,349   $ 48,345  
Purchased dried cannabis   8,087     -     8,087  
Oils   17,377     5,366     22,743  
Hemp derived distillate   1,523     -     1,523  
Packaging and supplies   3,156     -     3,156  
  $ 59,139   $ 24,715   $ 83,854  


HEXO Corp. 2020 Consolidated Financial Statements

The Company recognizes the costs of inventory expensed in two separate lines on the consolidated statement of loss. Capitalized costs relating to inventory expensed during the year was included in Cost of goods sold and amounted to $127,424 for the year ended July 31, 2020 (July 31, 2019 – $45,532). The unrealized fair value gain on biological fair value adjustments on the consolidated statement of loss during the year ended July 31, 2020 were $29,356 (July 31, 2019 – $38,856). The realized fair value amounts on inventory sold on the consolidated statement of loss was $40,910 for the year ended July 31, 2020 (July 31, 2019 – $16,357) and included a write down of inventory to its net realizable value of $13,366 (July 31, 2019 – $2,417).

Total share-based compensation capitalized to inventory in the year ended July 31, 2020 was $6,105 (2019 - $1,724). Total depreciation capitalized to inventory in the year ended July 31, 2020 was $11,988 (2019 - $4,825).

In the year ended July 31, 2020, the Company disposed of inventory of $4,392 (July 31, 2019 - $nil) and included in Costs of sales in the consolidated statement of loss. The Company also wrote down inventory to its net realizable value, incurring a loss of $68,021 for the year ended July 31, 2020 (July 31, 2019 - $19,335) due to inventory deemed. These amounts were included in Costs of goods sold in the consolidated statement of loss.

9. Biological Assets

The Company's biological assets consist of cannabis plants from seeds all the way through to mature plants. The changes in the carrying value of biological assets are as follows:

For the years ended   July 31, 2020     July 31, 2019  
Balance, beginning of year $ 7,371   $ 2,332  
Acquired through acquisition1   -     3,291  
Production costs capitalized   38,638     19,215  
Net increase in fair value due to biological transformation and estimates   29,356     38,856  
Transferred to inventory upon harvest   (67,131 )   (56,323 )
Disposal of biological assets   (663 )   -  
Balance, end of year $ 7,571   $ 7,371  

  1Acquired through the Newstrike acquisition on May 24, 2019

During the year ended July 31, 2020, the Company recorded a loss of $663 relating to plants disposed of prior to harvest (2019 - $Nil).

The valuation of biological assets is based on an income approach (Level 3) in which the fair value at the point of harvesting is estimated based on selling prices less the costs to sell. For in process biological assets, the fair value at the point of harvest is adjusted based on the stage of growth at period-end.

The significant estimates used in determining the fair value of cannabis plants are as follows:

  • yield per plant;
  • stage of growth percentage estimated as  costs incurred as a percentage of total cost as applied to the estimated total fair value per gram (less fulfilment costs) to arrive at an in-process fair value for estimated biological assets, which have not yet been harvested;
  • percentage of costs incurred for each stage of plant growth.
  • fair value selling price per gram less cost to complete and cost to sell.
  • destruction/wastage of plants during the harvesting and processing process.

Management's identified significant unobservable inputs, their range of values and sensitivity analysis are presented in the tables below.

Unobservable inputs

Input values

An increase or decrease of 5% applied to the unobservable input would result in a change to the fair value of approximately

 

July 31, 2020

July 31, 2019

July 31, 2020

July 31, 2019

Weighted average selling price

Derived from actual retail prices on a per product basis using the expected Flower and Trim yields per plant.

$3.23 per dried gram

$4.23 per dried gram

$550

$480

Yield per plant

Derived from historical harvest cycle results on a per strain basis.

46 - 135 grams per plant

15 - 123 grams per plant

$376

$344

Stage of growth

Derived from the estimates of stage of completion within the harvest cycle.

Average of 43% completion

Average of 29% completion

$376

$1,148

Waste

Derived from the estimates of planned removal and naturally occurring waste within the cultivation and production cycle.

0%-21% dependent upon the stage within the harvest cycle

0%-30% dependent upon the stage within the harvest cycle

No material variance

$302



HEXO Corp. 2020 Consolidated Financial Statements

10. Investments in Associates & Joint Ventures

For the year ended   July 31, 2020     July 31, 2019  
    Truss LP     Other     Total     Truss LP     Other     Total  
    $     $     $     $     $     $  
Opening Balance   51,786     1,063     52,849     -     -     -  
Cash contributed to investment   29,155     1,231     30,386     11,476     1,106     12,582  
Fair value of warrant consideration   -     -     -     42,386     -     42,386  
Capitalized transaction costs   -     109     109     720     125     845  
Share of net loss for the year   (5,975 )   (356 )   (6,331 )   (2,796 )   (168 )   (2,964 )
Impairment   -     (707 )   (707 )   -     -     -  
Ending Balance   74,966     1,340     76,306     51,786     1,063     52,849  

The table below summarises financial information for the Company's associate that are material to the group, which is the investment in Truss LP. The information disclosed reflects the amounts presented in the financial statements of the associate and not the Company's share of those amounts. They have been amended to reflect adjustments made by the Company when using the equity method, including fair value adjustments and modifications for differences in accounting policy.

    Truss LP  
As at   July 31, 2020     July 31, 2019  
Statement of Financial Position   $     $  
Cash and cash equivalents   19,561     14,318  
Current assets (excluded cash and cash equivalents)   7,867     5,701  
             
Non- current assets   66,863     7,880  
             
Current liabilities   11,112     7,477  
Non-current liabilities    8,903     -  
             
Period   year ended
July 31, 2020
    11 months ended
July 31, 2019
 
             
Statement of Comprehensive Loss            
Revenue   705(1 )   -  
             
Operating expenses excluding depreciation and amortization   (12,243 )   (6,579 )
Depreciation and amortization   (617 )   -  
Other expenses   (7 )   -  
Loss from operations   (13,423 )   (6,579 )
Interest income   1     -  
Interest expenses   (233 )   -  
Income tax expenses   -     -  
Total comprehensive loss   (13,655 )   (6,579 )

  1The Company notes, the revenues of Truss LP are rental fees paid by the Company for the sublease it has with the sub-lessor, Truss LP.

The following table is a reconciliation of summarized financial information of the Company's' significant investment in associate to the presented carrying amount for the year ended July 31, 2020 and 2019.

For the year ended     July 31, 2020     July 31, 2019  
    $     $  
Opening net assets   20423     -  
Acquisition of associate/capital calls   68,600     27,002  
Total comprehensive loss   (14,059 )   (6,579 )
Closing net assets   74,964     20,423  
Interest in associate   42.5%     42.5%  
Interest in associate value   31,860     8,680  
Fair value of warrant consideration   42,386     42,386  
Capitalized transaction costs   720     720  
Total interest in associate value   74,966     51,786  


HEXO Corp. 2020 Consolidated Financial Statements

Truss

On October 4, 2018, the formation of the entity Truss Limited Partnership between the Company and Molson Coors Canada (the "Partner") was finalized. Truss is a standalone entity with its own board of directors and an independent management team and is incorporated in Canada. Truss is a private limited partnership and its principal operating activities consist of pursuing opportunities to develop non-alcoholic, cannabis-infused beverages.

