“Sometimes you eat the bear, and sometimes, well, he eats you”

– The Stranger, The Big Lebowski (1998)

Looking over so many different outfits and financial statements for the past 4 years, a person gets to know a particular cadence….or ‘flow’ to a company’s financials.

Some outfits are nakedly transparent (a tip o’ the hat to Planet 13 ($PLTH) and Entourage Health ($ENTG) here), while some are opaque (no tip for Curaleaf ($CURA) and Slang Worldwide ($SLNG))….and some….we see some that are what I’d consider downright deceptive.

I wouldn’t put 4Front Ventures ($FFNT) in that latter category – but they do walk a fine line in what I’d consider ‘ethical’ disclosure.

In some other financials, one is presented with a literal ‘grab bag’ of red flags of deals, low/no profitability, of deep rooted related party transactions…..outfits that present no clear path forward. These kind of outfits (thinking about Heritage Cannabis ($CANN) right here), present clear signals of companies one should avoid investing in. That’s as useful to myself as a positive marker. And to be sure, $FFNT has planted several of what I consider to be the ‘negative’ markers.

From low levels of working capital through pricy loans; inordinate SBC to optionality left to get even more expensive….all I really see is an outfit strung as tight as a piano wire. My first Structure on them was <ahem> uncomplimentary. My second wasn’t exactly effusive either – but I’ve honestly tried to be fair.

They catch my attention because of the red flags, and my groans probably stem from the fact I have to spend a similar amount of time divining these financials as a $CURA or Green Thumb Industries ($GTII). This, despite $FFNT being a 10th of the size and scale of those.

$FFNT’s shown similar price softness as others in the MSO space, but have mystifyingly avoided an actual price decline since the start of the year. This, despite a burgeoning share count and an absence of genuine profitability:

This is our fourth kick at this cat, might as well take the punch.

To the financials!

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• Cash down $6MM QoQ, now at $11MM. This number is important – as we’ll see below.
• A/R under a million, and negligible, and always has been. Inventory up $2.7MM to $22MM.
• Sales are up to $24MM ($20MM Q prior). Sales growth looks good on them (entirely in THC products). Wholesale/Retail splits unavailable. ‘Rental Income’ – which has been running ~=10% of total sales this year, is down another 10% ($200k) this quarter.
• That rental income looks like a terminal sale annuity, and will likely decline steadily until extinguished. I’ve no interest in hunting it down at this point. Their sales growth is offsetting handily.
• 67% gross profit margin reported in their MD&A. Hard to tell, because…..not only is real-estate income included….
• ….one has to look in the MD&A to see they’re selling equipment in Washington state to other growers. This quarter, it came in at $1.3MM. Likely a legacy business line that came in from Cannex. Either or, weed margin is going to be skewed by its’ inclusion.
• Last quarter, they reported a 31% margin on equipment sales, this Q came in at 43%.
• In any event, they claim a 67% ‘gross profit margin’ this quarter is genuinely meaningless without segmentation. More below.
• They’ve been able to open another dispensary – this one in Brookline, MASS. We’ll see 6 weeks of its’ operations next quarter.
• $FFNT announced an acquisition in NECC earlier this month. It required some creative financing – something I haven’t seen before in the sector – a vendor take back. More below.
• Speaking of which, cash and capital availability are going to be front and centre over the next while. That Commerce facility, along with the new one in MASS – as well as Illinois – are going to need it. Despite IIPR financing the ILL build – $FFNT is definitely not deep in terms of capital at this point.

Enough for now.

That Vendor Take Back (VTB) financing is the first I can recall in the sector. Its’ essentially a leveraged transaction, one can find the entire deal on SEDAR – posted as ‘Other’ on October 8th, 2021. That $15MM referred to comes onto $FFNT’s books – discounted by 4% ($600k), taking the effective interest rate up a point. They are convertible, with a 3 year option $0.17 in-the-money – I see those at ~=$ 0.65 each (which is a helluva inducement) and to myself demonstrates how hard $FFNT wants to lean on its’ paper. Well, not many other options here.

