Heritage Cannabis – Structure and Current State – Q3 F2020
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I look forward every quarter to this outfit releasing its’ numbers.
Their CEO has called me a ‘mental munchkin’ (I take pride in that), many of $CANN’s paid promotors have hounded my social media over months, and the most beholden of their shareholders continue to cast allusions to my familial lineage – and frequently suggest its reptilian.
We’ve also been there since the beginning, when I came across this mutt in our very first Christmas Dive Bar. Since then, we’ve chronicled pivots, deals they’ve mis-characterized, and an extremely aggressive deployment of paid stock promotion/marketing. I’ve followed their social media channels for some time – and the depth of the pump on them has been an eye-opener for me. They were like Maricann in promotion as well – marketing hard in Germany’s bulletin boards and stock sites ($TGIF has been another notable in this practice, as its’ probably seen to be easier raise money when a narrative can be tightly managed. Overseas bull boards would be far easier to run in this respect, especially if done in a native language).
Our last structure highlighted some of the challenges $CANN’s facing, the most notable being a lack of deals. Of sales deals. Of manufacturing/assembly deals. Extraction deals. Heck – anything that resembles an actual deal would probably help at this point.
The Cronos ($CRON) assembly contract failure has been characterized as being entirely $CRON’s fault…….blamed upon high initial pricing of their vapes, which prevented the product from selling ($LABS is producing $CRON’s vapes now – and unlike $CANN – they’ve always had a firm off-take agreement with $CRON. The assembly contract with $CANN was probably a low ball to get a deal, and originally inked by $CRON to keep $LABS honest). A deal with ‘Endocanna’ is nowhere: $2MM USD for a piece of a company that sells ‘DNA Kits for cannabinoids’. Endocanna has since pivoted into searching for COVID riches, leaving $CANN waiting for someone to return their phone call. Some sort of blow out has also happened with one of $CANN’s founders (Debra Senger), which has seen them dumping shares into the bid for the past month (2 million shares down, 7 million more to go).
It’s becoming a Saga.
Some wags out there have suggested $CANN change their stock ticker to $SOON – because that running gag we’ve made about positive results always being 2 quarters out……has been true. It’ll all happen soon if you listen to $CANN.
To the financials!
- Cash to $4MM. More below.
- Inventory relatively flat QoQ, around $4MM. No build here. No sales yet either to bother it with. This will hopefully change with the announcement of 7 SKUs they’re putting out. More below.
- They’ve pulled more than $1.1MM in executive compensation and consulting fees to management this year. Far better than previously reported, but will probably be a surprise to shareholders given $CANN’s CEO has claimed to be taking compensation in equity. He certainly isn’t taking paper on the buildings he’s renting to himself.
- They’ve pulled in $385k in COVID wage subsidies, joining a raft of business’ that have lined up for it. Smoke ’em while you got ’em.
- Their earlier pickups of 2 licensed producers ended up in being restated, as $CANN missed recording a $5MM deferred tax liability back at the inception of the deals. A cumulative restatement was made in these financials, after the initial recording in December 2018 was restated in December 2019, and finally resolved here. Only a $2MM increase in liabilities, but really, 2 years?
- We know this because management tells us exactly so at the end of Note 23(b) by stating: “Lastly, management has now appropriately captured the deferred tax implications stemming from the two acquisitions”. There you go.
- Still 4.5MM $0.10 options on the books, and another 27MM that probably will never see the light of day.
- Contingent liabilities on their production asset buys (Note 11) consumes 4 full pages of the statements. Cash and non-cash triggers in there. To look at Purefarma’s gross margin required to trigger performance targets, payable in $CANN shares: 2019 GM of $25MM = 5M in $CANN shares. For 2020: $50MM in GM gets another 5MM shares. You get the idea. This goes on until 2023.
- They didn’t make 2019’s target.
- Sales of $2.3MM. Gross margin: minus $960k.
- That revenue is generated from 4 customers. Demand concentration is something we’ve seen $LABS and $RTI wrestle with as well….it’s a suboptimal condition if you’re a supplier. Credit risk is enhanced, and just like your portfolio……lower diversification brings higher risk.
- They do have deals for manufacturing: Sugarbud, WeedMe, some edible thing called Cannahive….and TrueNorth. A sight better than the leg $PUMP is currently showing.
- Hope that negative margin doesn’t come back to bite them in the ass.
- 61% of their business is neither tolling nor processing, but sales of pulled product. For a processor, I think that’s good.
- Expenses for the quarter are a bright spot, dropping some $800k to $2MM. The COVID subsidy and a near halving of ‘Occupancy & G&A’ make the total.
Ok. There’s more, but nothing much to see. We’ve got a full history on the deals and ‘State of the Nation….as it were. And $CANN seems right in the position they were heading for. No significant deals worth speaking of (economically), and an uneasy negative gross margin stasis. It should be granted though, that at least they are making deals….think about when the last time $PUMP or $LABS said anything at all about their core business.