The Partner holds 57,500 common shares representing 57.5% controlling interest in Truss with the Company holding 42,500 common shares and representing the remaining 42.5%. In connection with the formation of Truss, the Company granted the Partner 11,500,000 common share warrants in the Company at an exercise price of $6.00 for a period of three years (Note 16).

11. Long-term Investments

    Fair value
July 31,
2019
    Investment/
Transfer
    Divestiture     Change in
fair value
    Fair value
July 31,
2020
 
    $     $     $     $     $  
Level 1 Investments                              
Fire and Flower common shares   -     1,232     -     60     1,292  
Inner Spirit common shares   3,000     -     (643 )   (1,097 )   1,260  
Other long-term investments   -     517     -     -     517  
Level 2 Investments                              
Inner Spirit common share purchase warrants   403     -     -     (403 )   -  
Level 3 Investments                              
Greentank Technologies   6,574     -     -     (6,574 )   -  
Neal Brothers Inc.   4,000     -     -     (4,000 )   -  
Segra International Corp.   300     -     -     (160 )   140  
Total   14,277     1,749     (643 )   (12,174 )   3,209  

    Fair value
July 31,
2018
    Investment     Divesture     Change in
fair value
    Fair value
July 31,
2019
 
    $     $     $     $     $  
Level 1 Investments                              
Fire & Flower Inc. common shares   -     2,970     (2,493 )   (477 )   -  
Fire & Flower Inc. common share purchase warrants1   -     505     (262 )   (243 )   -  
Inner Spirit common shares1   -     2,850     -     150     3,000  
Level 2 Investments                              
Inner Spirit common share purchase warrants1   -     414     -     (11 )   403  
Level 3 Investments                              
Greentank Technologies1   -     6,723     -     (149 )   6,574  
Neal Brothers Inc. 1   -     4,000     -     -     4,000  
Segra International Corp.   100     -     -     200     300  
Total   100     17,462     (2,755 )   (530 )   14,277  

1 Acquired in the Newstrike acquisition on May 24, 2019 at fair market value

Fire & Flower

Common Shares

On November 30, 2019, the Company obtained 1,000,000 common shares in FAF through the conversion of its $800 zero interest bearing convertible debentures (Note 16). The debentures were convertible at $0.80 per common share. The fair value of the shares upon conversion was $920. The shares were revalued to $980 using a market rate of $0.98 as at July 31, 2020. The Company incurred a gain of $60 upon revaluation. 

On February 11, 2020, the Company received 319,377 common shares of FAF as settlement for the accrued and unpaid interest on the FAF convertible debentures on that date (Note 7). The shares were valued to $313 using a market rate of $0.98 as at July 31, 2020.

On November 1, 2018, the Company obtained 1,980,000 subscription receipts in FAF for proceeds of $2,970. The subscription receipts converted into common shares of FAF at a 1:1 ratio on February 19, 2019 upon the commencement of trading on the TSX Venture and recognised at an initial fair value of $2,970. On July 25, 2019, the Company liquidated the investment in full resulting in cash proceeds of $2,493. The Level 1 long-term investment fair value and associated realized loss as at July 31, 2019 were $nil and ($477), respectively.

Common Share Purchase Warrants

On May 24, 2019, through the acquisition of Newstrike, the Company obtained 1,000,000 common share purchase warrants in the entity FAF. Each warrant entitles the Company to a common share at a ratio of 1:1. The warrants held an initial fair value of $505. The investment was fair valued through the Black-Scholes-Merton option pricing model at $243 and disposed of on July 30, 2019. The Company realized a loss of ($243) as at July 30, 2019 based upon the following assumptions and inputs:


HEXO Corp. 2020 Consolidated Financial Statements

  • market price of $1.33;
  • expected life of 8.4 months;
  • $nil dividends;
  • 100% volatility based upon comparative market indicators and historical data; and
  • Risk- free interest rate of 1.46%.

Inner Spirit Holdings Inc.

Common Shares

On May 24, 2019, on acquisition of Newstrike, the Company acquired 15,000,000 common shares in Inner Spirit Holdings Inc., which were valued at $2,850 on initial recognition. During the year ended July 31, 2020, the Company disposed of 6,005,500 common shares, at prices ranging from $0.09-$0.15 per share, resulting in a gain of $24 (July 31, 2019 - $nil). The remaining 8,994,500 shares held at July 31, 2020 were valued based upon the market price of $0.14 (July 31, 2019 - $0.20) per share resulting in a fair value of $1,260 at year end.

Common Share Purchase Warrants

On May 24, 2019, through the acquisition of Newstrike, the Company obtained 7,500,000 common share purchase warrants in Inner Spirit Holdings Inc. Each warrant entitles the Company to a common share at a ratio of 1:1. The warrants held an initial fair value of $414. The investment is fair valued through the Black-Scholes-Merton option pricing model. The Company agreed to the early termination of the warrants with the issuer on February 17, 2020 and realized a loss of $403 (July 31, 2019 - unrealized loss of $11).

Greentank Technologies

On May 24, 2019, on acquisition of Newstrike, the Company acquired 1,953,125 preferred shares of Greentank Technologies, which were valued at $6,723 on acquisition date. During the year ended July 31, 2020, through the assessment of relevant financial information the Company determined the fair value of the investment was $nil.  During the year ended July 31, 2020, the impairment of the investment totaled $6,574 (July 31, 2019 - ($149)).

Neal Brothers Brands Inc.

The Company also acquired 19.9% of the shares of Neal Brothers Brands Inc. through the acquisition of Newstrike on May 24, 2019. The Company does not hold, nor is it entitled to a board seat. The fair value of the investment was $4,000 on acquisition date. During the year ended July 31, 2020, the private investment was written down to $nil based on the Company's assessment of relevant financial information (July 31, 2019 - $nil) therefore, during the year ended July 31, 2020, the impairment loss totaled $4,000 (July 31, 2019 - $nil). 

