Last time we looked at Fire & Flower ($FAF), we noted a company that was in need of financing, and a re-price of Couche-Tard’s ($ATD-B) options.

$FAF’s been on a press release and acquisition warpath – bulking up against the other ‘big’ player in cannabis retail, High Tide ($HITI). Who, is also in intense competition with $FAF for press releases and acquisitions¹.

Let’s see how $FAF’s fiscal year is progressing, and how those sales are coming along.

To the financials!

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• And sales are up $4.5MM (retail +$3.2MM, wholesale +$800k, digital +$500k). All heading in the right direction.
• External digital revenues now exceed inter-company – this must feel good for $FAF, they’ve put a lot of ink out promoting their data/system.
• 32% margin from retail, 17% wholesale, total of $11.5MM in gross profit against $9MM in OPEX. Given depreciation, it’s a break even shop now, operationally at least.
• Some flux in finance costs, last three quarters have been $6.7MM, $8.2MM, and $6.1MM respectively. That $8MM bump was related to an April 2020 convertible issue. The levels are high, and are a BIG hurdle in the mid-term.
• They set up a new $15MM at-the-market program during the quarter. I’m having a hard time finding out how much has come in under it this year. That’s odd, given good disclosure overall (more below on the equity issues).
• SBC is far lower than in the past (at $580k), and appears to have a bit in its’ mouth. Good.
• Note 10 remains a cluster, and it will grow. They reported a loss of <$20MM> when gains on revaluing their derivatives is combined with losses from reprices and extinguishments. They’ve installed complexity into the capital structure during build, and anything built on top of it from here (cet par) will simply add.
• There’s 23 references to Note 10 in the financials……..before one even gets to the note. We’ve detailed $FAF’s capital in the past, the $ACT-D options are a bear to value.
• And $FAF was busy over the quarter: executing a special shareholders meeting to pass a July reprice of those $ACT-D options (you can exhale, it passed); they issued incremental warrants to $ACT-D to maintain future ownership ratios; and….they also optioned $ACT-D’s interest payments under the April 20 placement to be paid in shares (helpful, and likely co-ordinated).
• Green Acre’s timing/negotiation was expensive for $FAF, and the paper (fully secured) is convertible at $0.50/share.
• Understand, $ACT-D will be agnostic towards any leverage $FAF induces or pricy paper they might take on…..$ACT-D is fully inured regarding possible change of $FAF ownership. More below.
• $39MM in intangibles, all licenses.
• They report a notional loss of $12MM, a net of values around ‘extinguishment of debt’ with gains on a ‘derivative liability’. This stems from the $ACT-D reprice, and an extension of debenture tenors. A feature of having optionality embedded in capital.
• Their SCFP (yeah, I’m that old) reveals cash largely flat over the period, and that it’s very actively managed. Another $ACT-D enhancement I’m guessing.

Ok.

I knew that 4 of the Friendly Stranger stores that came in from the recent acquisition were head-shop only. I didn’t know that the stores are currently under lockdown as a non-essential business. Tough times, a return to ‘normal’ will likely be appreciated (ASAP!):

Within ‘Related Party’ transactions (Note 16), we get a glimpse of how their relationship with Couche-Tard will progress. The ‘Circle-K’ test stores that have been set up in Alberta will probably presage how it’ll go. For now, $FAF sub-leases space from $ACT-D. A definite plus to be able to lever off of a genuine real-live internal real-estate division:

An example of good disclosure in within $FAF’s table of raises. They list equity issued over the current year and footnote origination. I’ve included part of the table containing it below. This presentation of changes in share capital is gold standard….albeit, it only reports actual equity flows rather than the potential ones:

I mentioned last time I’d look up the voting results from that ‘special meeting’ that saw approval required for $ACD-B’s re-price. I haven’t found it yet, at least on SEDAR. It passed (natch), but I’m still curious about vote totals. Nor have I been able to find shares issued under their ATM program for this year….odd given how transparent much of their financials are.

Another exception is in their SCFP, which only reports fiscal year to date. Cursorily, I wanted to test something…..so…I un-wound their reported disgorgements of assets, and tried to back into the cost of the 3 stores they shuttered. It’s about a million a store, but probably varies a lot. Given the sensitivity of commercial information, it’s not a surprise one has to ‘do sums’ to get at a number. Retailers walk a close line to revealing commercially sensitive information – knowledge to a competitor about asset pricing within a region……or average store sales……is extremely valuable.

