Today we’ll have a brief look at Rubicon Organics ($ROMJ). They’d caught my eye with a press release announcing the issue of an $8MM USD secured debenture at 6.5% – which as interest rates go – looks pretty modest for legal cannabis. Some 907k warrants (3 year tenor and $4 strike) went out, euphemistically called bonus (!) warrants. Fair enough, lenders like upside – companies like conserving cash where they can.

But it does increase the total cost of lending to the company (nee: shareholders). By my trusty napkin:

I never view a nominal interest rate as equivalent to an APR – as I include the ‘free’ optionality gifted to the lender as their fee. We’ve seen it a lot in the sector, and in many flavours. The press release is silent on closing costs and other fees (we’ve seen as high as 15% in fees attach to some loans), and its’ also silent on if the strike is in USD or CAD. We’ll find out next quarter – because if there is CDN denominated optionality on USD denominated debt, they’ll need to report it as a derivative liability.

At any rate, I took a quick run around their financials, and I think they’re a good encapsulation of where the Canadian sector is at the moment. $ROMJ also hit a $22MM raise out of the park (net $18MM) on February 26th of this year – timing it well with market demand.

I see some ‘good’ things here, and some…..not so much. I think this’ll present several examples for the reader to look for in their own holdings. So, let’s have our first look at $ROMJ.

To the financials!

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• Cash a civilized $20.2MM. Outside of Jushi – I don’t think there’s many who timed a raise so well.
• And I’m not terribly sure it was by design. Quarter prior, they were down to $4MM in working capital, only $12MM of cash, and dumping about $3MM/quarter in EBITDA.
• They also had 2 mortgages ($9.5MM) coming due by mid-April. A raise was inevitable before the end of March, so I am hesitant to chalk it up to management’s prescience.
• Last 3 quarter’s sales have been $4.1MM/$4.7MM/$3.1MM – with a strong Q4 landing right in the middle. They’re undergoing a rebranding/SKU re-alignment (as other are) as the market continues to mature.
• They wrote off $600k in inventory this quarter ($1.3MM year prior). Sequentially, inventory has been growing QoQ, with the last 3 being $11.1MM/$8.5MM/$6.5MM. This is a dark cloud on their horizon.
• They shot out a whack of RSU’s to the executive in mid-April. More below.
• Corporately, decent housekeeping overall. Pooling tax losses, disgorging a previous US folly, and accelerating warrants last fall, all points to hands on governance. Whether it’s by design or necessity (definitely more the latter), it’s a contrast with the $NRTH and $AH’s of the world.
• By the time you read this, there’ll have been 590k options at $1.25 struck. There’s still 3.6MM remaining, and becoming worth less every month. Another 7.7MM warrants – all out of the money. RSU use will likely supplant go-forward.
• Good disclosure overall. Their MD&A is very good for their size. The caveat being some nitpicking of their financials I’ll illustrate below.

One thing I’ll note is the lack of consistency QoQoQ (outside of inventory build). Sales, inventory write-offs, margins, $ROMJ can’t seem to put together 2 consistent quarters back to back. From a distance, I’d muse they haven’t got operations stabilized. Perhaps the market is keeping them off balance. It does suggest a lack of vision. They’ve added $2MM in equipment this quarter – likely for use in new product platforms (something we’ve seen across companies trying to grow/penetrate 2.0).

Regarding those RSU’s – as executive compensation goes, $ROMJ is pretty average. Their financial performance (and share price) hasn’t exactly been knocking it out of the park. Looks like the CEO’s been deferring cash bonus’ as well – and early in this quarter it looks like they recognized some needed belt tightening. $ROMJ even paid $100k in taxes on the CEO’s behalf, letting him repay it next quarter out of executive compensation.

In mid April, they issued the executive some 2.1MM in RSU’s (~=$4.5MM), but, the Board obviously has a pretty good handle on linking performance to compensation. Given cost struggles (they have been breakeven or less operationally for 5 quarters now) – tying RSU issuance to EBITDA milestones is a good move. As is the annual focus:

Some of the verbiage in their press releases and financials are not very specific. For example, the strike currency of their latest warrants issued with the debentures in the press release mentioned up top. Or, as in Note 13 – the half warrants that went out with the February raise are referenced to be able to purchase a full common share. I’m sure the indenture covers this gap in language – I mention it because they’re the only outfit I’ve seen come up short specifically on this type of thing.

Using another example – that raise they executed came with a valuation of those half warrants – and here’s what they provide:

$ROMJ claims to use Black-Scholes to value them. Using their inputs, I see the half warrants at $0.46. Using mine, I see them at $0.73. They didn’t do either. What they did was use the spread between market price and the issue price at the time, plugged the value for the warrant, and applied the fair value method to the entry. This is exactly how an accountant would do it. I’ve seen it a hundred times if I’ve seen it once. These values are not ‘material’ per se (the difference is around $360k on $1.7MM). If it were, the auditors would step in at year end if the value hadn’t been trued up in subsequent quarters (I wouldn’t be surprised if it was done next quarter).

And hey – don’t read much into this……I’m not picking on these guys. This is only presented for your information and awareness. I’ve seen far worse trolls loitering under financial statement bridges, particularly in the MSO’s.

Lingering on that raise – much like $GTEC’s second raise and not their rimfire a month earlier) – it came both when it was needed, and also happened to catch a market wave:

I’ve tried their ‘Simply Bare’ products – very high quality (and high price). Their CEO is ex-Whistler Medical (also known for high quality), and looks to have a background as a grower. Which, might explain the challenges he’s been having with getting costs down. As a gross generalization, growers aren’t known of as businesspeople strictly speaking.

$ROMJ presents many of the challenges in the Canadian sector – an increasing array of higher quality product; increasing competition for shelf space; and a maturing market that’s splintering into 2.0 silos. <An aside, the excise tax structure on concentrates doesn’t do these folks any favours as is – as it moves upwards as a function of THC content.- and not necessarily value add. As if the smaller folks need another weight put on their ankles>.

$ROMJ’s near-term challenges are threefold:

1. Smooth out quarterly sales numbers and establish a baseline to build upon.
2. Align production with throughput. Burgeoning inventory could become a real problem.
3. Get production cost under control. If they continue operating as a break even – they’ll go broke.

That stellar raise in February has bought them 4-5 quarters of runway. Packing a current valuation of around $140MM, they’re going to need to show marked improvement in all three of those areas to have any chance of sustaining it. I suspect the next 2-3 quarters will demonstrate whether the current CEO will still be there by this year end.

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 $ROMJ.