12. Property, Plant and Equipment 

Cost   Land     Buildings     Leasehold
improvements
    Cultivation
and production
equipment
    Furniture,
computers,
vehicles and
equipment
    Construction
in progress
    Right-of-Use
assets
    Total  
    $     $     $     $     $     $     $     $  
At July 31, 2018   1,038     32,536     206     4,031     2,471     15,433     -     55,715  
Business acquisitions   4,301     18,855     -     9,913     648     12,286     -     46,003  
Additions   -     11,365     421     28,085     7,249     117,909     -     165,029  
Transfers   -     88,078     -     -     -     (88,078 )   -     -  
At July 31, 2019   5,339     150,834     627     42,029     10,368     57,550     -     266,747  
Additions   -     24,432     1,395     14,969     9,404     66,246     24,405     140,851  
Disposals   (3,683 )   (18,260 )   -     (13,402 )   (909 )   (5,428 )   -     (41,682 )
Transfers   -     7,943     22,417     (10,135)     8     (20,233 )   -     -  
At July 31, 2020   1,656     164,949     24,439     33,461     18,871     98,135     24,405     365,916  
                                                 
Accumulated depreciation and impairments                                      
At July 31, 2018   -     533     9     69     771     -     -     1,382  
Depreciation   -     3,859     121     1,497     1,095     -     -     6,572  
Transfers   -     -     -     650     (650 )   -     -     -  
At July 31, 2019   -     4,392     130     2,216     1,216     -     -     7,954  
Depreciation   -     7,395     879     3,702     3,562     -     2,522     18,060  
Transfers   -     -     -     271     (271 )   -     -     -  
Disposals   -     (17,081 )   -     (7,435 )   (366 )   -     -     (24,882 )
Impairments   307     19,006     -     9,937     -     48,990     1,178     79,418  
At July 31, 2020   307     13,712     1,009     8,691     4,141     48,890     3,700     80,550  


HEXO Corp. 2020 Consolidated Financial Statements


Net book value                                      
At July 31, 2018   1,038     32,003     197     3,962     1,700     15,433     -     54,333  
At July 31, 2019   5,339     146,442     497     39,813     9,152     57,550     -     258,793  
At July 31, 2020   1,349     151,237     23,430     24,770     14,730     49,145     20,705     385,366  

During the year ended July 31, 2020, the Company capitalized $11,988 (July 31, 2019 – $4,825) of depreciation to inventory. During the year ended July 31, 2020, depreciation expensed to the consolidated statement of loss and comprehensive loss was $6,072 (July 31, 2019 – $1,747).

Capitalized borrowing costs to buildings were realized in the year ended July 31, 2020 in the amount of $2,385 (July 31, 2019 – $511) at an average interest rate of 7.22% (July 31, 2019 – 3.2%). Transfers are inclusive of $21,100 added to construction ($12,941 of cultivation and production equipment and $8,189 of buildings) added to construction in progress for of non-depreciated assets which the Company has not and cannot utilize.

Adjustments to construction in progress during the period reflect the activation of an asset's useful life, transitioning from construction in progress to the appropriate property, plant and equipment classification. Right-of-use assets in the year were impaired by an amount of $1,178 due to the abandonment of a commercial administration building which the Company intends to sublease and included in the additions is the deferred rent liability of $1,116, previously accounted for under IAS 17 - Leases.

IMPAIRMENT AND SALE OF NIAGARA FACILITY

On March 2, 2020, the Company completed a strategic review of its cultivation capacity and made the decision to market the Niagara facility for sale. As a result, the carrying amount of the Niagara facility expected to be recovered principally through its sale. The sale was completed on June 17, 2020.

The Niagara facility was subject to impairment testing during the fiscal year. The Niagara facility was acquired from Newstrike in May 2019 and consists primarily of equipment, cultivation and processing facilities and land assets that are included within property, plant and equipment, as well as related cultivation and processing licenses that are recorded as intangible assets (Note 13). These assets were previously included in the HEXO CGU.

The recoverable amount was determined by reference to fair value less costs of disposal using a market approach. The market approach was based on comparable transactions for similar assets, which is categorized within Level 2 of the fair value hierarchy. As a result, an impairment loss of $31,606 was recorded in property, plant and equipment. Additional impairment losses were recorded for cultivation and processing licenses (Note 13).

The adjustments reflect the activation of an asset's useful life, transitioning from construction in progress to the appropriate property, plant and equipment classification.

On June 17, 2020, the Company closed the sale of the Niagara Facility for proceeds of $12,250. The sale resulted in a loss on disposal of $2,219.

IMPAIRMENT OF CERTAIN OPTIMIZATION PROJECTS

As at July 31, 2020, the Company identified an impairment indicator for certain capital assets and expenditures made as a result of suspending certain optimization projects that were under construction. As a result, the Company recorded an impairment loss of $43,585 relating to redundant and idle capital assets, as well as excess leasehold improvement expenditure that is not expected to contribute to future cash flows of the Company. The recoverable amount of the assets was determined to be zero, as the assets have no continuing use to the Company and negligible value would be derived from sale as the assets were highly customised for a specific purpose and location.

IMPAIRMENT OF HEXO CGU

On January 31, 2020, an indicator of impairment was identified for the HEXO CGU as the carrying amount of the Company’s total net assets significantly exceeded the Company’s market capitalization. The HEXO CGU consists of the Company’s Canadian cultivation and production facilities.         

The recoverable amount of the CGU was determined based on fair value less cost of disposal using a market-based approach (Level 3) based on an income based discounted cash flow analysis (DCF). The Company uses its market capitalization and comparative market multiples to aid in validating the discounted cash flow results. The significant assumptions in the DCF analysis were as follows:

i. Cash flows: Estimated cash flows were projected based on actual operating results from internal sources as well as industry and market trends. A discrete four year period was forecasted with an extended 5 year period calculated using the H-Model which is an alternative dividend discount model that assumes the growth rate will fall linearly to the terminal value with a short-term growth rate of 10% in the first year, declining each year over the 5 years to a terminal growth rate of 3%.  If all other assumption were held constant and the short-term growth rate in the first year was decreased by 1%, the recoverable amount would decrease by approximately $24,000;

ii. Revenue and gross margin: Forecast revenues and resulting gross margin are based on internal projections, developed with reference to historical experience and external market information. If all other assumptions were held constant and forecasted revenues and resulting gross margin declined by 3%, the recoverable amount would decrease by approximately $34,000;

iii. Terminal value growth rate: Management used a 3% terminal growth rate which is based on historical and projected consumer inflation, historical and projected economic indicators, and projected industry growth. If all other assumption were held constant and the terminal growth rate was decreased by 1%, the recoverable amount would decrease by approximately $38,000;


HEXO Corp. 2020 Consolidated Financial Statements

 

iv. Discount rate: Management used a 14.1% post-tax discount rate which is reflective of an industry Weighted Average Cost of Capital (“WACC”). The WACC was estimated based on the risk-free rate, equity risk premium based on a direct comparison approach, a size premium and company specific risk, and after-tax cost of debt based on corporate bond yields. If all other assumption were held constant and the discount rate was in increased by 1%, the recoverable amount would decrease by approximately $59,000; and

v. Tax rate: The tax rates used in determining the future cash flows were those substantively enacted at the respective valuation date.

As a result of the impairment, no further impairment losses were required to be recorded.

