Despite the wide range of material Zenabis has given us to write about, I’ve never done a structure on them.

Their last financing was really something else with a 32 quarter ‘royalty’ fee being paid to debt-holders. The challenge of companies subjected to lenders writing terms is that lender’s interests aren’t aligned with creating shareholder value. Sure, they want to keep something with potential going rather than shut it down, and share price accretion isn’t a bad thing to them, but, they are ultimately a cost to business, not a profit centre. Their capital is at risk, and they’re going to do everything they can to get paid back.

A $3.75MM fee on a $10MM bridge loan is an example of this, where shareholders are blocked from receiving value from assets, even in disposition.

There’s always been supporters of this outfit, even through the nonsense that previous CEO Andrew Grieve put them through last fall. He’s still there, on the Board and listed as an ‘independent director’ no less. Despite engaging an executive search firm and promising a new CEO to be in place by the end of March, interim CEO Kevin Coft remains in place, and ‘interim’ has been quietly removed from his titular.

They recently put out a massive corporate update that covers many aspects of the outfit and operations…..aimed directly at appeasing long-suffering shareholders. The executive search doesn’t seem to have panned out. Perhaps it’s taking longer than expected. But. It’s hard one to explain when one announces a CEO search – and nothing happens.

I find this company interesting. Not from an investment perspective mind you (even without having run a formal structure on them), but from a business angle. A few points about that:

• That they have the sales rates that they do has given them an ability to keep their nose above water, even if their mouth isn’t.
• They have extremely close and apparently intimate relations with lenders. Relations that’s gone to places most lenders wouldn’t dream of going.
• That they set a forward price on their stock that was lower than market, gave trade a month of optionality tanking the equity value – and kept the guy who did it on the Board. As an ‘independent’ director.
• Creative (and expensive) moves to stay alive: like subcontracting grow space, fees on a bridge loan that’d be considered usury by any reasonable person, and giving up a 3.5% royalty for 8 years on gross sales.
• That latter point is also ‘negotiable’ – with the financiers’ hands on the lever. Hella.

So, let’s take our first formal run at $ZENA’s financials. What I hope we’ll gain is seeing if there is any lessons to be applied elsewhere, and try to understand why the debt-holders are willing to become contortionists. Surely, there’s a reason, right?

To the financials!

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• $12.6 in sales with a reported margin of 39%. But, excluding GoB, they’re operating at a loss (~=$1.2MM). It’s not terrible per se, with one time restructuring costs of $1MM, and depreciation of $2MM.
• And, since they are an actual veggie/flower producer, there’s some crossover in spots. It’s challenging to unwind: they report a fantastic margin in their veggie business, north of 70%. Wow. A positive net income on it of $2.5MM on $8MM in sales. Another wow.
• I’m sure Village Farms would love to see that kind of margin.
• Sales and marketing – at $175k – is crazy-like low for an outfit moving $12MM in dope, and $8MM in flowers.
• Cash down to $8MM (from $16MM at year end).
• 16MM more shares came into existence on May 4th, with $0.07 warrants being struck 11 days before these financials were issued. 400MM shares now in existence.
• You wouldn’t have seen these in the financials though, they went out with the financing. Someone somewhere might consider their strike curious only 11 days after issue, but before these fins. I do. 55MM more of them to come too.
• Warrants and options and share capital is an eye watering mess.
• $1.4MM in exec compensation in the quarter. Chief growing officer is pulling in a half million a year. Rest of executive appears similar. Many related party transactions as well.
• We see that the Delta 3 asset’s been valued at some $12MM by a third party. It’s still got a ‘for sale’ sign on it, but as we noted – its’ disposition is likely underway right now.

Ugh. Several hours of my life I’ll never get back.

It’s easy to forget that these guys took a $40MM advance in cash for a 2 year supply agreement awhile back That cash is loooooong gone, but the obligation remains. I’d ask management what the pricing mechanism is on it (fixed, variable, tiered, indexed), because of such a large volume that needs to feed it. And….they secured assets (like they have with pretty much everything they have) against the prepayment.

I’d be curious about seeing – as they’ve announced an entire sweep and rejig of their retail flower offerings to chase high THC cultivars) – how much capacity can be used to support highest margin channels. How much control is in the product mix possible?

I can go on with a dozen more questions on this alone – there is much trust required to be given to management. The money is gone, the obligation remains. They’ve just begun recognizing it this quarter ($2.8MM) so sales are going to be uplifted for awhile, but there’s going to be impact to margin that will be invisible. All we can do is correlate it’s accretion against sales, and impute. The 3.5% royalty also impacts the economics of it directly, reducing the sales revenue generated from it by $1.4MM, and giving lenders uncapped royalties on future sales.

I regret having taken a run at these. The financials are extremely complex for a Canadian LP. As complex (or more) than Canopy’s in a couple of respects. And honestly – I barely have a grip on this place.

That super sexy non-cannabis margin appears driven by flower sales (bedding plants), but mix/yield numbers aren’t provided in segmentation.

I came across a way cute QoQ comparison in their MD&A. I don’t know if it’s a simple error, but comparing net revenue per gram to a 2018 number would be disingenuous if not:

The leverage is huge, even by cannabis sector standards. The financials are also complex – driven by that leverage and debt and amendments to all of it. Warrants and options are way out of the money, but they’ve installed an equity and cash settlement mechanism via RSU’s (et al) to make up for it. Like $FIRE, they’re likely using this to retain folks. The market reacted favourably to the sales numbers and press releases, and I have little doubt that the lenders will make full use of the 55MM remaining $0.07 warrants.

From a high level, it looks like the vegetable/flower business is supporting everything. Which is the inverse of Village Farms, whose cannabis business is supporting their veggie business.

If their last year wasn’t bad enough in general, they got to revisit it by refiling their year end to correct several errors. The inventory change is something else. Booking accretion expense to accrued interest….that’s an ‘oops’:

Unfortunately, there’s no real lessons to be taken away from this. It’s a story of an outfit missing a range of targets. The good news is they have cannabis sales. That’s all I can say.

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 $ZENA