We’ve written a fair amount of commentary on Fire & Flower ($FAF)….from their deal with Couche-Tard (the initial tranche of option which were just struck), to recent financings.

They are noisy as well. Aside from announcing curb-side pick-up with enthusiasm, press releases about new private placements, a credit facility, are coming out, and buried below yet another press release of a week ago announcing a $3MM expansion in the Green Acre placement, there was news included of Couche-Tard striking their initial option:

We looked at this deal in depth last summer. One of the contingencies on the deal was that they have 45 stores open by the date of the first gate (in at least one reference they didn’t). As of February 2020, they had 48(?), so, it looks like they got to the finish line^1. Couche-Tard’s option strike is mentioned in one of the press releases, but its’ lower billing to a private placement reduces emphasis on what might reasonably viewed as the sale of the company.

With a 146MM shares outstanding currently, the new placements will more than double that, and so will the 38MM warrants that went out the door to Couche. And another 160MM to come if successive gates are crossed. These share counts could get larger too: proportionate ownership provisions exist in the deal, so if there’s 20 billion shares outstanding by the time they get to it, so be it. They’ll still own a controlling interest in the company, and, they’ll run the joint as they like. All at a known purchase price in advance (relative to share value).

At any rate………

To the financials!

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• ~=$14MM in retail sales over the period, $2.1MM in wholesale, and their IT platform generated $1MM in revenue.
• Margin is 33%, 18%, and 99% respectively. They address margin degradation in retail by stating that holiday promos and discounts on slow moving product is occurring, and that the halcyon days of prices at the start of legalization are pretty much over.
• The IT sales are from their proprietary system. And a million in the quarter is good. I’ve been sceptical about the potential of it, but if revenues are durable, margin potential exists. More below.
• Finance costs are atrocious at $5.7MM. Leverage will do that. As will cash planning that appears continually in flux.
• It’s all reflected in Note 17 (Debentures and Derivative Liability) and Note 18 (Shareholders Equity and Share Based Arrangements). Both are unwieldy, and lengthy.
• Intangibles are a homely $36MM. That’s a lot for a Canadian retailer, and reflects the rush into retailer land grabs.
• There’s a whack of cheap optionality laying around yet. 4MM+ of warrants/options at prices as low as $0.08. Ugh. that said, SBC for the year hasn’t been terribly aggressive, but that’s also a function of sector price decline.
• Merchandise sales look to be declining hard (as do inventories of it). Other outfits are showing the same trend. I suspect they’ll keep extremely focused on what actually moves, and minimize non-cannabis inventories. Outfits like $HITI (who has vertical in that) are a contrast.
• The initial run into land grabs has also brought some $6MM in impairments in PP&E and lease assets. Might as well take the punch early.

Ok. These financials are complex, and they have a heck of lot of things going on compared to most other retailers in the sector. For the most part, disclosure is pretty good, but for some circular references and ricochets around the ‘restructuring’ (I think that’s hyperbole for what they’ve done).

From their MD&A, it looks like $FAF is shuttering/selling three locations in Alberta. Boy, that was fast:

There’s something that could be said about the wisdom of the initial choices. Some might see this as an indictment of decision making. On 16th Avenue North in Calgary, I’ve seen a F&F location that’s been sitting there as ‘Coming Soon!’ for more than 8 months. It’s a location with crap parking and accessibility, and was probably picked up because of availability at the time. Abandoning a decision early (rather than later) based upon economics…..happens. And a willingness to do it so quickly is a strength in leadership to me. Whether their example is one of them, I don’t know. But the evolution of this sector is rocket fast. Decisions need to be made as fast. I view it as active management taking a look at things and moving on.

About the Hifyre IT thing. Fencott has stayed the course on what’s essentially a data aggregation tool. These are typically not much unto themselves in terms of breadth – and a deal announced last January with Cova fills some gaps. I’m reflexively sceptical about IT and claims of greatness. If people thought hype around cannabis was over the top in terms of being ‘game-changing’ and the road to absolute riches, they’ve obviously not been near IT at the commercial level much. IT is so filled with bullshit and incremental nothings being touted as miracles that its’ easy to develop a callous about the subject. I’ve personally seen more wasted money chasing software – and development – than almost any other line item in G&A. Both in the absolute and proportionately. ‘Consultants’ abound in the space, often trapping a company along a specific technology path that gives up much in terms of utility in exchange for standardization/uniformity/interface API’s. Ethics in the software industry <ahem> could be viewed as ‘less robust’ than in many (many) others. Similar to the stories of ‘cannabis consultancies’ during the gold rush to licensing, I’ve witnessed things in software sales cycles that would make a roving band of Somali pirates look saintly.

This isn’t intended to tar a sector. But if I seem longwinded over a small part of this specific company, know that it’s for context. Future revenues from IT are often contingent upon continued development, release management, and consistent value add. It’s a very specific and unique business model that is miles away from retailing dope, and it’s not simple. That they had to do a deal with Cova (to my understanding, Cova’s platform is a repurposed, bland, but functional….POS system), suggests to me that $FAF’s platform as standalone is limited in functionality. Time will tell, but reported revenues from the IT thing is promising.

Yet despite it’s margin, OPEX for the digital segment took all that sexy margin from it to negative income for the year. Dev costs will do that. Corporate allocations won’t help. Based upon the numbers so far, I’ve moved to being cautiously optimistic about it. Whether the revenues are durable outside of $FAF’s own walls is another question. The next few quarters will give one a marker.

I’ve also gone on at length about the Couche-Tard deal, although I don’t really have a well formed view on it yet. Couche-Tard is a retailer with depth and breadth, and I’m sure they’re pretty adroit in their lane. The reason why I keep talking about it is because of the investor who buys $FAF. The reality is that your ‘x’ shares invested today will give you ‘y’ percentage ownership. Understand, that if all optionality is struck and the sale of $FAF comes about, you’ll have a crap ton less of a percentage of the equity, and aggregate share price will reflect the dilutive nature of the purchase by Couche. So, any returns via equity price accretion will be reduced (cet par). A $1 gain in share price now is far removed from a $1 gain in share price in the future.

A good example of the cannonball that Couche is dropping into the capital structure can be seen in the warrant schedule (the Mar 31st strikes):

So, where is this outfit now?

Margins are going to (one may assume) be relatively stable, so, that leads us to volume of transactions. With as many stores as they have in the fleet, individual store sales aren’t terribly impressive. Timing differences of store openings still occludes run rates, and the market is in early formation/build.

That there is no guidance as to the how and when this outfit is going to be bringing in the Benjamins remains open. The only outlook they’ve provided sticks to what’s within arm’s reach, and largely nothing. They reference ‘tough decisions’ in closing the 3 Alberta stores as proof of a relentless drive to profitability and discipline. Ok.

Tell me how many outlets you’ll need to hit returns at your cost of capital (I’ve got it in the high 20’s) – then I’ll think they’re tough too. Until then, we’ll see more capital infusions, more warrants, and more assets collaterized. The increasing presence of Big Daddy Couche over time is an X-factor.

Perhaps this is the paradigm of retail deployment: tight money and tight margins overlaying a high level of activity that changes direction at the whim of the consumer market’s preferences.

But even if it is, the leverage and capital structure $FAF is packing is uncomfortable from my perspective.

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

^1 – As of the November financials, the MD&A states $FAF had 48 stores in operation. They’ve advised that store count may be reflective of COVID restrictions and such, so the 48 listed in these likely isn’t the operating total.