13. Intangible Assets 

Cost   Cultivating and
processing license
    Brand     Software     Domain
names
    Patents     Other     Total  
    $     $     $     $     $     $     $  
At July 31, 2018   2,545     -     1,800     585     -     312     5,242  
  Business acquisitions   113,888     8,440     12     -     -     -     122,340  
  Additions   -     -     1,746     -     1,231     -     2,977  
  Transfers   -     -     -     -           (312 )   (312 )
At July 31, 2019   116,433     8,440     3,558     585     1,231     -     130,247  
  Additions   -     -     702     -     875     -     1,577  
  Disposals   -     -     (550 )   -     (173 )   -     (723 )
At July 31, 2020   116,433     8,440     3,710     585     1,933     -     131,101  

Accumulated amortization                                          
At July 31, 2018   403     -     786     9     -     -     1,198  
  Amortization   1,198     -     483     57     29     -     1,767  
At July 31, 2019   1,601     -     1,269     66     29     -     2,965  
  Amortization   3,167     -     697     59     16     -     3,939  
  Impairment   106,189     2,000     -     -     -     -     108,189  
At July 31, 2020   110,957     2,000     1,966     125     45     -     115,093  

Net book value                                          
At July 31, 2018   2,142     -     1,014     576     -     312     4,044  
At July 31, 2019   114,832     8,440     2,289     519     1,202     -     127,282  
At July 31, 2020   5,476     6,440     1,744     460     1,888     -     16,008  

Research and development expenses in the period amounted to $4,639 (July 31, 2019 - $2,822). The transfer represents $212 of capitalized transaction costs being allocated to the Truss investment in associate (Note 10) and $100 other longer-term investment has been reclassified to long-term investments.

IMPAIRMENT

In connection with the impairment loss recorded in the second quarter of fiscal 2020, for the Niagara facility, the Company recorded an impairment loss of $106,189 relating to cultivation and processing licenses associated with the Niagara facility. The acquired brand (Note 14) was also impaired by $2,000 as a result of an impairment test as at July 31, 2020.

14. Business Acquisition

Acquisition of Newstrike Brands Limited.

On May 24, 2019, the Company acquired 100% of the issued and outstanding common shares of Newstrike Brands Limited ("Newstrike") pursuant to an arrangement agreement entered into on March 13, 2019. Newstrike is a licensed producer of cannabis operating in Ontario, Canada and was acquired for additional production capacity, established sales relationships and its brand. Under the arrangement, each former Newstrike common share was exchanged for 0.06332 of a HEXO common share (the "Exchange Ratio"), subject to certain exceptions. In addition, all issued and outstanding stock options of Newstrike were replaced with stock options of HEXO having the same terms but adjusted for the Exchange Ratio, and all issued and outstanding common share purchase warrants of Newstrike became exercisable for HEXO common shares adjusted for the Exchange Ratio.

The following table summarizes the preliminary values of the net assets acquired from Newstrike on the acquisition date.



HEXO Corp. 2020 Consolidated Financial Statements


  Note   Number of Shares,
Warrants and Options
    Share Price
($)
    Amount
($)
 
Consideration                    
  Shares issued (i)   35,394,041     9.11     322,439  
  Warrants outstanding (ii)   7,196,164           12,229  
  Replacement options issued (iii)   2,002,365           7,134  
Total fair value of consideration                 341,802  
                     
Net assets acquired                    
Current assets                    
  Cash and cash equivalents                  49,366  
  Accounts receivable                 1,204  
  Other receivables                 4,585  
  Inventory                 22,359  
  Biological assets                 3,291  
                     
Long-term assets                    
  Property, Plant and Equipment                 46,003  
  Investments (iv)               14,492  
  Convertible debenture receivable                 1,220  
  Prepaid expenses                 1,631  
  Prepaid expense and license                 1,526  
  Software                 10  
  Cultivation and processing license                 113,888  
  Brand                 8,440  
  Goodwill                 111,877  
Total assets                 379,892  
                     
Current liabilities                    
  Accounts payable and accrued liabilities               12,849  
  Payment received in advance                 5  
                     
Long-term liabilities                    
  Deferred tax liabilities                 24,236  
Total liabilities                 37,090  
                     
Non-controlling interest                 1,000  
Total net assets acquired                 341,802  
                     
Net accounts receivables acquired                    
Total accounts receivable                 5,789  
Expected uncollectible receivables                 -  
Net accounts receivables acquired                 5,789  

(i) Share price based upon the TSX market price of common shares as at May 24, 2019.

(ii) Warrants were valued using the Black-Scholes option pricing model as at the acquisition date May 24, 2019, using the following assumptions and inputs;

  • Risk free rate of 1.48% - 1.57%
  • Expected life of 0.73 - 4.07 years
  • Volatility rate of 75%; determined using historical volatility data
  • Exercise prices of $11.84 - $27.64
  • Stock price of $9.11

(iii) All replacement options were valued using the Black-Scholes option pricing model as at the acquisition date of May 24, 2019, using the following assumptions and inputs;

  • Risk free rate of 1.48% - 1.57%
  • Expected life of 1.2 - 4.7 years
  • Volatility rate of 75%; determined using historical volatility data
  • Exercise prices of $6.00 - $17.37
  • Stock price of $9.11

The fair value of the vested options as at the acquisition date was deemed consideration paid in the transaction. The fair value of those options not yet vested at the acquisition date was added to the Company's share-based payment reserve to be expensed over the remaining vesting period of the options as permitted under IFRS 3 - Business Combinations.

(iv) Included in total investments were two level 3 private company investments (see 'Greentank Technologies' and 'Neal Brothers Inc.' in Note 11). There existed limited financial information over both investments at the acquisition date. The preliminary fair values have been determined using the best available information.

Newstrike was amalgamated into HEXO Operations Inc on August 1, 2019. During the year ended July 31, 2019, Newstrike contributed net revenue of $2,770 and a net loss of $13,699 to the Company's consolidated results since the date of acquisition. If each acquisition had occurred on August 1, 2018, management estimates that the Company's consolidated net revenue would have increased by $9,287 and the net loss would have increased by $19,096 for the year ended July 31, 2019.


HEXO Corp. 2020 Consolidated Financial Statements

Goodwill arising from the acquisition represents the expected synergies, future income and growth, and other intangibles that do not qualify for separate recognition. None of the goodwill arising on these acquisitions are expected to be deductible for tax purposes. During the year ended July 31, 2020, the associated Goodwill was assessed for impairment and written down to $Nil (Note 15).

The Non-Controlling Interest ("NCI") acquired at the acquisition date arises from Newstrike holding a 60% interest in Neal Brothers Inc. The net assets of Neal Brothers Inc. consist of cash only and the NCI was measured at its fair value. The NCI acquired at the acquisition date arises from Newstrike holding a 60% interest in Neal Brothers Inc. as the NCI relates to the joint venture Neal Up Brands Inc. During the year ended July 31, 2020, the NCI was eliminated through the effective dissolution of the entity, there existed no operations and all cash was returned to the owners.

Total non-capitalized transaction expenses in the year ended July 31, 2020 amounted to $nil (July 31, 2019 - $3,958) in the period.