$FAF’s stated path is to grow sales both organically and via acquisition. They’ve been doing the latter, and have 16 licenses pending nationally:

And….most store opening dates are outside of their control, particularly in Ontario and BC.

Which, brings us to 2 important things for $FAF at this point: opportunity, and, cash.

With respect to opportunity, running a breakeven business with 67 stores gives us a look at what $FAF needs to do from here: add stores. We at least have a measure of next steps operationally: $FAF needs to cover finance charges and capital structure mass. Given provincial ownership caps, raw location availability, and the time required to site a storefront……adding producing assets to a fleet isn’t as simple as making a wire transfer. Storefronts run about $1MM in Ontario for those holding permitting, with about $400k more needed for finishing. For $FAF, Couche-Tard’s long game will help immeasurably….as will their discipline. Some are in the pipeline, $FAF’s CEO Trevor Fencott’s role in 2021 is making sure that that pipe stays filled, to keep opening locations, all while doing it affordably. $ACT-D has likely told him the same.

With respect to cash, $FAF’s got $24MM, will need it, and will need more. The milestone of hitting a positive adjusted EBITDA (give or take) is a big deal. They’ve knuckled down on expenses, and that’ll likely continue. As we’ve seen in other retailers, it appears to take 4-5 quarters to establish the system support and infra-structure required to get to a ‘full’ operational state. From there, optimization. $FAF and $HITI began showing similar trajectories in G&A around the end of 2019.

In my opinion, $FAF commands a hearty share premium – and trading range – through their connection with Big-Daddy-Couche. ACT-D’s influence on $FAF has been present in managing working capital, store topology, and branding strategy (they now are under 4 retail banners). $ACT-D has moved goalposts on the acquisition price of $FAF and its’ desire of when it’ll happen. $ACT-D is massive…….8,000+ retail stores globally………and has proficiency all around the elements of running a high transaction/variable margin business. That premium is for those proficiencies.

Like all things though, something that holds value commands more dollars relatively speaking. And Couche commanded theirs. In $FAF’s case, a common shareholder will see an ownership position halved if/when $ACT-D strikes their options. $ACT-D will run $FAF like it runs it’s own business: as income trust. There will be appeal there to an investor who desires exposure to ‘cannabis’ retail within this context.

For the cost of Couche’s involvement, I honestly don’t see $FAF as a good ‘cannabis’ retail investment. It’s a retail investment for sure. And $FAF’s linked to a globally present and largely successful MegaCorp – who’ll not only hand hold their money – but will make sure the money’s new home has been safety proofed. $ACT-D will manage their assets to a formula, built around models that dictate everything. There’s good in that, particularly for one who wants retail exposure.

I get ‘Couche’ and the sex they bring. The price shareholders paid to bring $ACT-D in was ridiculously high, and I think that moment was a ‘flinch‘ from Fencott………who saw few avenues forward at the time. For Canadian retail ‘cannabis’ exposure, I believe one can get it for less cost than here. The model I have tells me $FAF is worth about $0.40 if ACT-D’s options are fully exercised. It’s exactly the same percentage difference in share-price-to-market that initial Couche options were priced at relative to share price at the time. This entire deal is a formula in a Couche-Tard spreadsheet: $FAF is just a variable.

Look next time for continued growth within their segments……an expansion in digital revenues will be very positive. Finance costs are their next hill to climb. Uplift for $FAF (and all retail) is in accessories – $FAF’s hasn’t done much here. They’ll need to. If capital is expended over the next couple of quarters investing in it……..it’ll be a tell that what they do have needs to be fixed.

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. Of all companies mentioned, the author holds position only in $HITI

¹ – I’ve excluded Inner Spirit ($ISH) for comparison. Despite $ISH having a nominal store count similar to $FAF and $HITI, the franchise is embedded around a dozen corporate shops, and doesn’t translate well. $YSS would be a far better proxy for comparison. Perhaps as $ISH’s model develops, we’ll see some more revenue from franchising emerge. As it stands, the bulk of franchised stores under $ISH’s total count looks to be effectively a break-even outfit at this point.