Following shortly after their year-end filing, Fire & Flower is reporting their first full quarter of 2.0 sales as well as the first retail numbers we see reporting with COVID’s impact right in the middle of the period.

Catch up on where they landed at year-end, and let’s dive right into these latest statements.

To the financials!

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• Cannabis sales up in the quarter (to $18MM from $14MM), ‘Wholesale’ up (from $2.1MM to $3.8MM), while digital development was off 20% (from $1MM to $.8MM). No view as to pantry loading provided.
• Margin is 29%, 19%, and 100% respectively (no allocations to digital in segmentation). Over all, they booked system wide margin of 32%, or $7.5MM
• SG&A for that margin? $14.1MM. Why margin declined on their core business
• Money’s coming in direct from management via related party transactions ($1MM in subscription and debenture purchases, Note 16). I’ve never been a fan of CEO’s and Directors having consulting companies that do business with an outfit. Honestly, I don’t believe one can maintain impartiality around commercial transactions that enrich existing officers that are under payroll. It’s not that uncommon: I simply don’t like the optics nor motivations, even if one is for tax planning.
• $6.7MM in finance costs this quarter, a hair below their entire gross margin. Despite a new run rate for cannabis sales ($18MM), it cost them $24MM to generate that. With 46 stores listed in operation, that means per store sales are at $130k/month.
• Cash at a healthy $48MM. The chunk they got in with Couche-Tard’s option strike and April’s debenture raise has been successful. Only thing to do now is deploy that capital for higher returns than it cost, right?
• Much of that cash is earmarked to roll existing debt, so there isn’t much left. $27MM in debentures is current, as is $21MM in liabilities. Man, that’s thin, despite the cash balance.
• Inventory up slightly. Merchandise inventory flat. Doesn’t look like they’re moving many items beyond weed. This has been somewhat typical of retailers, and I suspect weed stores aren’t a primary destination for bong sales. Despite the lower numbers, I gotta think that verticality is vital for any chain. A Mom & Pop with a solid clientele might be able to eat lower margins, but I have a harder time thinking a chain can hold inventory and stock handling without a higher margin coming along with it. $HITI & $FAF are there with in-house supply. I’d like to see sales split out for it. We won’t.
• $900k in impairments, related to the store purchase agreement lapsing above, and the ‘restructured’ locations having their leasehold improvements written off. Another $3.2MM impaired on a lease, where the location ‘no longer met’ provincial regs for siting. Ouch.
• $39MM now in intangibles (or 23% of total assets). A far cry from retail location costs in the USA. Still, it reminds me of how LP’s capitalized Health Canada licenses early on, leaving large intangible values attached to an ‘asset’ that will show a continuous decrease in value as time goes by. An investor needs to see that excess value produced in the time period before license costs go to their extrinsic value (in theory, the total cash cost of an application).
• They’ve secured $10MM in conventional lending, half term, half revolver. Cheaper than the paper they’ve been printing, but secured.
• The warrant balance is way cute due to to the optioned sale of $FAF to Couch-Tard. PIcture below. An aside – someone cashed out 300k of $0.07 stock options in the quarter, looks like the last of the cheap options are now gone, someone got a nice payday.
• G&A is weighted heavily to salaries (natch), yet. While it might seem a little small relative to $8MM of it in the quarter, from wherever it’s coming from, $FAF is spending $200k/mo in ‘office expenses & other’. $200k per month? Must have some fantastic lunches in the employee lounge. And free Bic pens and Post It notes for everyone apparently.
• Green Acre Capital’s subscription to the April financing came at a recent low for $FAF stock, and they hold a whack of $0.50 converts and warrants for their entry. All signs are that $FAF’s share price is heading for a rangebound walk for the next while. More below.
• Disclosure overall is ok. That they’ve ensconced the Couche-Tard detail into their Annual Information Form (AIF) leaves a reader of these statement without full disclosure of a significant and material transaction. A good example to any of the aspiring financial analysts here to make sure you’ve got it all on an outfit.

Ok.

And, it sucks being presented with YoY numbers when one is looking for quarterly information. The entire narrative of the MD&A is YoY. Given the relative decline over the previous quarter’s main numbers – it’s disingenuous. $FAF does offer up that a lack of availability in 2.0 products is crimping potential sales.

The closing of three stores in Alberta don’t appear to have made any impact on these financials. Digital sales don’t appear to be generating much traction. Sure, they’ve had good sales growth over the quarter (retail/wholesale), but I’m getting the same niggling feeling I have around $META, which is: ‘is that all?”

Growth’s been somewhat orderly, but March’s pantry loading impact isn’t readily apparent. A bump reported in the same period as a possible COVID dip occludes our view. According to $FAF, there’s nothing to see here:

$FAF is similar to High Tide ($HITI) in operating a distinct wholesale accessory business, at least in Saskatchewan. It’s uncertain how far beyond their walls that product is selling.

A move into BC was made last June (2019) to pick up 5 stores in BC’s interior (Note 3b). That deal collapsed, as conditions apparently weren’t met by the vendor. The deal was re-triggered/re-written during the quarter, but only one store made it through (Kelowna), and we find that that location in the Okanagan set $FAF back 2.4MM shares and $450k cash ($2.1MM total). Thumb-nailing it, it looks to be around a 7 year payback, which would land an ROR on the asset of some 12%. Hope it does better than system average, this is significantly less than their nested cost of capital.

Two other stores were picked up as well, Kingston and Ottawa. They also went for around $2MM, with some $2MM in intangibles booked to the acquisitions (so, 50% of a total of $4MM purchase price went to licenses). The store in Ottawa was emptied of inventory prior to sale.

Regarding CEO Travor Fencott’s sale of $FAF to Couche-Tard, there’s no better view of it than the picture below. $FAF’s share count has increased 33% over the past year, now standing at 155MM shares. Should Couche strike their options……that float is gonna go up hard. You can read more about the Couche-Tard deal here:

Some $9MM was reported as a loss on derivative revaluation. Seems they run an aggressive discount rate on the model. It’s inline with the cost of capital I see in their current structure:

The up-shot is that we see relatively stable store counts over the quarter, despite some little activity around the net numbers. The down-shot is that there is still no clear path to profitability – aside from the promise of Ontario’s opening bringing more locations online.

About their optionality and the Green Acre debenture pick up in April: the leverage that $FAF is packing – along with the optionality – will work to rangebound share price. From an investing standpoint, I don’t see much moving this needle absent some serious sales growth. Even at 30% growth QoQ, it’ll take a year for this thing to be able to show momentum, always with the cheap conversions and potential takeout of the outfit (‘ala Couche) is at the lender’s/option holders discretion. The digital platform needs to begin showing it’s got something, and incremental store additions need to exceed average store sales.

Nothing much more to add. I like the breadth and formality of the chain, but the sales numbers and near/mid/far term leverage they sport far out weighs the current potential they’re demonstrating. The ongoing restructuring (they budgeted $300k for it) has consumed about a third of the budget they set aside for severances and such. I suspect they’ve got a ways to go beyond that to knuckle down run-rates. A more charitable take is that Retail is in flux – finding their footing with customers and product differentiation – a process that takes time. That this process is underway, and results will emerge over time. Be patient and all.

Either or, I’m looking for a nearer dated retailer that hasn’t sold itself forward. $FAF isn’t in that category at the moment, and won’t be for quite some time. The Couche-Tard deal is showing some fluidity. There might be more movements within the deal now that CEO Fencott has effectively boxed share price for the time being.

He’s walking several capital structure tightropes at the moment, and sales growth is his only way off of them.

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 $FAF