15. Goodwill

Balance as at July 31, 2018 $ -  
Additions   111,877  
Balance as at July 31, 2019 $ 111,877  
Impairment   (111,877 )
Balance as at July 31, 2020 $ -  

Goodwill initially recognized on acquisition of Newstrike Brands Limited ("Newstrike") on May 24, 2019 and is monitored at the operating segment level, which is a company-wide level(“HEXO Corporate CGU”). On January 31, 2020, the carrying amount of the Company's total net assets significantly exceeded the Company's market capitalization. In addition, slower than expected retail store roll outs in Canada and delays in government approval for cannabis derivative products resulted in a constrained distribution channels, which have adversely affected overall market sales and profitability. As a result of these factors, management performed an indicator-based impairment test of goodwill as at January 31, 2020.

The recoverable amount was determined based on fair value less cost of disposal using a market-based approach (Level 2) which considered both the adjusted current market capitalization of the Company and an income based discounted cash flow analysis (DCF).

The calculation of the adjusted market capitalization was based on the share price of the Company on January 31, 2020, adjusted for a control premium of 10%, which was estimated by reference to premiums in recent acquisitions involving control, and from data on empirical control premium studies that considered industry, pricing, background, deal size, and timing of the observed premiums. If all other assumptions were held constant, and the share price declined by 5%, the impairment loss would increase by $26,647.

If all other assumption were held constant and the control premium was decreased by 5%, the impairment loss would increase by $24,283.The income based Discounted cash flow ("DCF") analysis (Level 3)  was also used to corroborate the results of the adjusted market capitalisation based valuation. The significant assumptions in the DCF analysis were as follows:

i. Cash flows: Estimated cash flows were projected based on actual operating results from internal sources as well as industry and market trends. A discrete four-and-a-half-year period was forecasted with an extended 5 year period calculated using the H-Model which is an alternative dividend discount model that assumes the growth rate will fall linearly to the terminal value with a short-term growth rate of 10% in the first year, declining each year over the 5 years to a terminal growth rate of 3%.  If all other assumption were held constant and the short-term growth rate in the first year was decreased by 1%, the impairment loss would increase by $12,598;

ii. Terminal value growth rate: Management used a 3% terminal growth rate which is based on historical and projected consumer inflation, historical and projected economic indicators, and projected industry growth. If all other assumption were held constant and the terminal growth rate was decreased by 1%, the impairment loss would increase by $27,000;

iii. Post-tax discount rate: Management used a 15.9% post-tax discount rate which is reflective of an industry Weighted Average Cost of Capital ("WACC"). The WACC was estimated based on the risk-free rate, equity risk premium based on a direct comparison approach, a size premium and company specific risk, and after-tax cost of debt based on corporate bond yields. If all other assumption were held constant and the discount rate was in increased by 1%, the impairment loss would increase by $53,933; and

iv. Tax rate: The tax rates used in determining the future cash flows were those substantively enacted at the respective valuation date.

As a result, management concluded that the carrying value of the HEXO Corporate CGU was higher than the recoverable amount and recorded a goodwill impairment loss of $111,877 during the second quarter of fiscal year 2020. The Company's goodwill impairment loss for the year ended July 31, 2020 was $111,877 (July 31, 2019 - $nil).


HEXO Corp. 2020 Consolidated Financial Statements

16. Warrant Liabilities

    2017 Unsecured
Convertible Debentures
Warrants
    USD$25,000
Registered Direct
Offering
    USD$20,000
Registered Direct
Offering
    Total  
Opening balance as at August 1, 2018 $ 3,130   $ -   $ -   $ 3,130  
Exercised   (6,367 )   -     -     (6,367 )
Loss in revaluation of financial instruments   3,730     -     -     3,730  
Balance as at July 31, 2019 $ 493   $ -   $ -   $ 493  
Issued   -     5,629     3,967     9,596  
Exercised   (106 )   -     -     (106 )
(Gain) in revaluation of financial instruments   (387 )   (3,712 )   (2,434 )   (6,533 )
Balance as at July 31, 2020 $ -   $ 1,917   $ 1,533   $ 3,450  

USD$20,000 Registered Direct Offering - Warrants

On January 21, 2020, the Company closed a registered direct offering with institutional investors for gross proceeds of USD$20,000 (Note 12). Under this offering, the Company issued 5,988,024 common share purchase warrants with an exercise price of USD$2.45 per share with a five year-term. The warrants are classified as a liability because the exercise price is denominated in US dollars, which is different to the functional currency of the Company.

The warrant liability was initially recognized at $3,967 using the Black-Scholes-Merton option pricing model (Level 2), using the following assumptions:

  • stock price of USD$1.45
  • expected life of 2.5 years;
  • $nil dividends;
  • 80% volatility based upon historical data;
  • risk free interest rate of 1.57%; and
  • USD/CAD exchange rate of 1.3116.

Financing costs of $223 were expensed at recognition.

The warrant liability was revalued on July 31, 2020 using the Black-Scholes-Merton option pricing model (Level 2). The warrant liability was revalued to $1,533 (USD$1,144) using the following assumptions:

  • stock price of USD$0.68;
  • expected life of 2.5 years;
  • $nil dividends;
  • 97% volatility based upon historical data;
  • risk-free interest rate of 0.22%; and
  • USD/CAD exchange rate of 1.3404.

The gain on the revaluation of the warrant liability during the year ended July 31, 2020 was $2,434 which is recorded in Other income and losses on the consolidated statements of loss and comprehensive loss. 

USD$25,000 Registered Direct Offering - Warrants

On December 31, 2019, the Company closed a registered direct offering with institutional investors for gross proceeds of USD$25,000 (Note 12). Under this offering, the Company issued 7,485,032 common share purchase warrants with an exercise price of USD$2.45 per share with a five year-term. The warrants are classified as a liability because the exercise price is denominated in US dollars, which is different to the functional currency of the Company.

The warrant liability was initially recognized at $5,629 using the Black-Scholes-Merton option pricing model (Level 2), using the following assumptions:

  • stock price of USD$1.59;
  • expected life of 2.5 years;
  • $nil dividends;
  • 79% volatility based upon historical data;
  • risk-free interest rate of 1.71%; and
  • USD/CAD exchange rate of 1.2988.

Financing costs of $350 were expensed at recognition.

The warrant liability was revalued on July 31, 2020 using the Black-Scholes-Merton option pricing model (Level 2). The warrant liability was revalued to $1,917 (USD$1,430) using the following assumptions:


HEXO Corp. 2020 Consolidated Financial Statements

  • stock price of USD$0.68;
  • expected life of 2.5 years;
  • $nil dividends;
  • 97% volatility based upon historical data;
  • risk-free interest rate of 0.22%; and
  • USD/CAD exchange rate of 1.3404.

The gain on the revaluation of the warrant liability during the year ended July 31, 2020 was $3,712 which is recorded in Other income and losses on the consolidated statements of loss and comprehensive loss. 

