Last time we looked at Fire & Flower ($FAF), we noted the potential for a range-bound share price as optionality ostensibly puts a box on top of it. Sales are a great way to get out of that box, and with High Tide ($HITI) showing some sale increases, it’ll be interesting to see how $FAF is faring.

I strongly encourage the reader to revisit our previous structure on them before proceeding – there’s been a lot going on with the company in terms of acquisitions and financing. The Green Acre credit facility has become much more expensive since the sector’s recent lows in March, an incursion into B.C. went pear shaped, and there were hints of loss of market share.

They had a good cash position, and despite the B.C. deal falling apart, they’ve been active in re-aligning/relocating unprofitable stores. Despite being a little dour last time due to the optionality they’re packing, let’s see how their second quarter went.

To the financials!

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• Cash down to $20MM from $48MM. Easy enough to spot that $27MM went to the current convertible debentures that came due in June.
• I’m more curious about the impact the $ACT reprice had on the capital structure. I’m gonna need a physicist’s help to back into the change, starting with Note 10 (Debentures and Loans, Derivative Liability). More below.
• Inventory up a million to $7.3MM. Accessories under $1MM of that total, but up some $100k from previous quarter.
• That Green Acre deal closed in 2 tranches, for a total $28MM in gross proceeds. Net proceeds? $24MM.
• Put another way: that’s 14% in transaction costs 😮 Highest direct cost on financing that I can recall in-sector.
• And that’s aside from the dilution and the cost of optionality we noted when the deal was struck.
• Working capital has gone from -$13.5MM to -$45MM as both $ACT’s and Green Acre’s debentures come into current year. Boy, that Green Acre tranche came up fast.
• Finance costs up from $6.7MM to $8.2MM QoQ
• G&A flat as a pancake QoQ, holding steady at around $8.5MM. Gross margin at 35%.
• Segmentation tells us that the digital side is largely flat, and their Saskatchewan based wholesaling side increased by $1MM (the growth being largely driven by stocking their own stores).
• You’ll recall they began a ‘restructuring’ 2 quarters ago, provisioning some $265k to enact it. $200k was for facility exits and another $60k in expected severance. There’s still $135k left, probably the gentlest restructuring ever made. The harder lifting was in terminated right-of-use and lease assets, which have been written down some $6.5MM during the same period.
• Largely normal course (but typically not this quick), it serves as good example of how pricy mis-steps or required adjustments can get.
• CEO Fencott picked up $900k in $FAF’s own debentures this quarter on his own dime

Ok.

Man, I’d wish these guys would give me quarter over quarter comparison’s in presenting data. It’s a nuisance, and it’s simple enough to impute basic sales and inventory data. But. When it comes to debt and capital structure…..YUCK. I have to go the long way. And the story these financials tell is all about capital structure, and an impending need for a raise.

An interesting picture in the life of Canadian retail is told by the forecast to actual¹ number of store openings. It’s been a challenge to get them going – especially in Ontario. As such, while they opened an additional 3 stores, they were all in Alberta. On the right is from their last MD&A, on the left, current quarter:

$FAF used to include a forecast of total stores expected by quarter for 2 years into the future. That table is gone from the current MD&A. Normally, it’s not too exceptional that tables come and go. But $FAF goes on at length about the need for additional capital to expand, how COVID has prevented incremental stores to be built due to social distancing, construction availability, permitting – and most importantly – how all of these things combine to describe why guidance of being positive adjusted EBITDA in this quarter was missed.

I’m guessing they removed that forward look as it too could perhaps qualify as ‘guidance’.

The big takeaway I get from these statements is that $FAF needs to go back to the well for more cash, and it’ll need to do it soon. As to how well that might go?

$FAF had a special meeting of shareholders yesterday to approve the $ACT reprice and Green Acre’s 2.6MM in juice. To nobody’s surprise, they were approved. $FAF’s stated that the vote results have been filed, but I can’t see them yet – I am curious if there’s anybody who wasn’t terribly thrilled at the idea. It’s doubtful, but vote outcomes can be a presage. The one thing the announcement didn’t pass was the spell checker though:

And that reprice was complicated. I’m going to include a passage from Note 10 describing revisions to the initial tranche (Series ‘A’) that takes optionality derivation to Mach 1. It’s a good insight into how complex revisits can become, as both parties seek to gain whatever they can when re-opening a contract:

That means that the passing of the amendment will bring in some $10MM (A-1) in exchange for 13MM shares ($0.78 * 13.146MM). It also sets an expectation that an additional $8MM will come in at the end of the year (A-2), provided $ACT stays the course. Note the extension of tenor the A-3’s bring to align with the initial debenture maturity, without impact upon the subsequent 2 tranches of options.

Thus, the reprice sees $18MM come in an $0.80 $FAF door that $ACT would’ve walked past at $1.40. And that’s the guts of it.

The derivative liability reported is a rolling calculation of the Green Acre debentures.

So. Now what?

Raise definitely. But they’re facing uncertainty in terms of the timing of getting outlets up and going, just like they have demonstrated.

One perspective on them is that the slow rollout whacked their fast deployment plans right on the nose, and trashed the business plan’s expected funding timeline. The capital structure re-alignment (vis a vis $ACT/GreenAcre) naturally flows from this.

A different take might suggest that the brand isn’t anchoring as deeply as hoped, overhead is persistent, that they need to optimize, and that they aren’t ‘operators’ at their core.

I think it’s probably a little of ‘Column A’, and a little of ‘Column B’. And it strikes me that laying their situation as heavy as they do on COVID is a little disingenuous. It’s probably as fair to say that by not growing organically, testing concept and brand and having existing sales/consumer data hasn’t helped. Putting up stores like mushrooms as fast as possible is a higher risk deployment strategy in comparison, and in some cases at $FAF, I’m sure that was the case. Same with others in the space.

The near-term for $FAF is all about the cash. They’ve got some mapped for the rest of the year, and I have a hard time at this point seeing $ACT wanting to walk away. Besides, $ACT’s installed. They’re big. They’re patient. They’re used to razor thin everything. And they know exactly what they will want in terms of locations and uniformity of assets/operations as they deploy in the future. That’s a far more formalized approach than Fencott was ever able to get to. But. So has everyone else.

It’s easy enough for $ACT to wait this time out, and end up buying a retailer for less money than they bargained for while capturing the data and market insight needed to create their perfect storefront platform. My gut tells me existing shareholders may ultimately get elbowed into a storage closet on another floor of the building. Maybe a different building. On a different block. Maybe a different city.

That the ~=85% of the outfit shareholders own now will become <40%, and $ACT ends up with an immaterial subdivision within MEGA-GIGANTI-CO ($ACT reported $2.5B in gross margin on $9.7B in sales last quarter).

Numerically, it’s looking like that as well. At least at this point.

I see several structural challenges facing $FAF: financing; execution; profitability; and sales growth. That’s 3 more than any CEO would want to be dealing with at once. I’m pretty sure $ACT will be helping out, probably across all of them. And if so, the investor might be better off taking a position in $ACT now rather than $FAF. Because if Fencott’s business is going to end up there – one’ll end up with a larger exposure to $FAF than one has now, more cheaply, and can get to that inevitable convenience store exposure sooner rather than later.

Look to see how successful Fencott is in raising over the next few months, and for improvements in the areas listed above. More than one needle moving will be a positive. If they move less than that, it could be a long winter for him.

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 $ACT nor $FAF

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