The existing seller is going to keep running the shop, and apparently will get $4.675MM up front, plus a higher interest rate (10%) on a direct sale of $5MM of the convertibles to the vendor than other ‘investors’ fronting the cash (also a year shorter in tenor). In total, there’s only ~=$5MM of actual new cash coming in under the deal. It’s relatively complex. My take on it is that $FFNT did a very creative deal here, and obviously found the ‘right’ seller. It also translates to $3,600/ft² of canopy – the highest number for an existing build I’ve ever seen. That can be caveated that it comes with an equal amount of processing/kitchen space – but even then – that’s $1,500/ft² for a facility. ‘Pricey’ is the word that comes to mind.

Despite YTD sales of $44MM – $FFNT again reiterated F21 sales to be $170-$180MM this year, implying they’ll get $135MM in sales in the next 2 quarters. The only way I can see them doing this is selling the entire California harvest (?!?!) on a facility that’s awaiting permitting as of mid-August. Until of course – one reads that this guidance is ‘pro-forma’ – which is meaningless to myself:

$FFNT reports their segmented business as either ‘THC’ or ‘CBD’ business lines. Last time, we noted their CBD sales falling off a cliff as they’d pivoted from an expensive (but obviously more effective) marketing platform, and did a deal with someone in-house to apparently replicate it. Sales from CBD are off another 14%, down to $725k during the quarter.

Their inventory includes equipment as ‘cultivation supplies’ – so they might hold a distributorship, or perhaps selling stuff that Cannex had originally held, but written off. If one is interested in this outfit – definitely a question for IR. Virtually all growth has comes from ‘unharvested cannabis’. The California grow op (Commerce) was initially slated to begin production in April, but as of mid-August – $FFNT was still awaiting permitting. Whether this is internal or external supply is unknown – their MD&A does not contain the word ‘inventory’:

I thought I’d have a quick run through that reported margin number to see if we can see what they’re actually selling gear proper for. $FFNT’s also made it harder by combining COGS into a single line item – but as we can see, incremental margin on the increase in sales was 57%.

But, I found that they don’t include Depreciation and Amortization in COGS – so – if I add it back, the reported gross margin drops by 3%:

And hey – 58% is really good frankly, and representative of being vertical in higher priced/limited licence States. Was this worth the time? Definitely – not only because there’s a marker now to measure against – but they have 2 significant capital projects (Commerce, CA as mentioned) and the planned build in Illinois.

I’ve had enough. The more I look, the more I have to comment on.

I’ll summarize this outfit as fairly as I can:

• $FFNT is packing some hard leverage in their capital structure. 40MM warrants on the books are in the money, as is another 31MM vested options (out of 56MM in total). Overall, there’s 71MM warrants/options in-the-money and exercisable.
• Their share count this year has grown from 538MM to current 593MM.
• Their working capital is now -$4.2MMM
• If the incremental dispensary (Brookline) does as the other dispos in-system, next Q will see sales ~=$27MM in cannabis products + $2.4MM in ‘rental’ income, which pro-forma (snicker) will contribute $18MM in gross margin.
• SG&A and interest expenses are currently at $14MM – with taxes payable adding another ~=$3.5MM/Q.
• Sales growth is good, as is margin. But against a backdrop of leverage that’ll eat into any return that could be spread across 600MM shares.
• They play way too cute with ‘projections’ and they don’t clearly report margin and performance. I mean, they should be swinging around that 58% margin with a marching band – not burying it.

And here’s that word again: leverage. $FFNT is going to need CA up and pounding, continued sales increases, and a hard hold on overall system margin to maintain. Their working capital position is not good.

This thing’s obviously got its’ fans – and since 40% of the float is held internally – it might suggest to one there’s faith inside. $10MM a year in SBC probably helps them to keep that faith – but I can’t help but wonder that if there’s a hard wobble, or additional delays in build, or if the pricing schema in MASS/ILL shifts downward…..that these guys will be very exposed.

They’re in similar shape as a Goodness Growth ($GDGN) or perhaps a Jushi Holdings ($JUSH) in terms of being on a high wire. If there’s a hard wind, lookout below. Contrasted with Canada – there’s inherent margin here, and US companies will tolerate more leverage than Canada does (generally speaking). I just can’t see any kind of risk/reward profile here as being worth a dollar of mine or yours.

I also expect a write-down of ~=$15-$20MM in G&I and year end – that Cannex buy was a real mutt cost wise.

The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds no position in any of the companies mentioned.