2017 Unsecured Convertible Debenture - Warrants

During the year ended July 31, 2020, 71,424 warrants were exercised prior to the expiry date of November 14, 2019, for cash proceeds of $72 (USD$54), based on an exercise price of USD$0.76.

The gain on the revaluation of the warrant liability during the year ended July 31, 2020 was $387 which was recorded in Revaluation of financial instruments gain/(loss) on the consolidated statements of loss and comprehensive loss.

During the year ended July 31, 2019, 863,693 warrants were exercised for cash proceeds of $863 (USD$656), based on an exercise price of USD$0.76. On the various dates of exercise, the warrant liability was revalued using the Black-Scholes-Merton option pricing model. Overall, the fair value of the warrants on exercise date was $6,367 (USD$4,819) using the following inputs:

  • stock prices ranging from $5.90 to $10.36;
  • expected life of 12 months;
  • $nil dividends;
  • 75% volatility based upon comparative market indicators and historical data;
  • Risk- free interest rates of 1.55% to 2.35%; and
  • USD/CAD exchange rate of various.

The warrant liability was revalued on July 31, 2019 using the Black-Scholes-Merton option pricing model (Level 2). The warrant liability was revalued to $493 (US$375); with a stock price of US$4.24; expected life of 12 months; $nil dividends; 74% volatility based upon historical data; risk-free interest rate of 1.61%; and USD/CAD exchange rate of 1.3148. The loss on the revaluation of the warrant liability for the year ended July 31, 2019 was ($3,730), which is recorded in Revaluation of financial instruments gain/(loss) on the consolidated statements of loss and comprehensive loss. 

17. Convertible Debentures 

Balance as at July 31, 2019 $ -  
Issued at amortized, net issuance costs   45,922  
Conversion   (20,603 )
Interest expense   6,854  
Interest paid   (3,205 )
Balance as at July 31, 2020 $ 28,969  

$70,000 Private Placement Unsecured Convertible Debentures

On December 5, 2019, the Company closed a $70,000 private placement of convertible debentures. The Company issued a total of $70,000 principal amount of 8.0% unsecured convertible debentures maturing on December 5, 2022 (the "Debentures"). The Debentures are convertible at the option of the holder at any time after December 7, 2020 and prior to maturity at a conversion price of $3.16 per share (the "Conversion Price"), subject to adjustment in certain events. The Company may force the conversion of all of the then outstanding Debentures at the Conversion Price at any time after December 7, 2020 and prior to maturity on 30 days' notice if the daily volume weighted average trading price of the common shares of the Company is greater than $7.50 for any 15 consecutive trading days.

At any time on or before December 4, 2020, the ‎Company may repay all, but not less than all, of the principal amount of the ‎Debentures, ‎plus accrued and unpaid interest. Upon maturity, the holders of the Debentures ‎have the right to require the Company to repay any principal amount of their ‎Debentures through the issuance of common shares of the Company in satisfaction of such ‎amounts at a price equal to the volume weighted average trading price of the ‎common shares on the TSX for the five trading days immediately preceding the ‎payment date.

Upon recognition, the Company allocated the gross proceeds first to the discounted gross proceeds of the debentures, which amounted to $46,098. The remaining balance of $23,902, was allocated to the conversion feature, which represents its inherent fair value.

In connection to closing the private placement, the Company incurred costs and fees of $204, which were allocated on a pro rata basis to the convertible debentures and conversion feature in the amounts of $176 and $28, respectively.


HEXO Corp. 2020 Consolidated Financial Statements

Early Conversion Inducement

In May 2020, the Company provided notice to all holders of the Debentures of an option to voluntarily convert their Debentures into units of the Company (the "Conversion Units") at a discounted early conversion price of $0.80 (the "Early Conversion Price") calculated based on the 5-day volume weighted average HEXO Corp. market prices (the "VWAP") preceding the announcement. The VWAP unitized data from both the TSX and NYSE. Each Conversion Unit will provide the holder one common share and one half common share purchase warrant (with an exercise price of $1.00 and term of three years).

The early conversion occurred in two phases, the first being on June 10, 2020 followed by the second and final phase June 30, 2020. During phases one and two, $23,595 principal amount, or approximately 34%, and $6,265 principal amount, or approximately 9% of the Debentures were converted under the Early Conversion Price into 29,493,750 and 7,831,250 common shares and 14,746,875 and 3,915,625 common share purchase warrants of HEXO Corp, respectively. In accordance with IAS 32 - Financial Instruments: Presentation, the reduction of the conversion price to induce early conversion resulted in a loss of $54,283 during the year ended July 31, 2020.

The loss is calculated as the difference between the fair value of the consideration the holders received on conversion under the revised terms and the fair value of the consideration the holders would have received under the original terms of the agreement.

On July 31, 2020, there remains $40,140 in principal debentures, the net present value of the debt was $26,600 and the remaining balance of $13,540, was allocated to the conversion feature.

Interest expense for the year ended July 31, 2020 was $6,854. The Company made interest payments of $3,205 in the year ended July 31, 2020. The accrued and unpaid interest as at July 31, 2020 was $202.

18. Lease Liabilities

The following is a continuity schedule of lease liabilities for the year ended July 31, 2020:

     $  
Balance as at July 31, 2019   -  
Adjustment on adoption of IFRS 16 (Note 3)   21,360  
Balance as at August 1, 2019   21,360  
Lease additions   9,030  
Lease payments   (4,341 )
Interest expense on lease liabilities   3,067  
Balance as at July 31, 2020   29,116  
Current portion   4,772  
Long-term portion   24,344  

The Company's leases consist of administrative real estate leases and a production real estate property. The Company expensed variable lease payments of $3,769 for the year ended July 31, 2020.

The following table is the Company's lease obligations over the next five fiscal years and thereafter as at July 31, 2020:

  Fiscal year   2021     2022 - 2023     2024 - 2025         Thereafter     Total  
    $     $     $                     $     $  
  Lease obligations   4,737     9,787     8,764     31,082     54,370  

19. Term Loan (Revised)

Term Loan

On February 14, 2019, the Company entered into a syndicated credit facility with Canadian Imperial Bank of Commerce ("CIBC") as Sole Bookrunner, Co-Lead Arranger and Administrative Agent and Bank of Montreal as Co-Lead Arranger and Syndication Agent (together "the Lenders"). The Lenders provided the Company with up to $65,000 in secured debt financing at a rate of interest that is expected to average in the mid-to-high 5% per annum range. The credit facility consisted of an up to $50,000 term loan ("Term Loan") and up to a $15,000 in a revolving credit facility ("Revolving Loan"). The credit facility matures in February 14, 2022. The Company may repay the loan without penalty, at any time and the loan is secured against the Company's property, plant and equipment. The Company shall repay at minimum 2.5% of the initial amount drawn each quarter per the terms of the credit facility agreement. On February 14, 2019, the Company received $35,000 on the Term Loan and incurred financing costs of $1,347. The Company had the ability to draw the remaining $15,000 on the Term Loan on or before December 31, 2019, which it did not exercise, as a result, that portion of the facility expired on December 31, 2019.