Regarding their cash balance, $CANN CEO Clint Sharples pulled a trigger in the quarter, pulling $5MM down from a $7MM credit facility established with Trichome Financial back in January. The interest rate is 9.5% in the press release, but adding in transaction fees and the 5% ‘discount’ to proceeds – it becomes an effective interest rate of 16%. By the looks of it, Trichome’s done high leveraged lending before……they’ve got the facility locked down tighter than a farmer’s daughter during fall fair:
The reality is that they now have $4.5MM against an 18 month loan of which they received $4.3MM in cash, and over two quarters ……..have reported $575k of interest expense. The current balance is greater than what their net proceeds were. That folks……that’s what a 16% loan looks like. Also note the assignment of contracts in the preceding. In the energy sector, assigning contracts means one might as well toss themselves onto a sword: contracts are the core of any company, and the reason for them to have value. Cannabis might be different, but it strikes me as a desperate move. Then again, the contracts might not be worth much here, and were demanded.
$CANN bought a company recently, an all paper deal for some $5MM. It’s called Opticann, and perfectly in-character, anonymous supporters everywhere tout the deal as bringing Heritage’s products straight into Wal-Mart, Walgreens, and 7-11’s nationally. Yep, their paid pump actually goes there
Opticann had been started by a couple of ex-MedReleaf execs, who built a new company off of licensing of some sort of IP for North America around cannabinoid absorption in the human body. While they have images of products (they didn’t have product images up a month ago) they haven’t actually launched anything, $CANN’s got no money to do anything if they wanted to, and with 8,000 SKUs of CBD products in the US so far and growing…..it’s going to be a dogfight for awhile (subscribers will be familiar with our looks at bell-weather Charlotte’s Web ($CWEB) and the larger US CBD market).
So, just in time to report another quarter of nothing, and a fresh new promise of national distribution and revenue that’ll make Jeff Bezos blush. As always, results are only 2 quarters away.
No mention of how – for $5MM in all paper – $CANN is able to purchase differentiated CBD product company with national distribution potential. Perhaps that’s all that needs to be said: $5MM won’t buy you a differentiated CBD product company with national distribution. Because it doesn’t exist. And if it did, $5MM certainly wouldn’t be enough to buy it.
All of that doesn’t matter to the faithful, nor to ‘media’ outlets taking $CANN’s money to keep putting out paid promotion. <NB: that link leads to utter garbage, but it is insightful as to how stocks are marketed. Note that technical information about products are up front and in depth, while financial data about both companies is thin and selective. It’s a sales technique I know as ‘shock and awe’, a variant of the ‘baffle them with bullshit’ method>
What I see in the Opticann deal is a marginally differentiated product using sub-licensed IP – which – is a business model that typically smokes margins as royalty payments hit the top line right in the happy sack (for those who demand an example, one has to look no farther than $TILT’s licensing deal with Jupiter).
The deal had initially been slated to close end of August (it was announced August 5th), but was delayed until the end of September. That $CANN’s price has gone down from $0.13 to $0.09 since it was announced might be a factor. As is probably the cash balance at Opticann. Nobody rational accepts paper for cash, which tells me Opticann doesn’t have any (cash will cross across big caps and in mature sectors, but, it’s rare among low-value/speculative acquisitions for obvious reasons. This is opinion). Always remember the essential in this: regarding any deal between two parties….’Cash is King’.
Which reminds me of pretty much every deal $CANN’s ever announced: either it isn’t as billed, or, it’s delayed because of insert reason here.
Like $LABS, $CANN has recently put out their own lines of vape cartridges. Despite promises of being in stores in July, they were listed on BC’s State Monopoly earlier this week, and are apparently carried in 2 stores in Manitoba. For extractors, I doubt there’s a way forward for them in bulk extraction alone. Rack jobs for small batches wouldn’t be cheap in either set up or retooling, and besides, for small batches (<500kg), I can see distributed extraction or even co-operative/collective models being formed to support.
$CANN’s poor dealmaking, pivots, $22MM cumulative SBC, $2.5MM in paid stock promotion (that I can identify), and packing a shit share price – holding that all aside – current industry conditions in extraction is one of excess inventory, a lack of stores, in-house build-outs by producers, and increasingly scarce capital……….are reflected within every extractor’s current business plan and future. Seeing a way forward for many of them is hard….and one suspects rationalization in extractors will be as curt and impolite as it will be in Retail, and across Producers.
Since these financials don’t have proprietary products in them, we’ll get a great look at throughput next quarter as they’ll have sales on for two of the three months. With a half a billion shares, debt capacity likely at max, and facing a raft of competition…..they’ve got a hill to climb.
With $CANN’s track record, it’ll probably end up as a bitter mouthful for those caught in this leg-hold trap. Without some serious catalyst, sales taking off massively, or, access to incremental capital……investors holding a position here are essentially on a high speed treadmill at a full run: they’ll likely end up utterly exhausted, having travelled absolutely nowhere.
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 $CANN, $TILT, or $CWEB.
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