On January 31, 2020, the Company amended its credit facility which resulted in:

(i) The modification of financial covenants which require the Company to:

i. Maintain a Tangible Net Worth Ratio of not more than 1:00 to 1:00 at all times;


HEXO Corp. 2020 Consolidated Financial Statements

ii. Maintain a Cash Balance of more than $15,000 at all times; and

iii. Maintain certain EBITDA requirements (as defined in the Credit Facility Agreement) with respect to each Fiscal Quarter.

(ii) the re-instatement of the $15,000 Term Loan capacity that previously expired un-used on December 31, 2019. In order for the Company to draw on this additional capacity, the Company must be (i) in compliance with its debt covenants; and (ii) achieve net revenue of $28,400 for the quarter ended July 31, 2020. These conditions were not satisfied as at July 31, 2020 and therefore the Term Loan capacity was not drawn upon and is no longer available to the Company. 

The Company was in compliance with the revised financial covenants noted above as at July 31, 2020.

On July 31, 2020 the Company was not in compliance with an administrative banking covenant which mandated that the Company not have a Canadian dollar operating bank account with any institution other than the Lenders. The Company was subject to the covenant 90 days after entering the syndicated credit facility on February 14, 2019. The Company received an amendment on October 29, 2020 allowing it to rectify this administrative breach by April 27, 2021.  However, since the amendment was received after July 31, 2020, the Company has classified its Term Loan as a current liability and has revised the applicable comparative information (Note 37) to reflect the same.

During the year ended July 31, 2020, total interest expense and total interest capitalized were $723 (July 31, 2019 - $252) and $896 (July 31, 2019 - $511). Non-cash interest expense relating to the amortization of deferred financing costs was $501 for the year ended July 31, 2020 (July 31, 2019 - $387).

The following table illustrates the continuity schedule of the term loan as at July 31, 2020 and July 31, 2019:

   

July 31, 2020

 

    July 31, 2019
(Revised – Note 37)
 
Term loan   $     $  
Opening balance   34,125     -  
Additions   -     35,000  
Repayments   (3,500 )   (875 )
Ending balance   30,625     34,125  
Deferred financing costs   $     $  
Opening balance   (751 )   -  
Additions   (445 )   (1,643 )
Adjustments   -     296  
Amortization of deferred finance costs   501     596  
Ending balance   (695 )   (751 )
Total term loan   29,930     33,374  
Current portion   3,069     3,117  
Long-term portion   26,861     30,257  

20. Share Capital

(a) Authorized

An unlimited number of common shares and an unlimited number of special shares, issuable in series.

(b) Issued and Outstanding

As at July 31, 2020, a total of 482,465,748 (July 31, 2019 - 256,981,753) common shares were issued and outstanding. No special shares have been issued or are outstanding.

      Number of shares     Share Capital  
Balance at July 31, 2019     256,981,753   $ 799,706  
June 2020 at the market offering (i)   32,942,479     33,263  
May 2020 underwritten public offering (ii)   63,940,000     43,495  
April 2020 underwritten public offering (iii)   59,800,000     22,928  
January 2020 registered offering (iv)   11,976,048     21,073  
December 2019 registered offering (v)   14,970,062     25,229  
December 2019 private placement Note 17   37,325,000     72,005  
Options exercised Note 22   116,532     223  
Warrants exercised  Note 21   4,413,874     5,866  
Balance at July 31, 2020     482,465,748   $ 1,023,788  


HEXO Corp. 2020 Consolidated Financial Statements

(i) June 2020 At-the-market ("ATM") Offering

On June 16, 2020, the Company established an ATM equity program allowing the Company to issue up to $34,500 (or its U.S. dollar equivalent) of common shares to the public. The common shares sold through the ATM program were sold through the TSX, the NYSE and other marketplaces on which the common shares were listed, quoted or otherwise traded, at the prevailing market price at the time of sale. The program closed on July 31, 2020 and a total of approximately $34,551 (after foreign exchange gains) was generated through the issuance of 32,942,479 common shares in the year ended July 31, 2020. On July 31, 2020 a receivable of $883 remained for irrevocable sales which occurred prior to year end and subsequently settled on August 5, 2020, at which time the remaining 979,500 shares were issued. Total issuance costs and broker fees amounted to $1,288.

(ii) May 2020 Underwritten Public Offering

On May 21, 2020 the Company closed an underwritten public offering for total gross proceeds or $57,545 through the issuance of 63,940,000 units at a price of $0.90 per unit. Each unit contained one common share and one half common share purchase warrant (Note 21) at an exercise price of $1.05. The net contribution to share capital, after warrant reserve adjustment, was $46,547 and total issuance costs amounted to $3,052.

(iii) April 2020 Underwritten Public Offering

On April 13, 2020, the Company closed an underwritten public offering in which 59,800,000 units were issued at $0.77 a unit for total gross proceeds of $46,046. Each unit consisted of one common share and one common share purchase warrant (Note 21) at an exercise price of $0.96. The net contribution to share capital after warrant reserve was $25,863 and total issuance costs amounted to $2,936.

(iv) January 2020 Registered Direct Offering

On January 22, 2020, the Company closed a registered direct offering in which 11,976,048 common shares were issued at $USD1.67 each for total gross proceeds of $26,290 (USD$20,000). Investors also received one half a common share purchase warrant for each common share purchased (Note 21) at an exercise price of $USD2.45. The net contribution to share capital, after warrant reserve adjustment, was $22,323 and total issuance costs amounted to $1,250.

(v) December 2019 Registered Direct Offering

On December 31, 2020, the Company closed a registered direct offering in which 14,970,062 common shares were issued at $USD1.67 each for total gross proceeds of $32,411 (USD$25,000). Investors also received one half common share purchase warrant for each common share purchased (Note 21) at an exercise price of $USD2.45. 

21. Common Share Purchase Warrants

The following table summarizes warrant activity during the year ended July 31, 2020 and year ended July 31, 2019.

    July 31, 2020     July 31, 2019  
    Number of     Weighted average     Number of     Weighted average  
    warrants     exercise price2     warrants     exercise price  
Outstanding, beginning of year   29,585,408   $ 9.95     26,425,504   $ 4.35  
Expired   (15,559,483 )   12.25     (531 )   -  
Assumed and reissued through acquisition1   -     -     7,196,164     23.10  
Issued   123,905,556     1.24     11,500,000     6.00  
Exercised   (4,413,874 )   0.97     (15,535,729 )   3.61  
Outstanding, end of year   133,517,607   $ 1.90     29,585,408   $ 9.95  

   1 Warrants cancelled and reissued on May 24, 2019, via the acquisition of Newstrike.

  2 USD denominated warrant's exercise price have been converted to the CAD equivalent as at the period end for presentation purposes.

No broker compensation warrants were exercised during the year ended July 31, 2020 (July 31, 2019 - 1,916,527).

The following table summarizes the warrants issued during the years ended July 31, 2020 and July 31, 2019.

Issuance date

Exercise price

Warrants issued/reissued

Expiry period

October 4, 2018

$6.00

11,500,000

3 years

May 24, 2019(1)

$11.84-$27.64

7,196,164

0.73-4.07 years

Total assumed and issued during the year ended July 31, 2019

 

18,696,164

 

December 31, 2019

USD$2.45

7,485,032

5 years

January 22, 2020

USD$2.45

5,988,024

5 years

April 13, 2020

$0.96

    59,800,000

5 years

May 21, 2020

$1.05

    31,970,000

5 years

June 10, 2020

$1.00

    14,746,875

3 years

June 30, 2020

$1.00

      3,915,625

3 years

Total issued during the year ended July 31, 2020

 

123,905,556

 

  1 Warrants acquired and reissued on May 24, 2019, via the acquisition of Newstrike.

The following is a consolidated summary of warrants outstanding as at July 31, 2020 and July 31, 2019.


HEXO Corp. 2020 Consolidated Financial Statements


          July 31, 2020     July 31, 2019  
    Number
outstanding
    Book value     Number
outstanding
    Book value  
Classified as Equity         $           $  
                         
2018 Equity financing                        
  Exercise price of $5.60 expired January 30, 2020   -     -     10,512,208     5,674  
  February 2018 financing warrants                        
  Exercise price of $27.64 expired February 16, 2020   -     -     4,413,498     1,331  
June 2019 financing warrants                        
  Exercise price of $15.79 expiring June 19, 2023   2,184,540     10,022     2,184,540     9,998  
April 2020 underwritten public offering warrants                        
  Exercise price of $0.96 expiring April 13, 2025   56,017,500     18,906     -     -  
May 2020 underwritten public offering warrants                        
  Exercise price of $1.05 expiring May 21, 2025   31,410,050     10,805     -     -  
Conversion Unit warrants                        
  Exercise price of $1.00 expiring June 10, 2023   14,746,875     11,426     -     -  
  Exercise price of $1.00 expiring June 30, 2023   3,915,625     1,928     -     -  
Broker / Consultant warrants                        
Exercise price of $20.85 expired February 16, 2020   -     -     264,809     160  
Exercise price of $11.84 expired June 19, 2020   -     -     262,021     610  
  Exercise price of $0.75 expiring November 3, 2021   175,618     78     175,618     78  
  Exercise price of $0.75 expiring March 14, 2022   94,282     66     94,282     66  
  Exercise price of $15.79 expiring June 19, 2023   61     -     61     -  
Inner Spirit warrants                        
  Exercise price of $15.63 expired July 21, 2020   -     -     71,235     129  
Molson warrants                        
  Exercise price of $6.00 expiring October 4, 2021   11,500,000     42,386     11,500,000     42,386  
    120,044,551     95,617     29,478,272     60,432  
Classified as Liability                        
2017 secured convertible debenture warrants                        
  Exercise price of USD$0.76 expired November 14, 2019   -     -     107,136     493  
USD$25m Registered Direct Offering Warrants                        
  Exercise price of USD$2.45 expiring December 31, 2024   7,485,032     1,917     -     -  
USD$20m Registered Direct Offering Warrants                        
  Exercise price of USD$2.45 expiring January 22, 2025   5,988,024     1,533     -     -  
    13,473,056     3,450     107,136     493  
    133,517,607     99,067     29,585,408     60,925  

22. Share-based Compensation

Omnibus Plan

The Company has a share option plan (the "Former Plan"), adopted in July 2017, that was administered by the Board of Directors who established exercise prices and expiry dates. Expiry dates are up to 10 years from issuance, as determined by the Board of Directors at the time of issuance. On June 28, 2018, the Board of Directors put forth a new share option plan (the "Omnibus Plan") which was approved by shareholders on August 28, 2019. Unless otherwise determined by the Board of Directors, options issued under both the Former Plan and Omnibus Plan vest over a three-year period. The maximum number of common shares reserved for issuance for options that may be granted under the Omnibus Plan is 10% of the issued and outstanding common shares or 48,246,574 common shares as at July 31, 2020 (July 31, 2019 - 25,698,175). The Omnibus plan is subject to cash and equity settlement, the Former Plan and Newstrike plan are subject to equity settlements. Options issued prior to July 2018 under the outgoing plan and the options assumed through the acquisition of Newstrike do not contribute to the available option pool reserved for issuance. As of July 31, 2020, the Company had 25,288,328 issued and outstanding under the Omnibus Plan, 4,305,048 issued and outstanding under the Former Plan and 421,327 issued and outstanding under the assumed Newstrike plan.

Stock Options

The following table summarizes stock option activity during the year ended July 31, 2020 and the year ended July 31, 2019.

    July 31, 2020     July 31, 2019  
    Number of     Weighted average     Number of     Weighted average  
    options     exercise price     options     exercise price  
Opening balance   24,288,919   $ 5.87     14,388,066   $ 3.02  
Granted   11,946,027     1.62     12,693,118     7.27  
Acquired and reissued through acquisition1   -     -     2,002,365     9.49  
  Forfeited   (4,582,440 )   5.55     (1,226,763 )   6.33  
Expired   (1,521,271 )   9.16     -     -  
Exercised   (116,532 )   1.15     (3,567,867 )   1.20  
Closing balance   30,014,703   $ 4.07     24,288,919   $ 5.87  


HEXO Corp. 2020 Consolidated Financial Statements


  1 Stock options acquired and reissued on May 24, 2019, via the acquisition of Newstrike.

The following table summarizes the stock option grants during the years ended July 31, 2020 and July 31, 2019.

 

 

Options granted

 

 

Grant date

Exercise price ($)

Executive and directors

Non-executive employees

Total

Vesting terms

Expiry period

September 17, 2018

7.93

650,000

523,500

1,173,500

Terms A

10 years

November 22, 2018

5.92

-

440,000

440,000

Terms A

10 years

December 17, 2018

5.09

74,000

227,500

301,500

Terms A, C

10 years

February 19, 2019

7.13

615,000

626,000

1,241,000

Terms A

10 years

February 21, 2019

7.46

3,333,333

-

3,333,333

Terms D

10 years

March 20, 2019

8.50

325,000

1,077,500

1,402,500

Terms A

10 years

April 17, 2019

8.24

-

1,132,500

1,132,500

Terms A

10 years

July 18, 2019

6.54

650,000

2,768,785

3,418,785

Terms A

10 years

July 26, 2019

5.88

250,000

-

250,000

Terms A

10 years

Total

 

5,897,333

6,795,785

12,693,118

 

 

October 29, 2019

3.30

829,034

2,732,277

3,561,311

Terms B

10 years

January 29, 2020

1.80

-

293,021

293,021

Terms B

10 years

April 28, 2020

0.69

900,000

2,565,322

3,465,322

Terms B

10 years

June 26, 2020

1.02

3,055,025

732,410

3,787,435

Terms B