KushCo: Trying To Package A Brighter Future

Summary

• KushCo's financial health is deteriorating.
• The company's cash burn threatens its ability to remain a going concern.
• Management have started to take the necessary steps to ensure survival.

KushCo entered into 2020 with financials in shambles, a sobering reality for a company that was once lauded as the perfect pick-and-shovel cannabis play. Its position as a supplier of a broad range of cannabis ancillary products and services was meant to act as a hedge against the inherent ebbs and flows of cannabis cultivation.

The protracted decline in its financial health has destroyed shareholder value and placed its future at risk. The former being reflected by a stock price down 87% from its 52-week high, and the later encapsulated by what has been a total dependency on equity raises to remain a going concern.

The company's second-quarter earnings for its fiscal 2020 point to more downside possibly ahead. Against a second quarter-over-quarter revenue decline was the continued entrenchment of negative cash from operations.

A Financials In Shambles

KushCo's earnings result for the Q2 2020 saw revenue decline by 14% QoQ to $30 million with long-term debt rising to $21 million.

Cash from operations also remained negative, increasing by 32% to $10.7 million. The cause of the revenue decline was multifaceted, with a broad decline in its largest geographical market being followed by collapsing demand across all its major product categories. California realized a YoY revenue decline of 72% and a QoQ decline of 24% while Vape product sales were down 17% YoY and 3% QoQ.

Gross profit was negative $8.9 million due to restructuring costs incurred during the quarter. Excluding this, a gross margin of 22% was achieved. This would have helped the company realize a gross profit of $6.6 million, albeit a QoQ decline of 9.6%. Gross margins were still up 200 basis points YoY.

KushCo's inability to stem its operational cash outflows had led to the extreme degradation of its financial standing. The company has historically been dependent on equity raises to plug its working capital requirements, hence, the collapse of its share price threatens and complicates its ability to raise capital. Indeed, taking on more debt with long-term debt already at $21 million would be difficult. Such a move would induce an even greater level of stress on a balance sheet at the brink. At the current rate of cash burn, another equity raise will likely be required within by the end of the next month.

The Road Ahead Is Fraught With Difficulty

KushCo's management still holds the hope of rescuing the company from the looming clutches of bankruptcy. They spelt out this strategic plan to accelerate their path to positive adjusted EBITDA during their last earnings call.

(1) Reduction in headcount.

(2) Deeper integration with MSOs, LPs, and leading brands.

(3) Implementing a streamlined approach with legacy customers.

(4) Cutting miscellaneous operating expenses.

The most material of these four tenets will be the reduction in headcount. This helped the company generate $3.7 million in annual cost savings from a 26-person headcount reduction during the last reported quarter. A further $4 million in annual cost savings was generated subsequent to the quarter-end through another round of headcount reduction. Since the start of its fiscal 2020, KushCo has instituted a near 50% reduction of its workforce to generate $12 million in SG&A cost savings.

The changing profile of the company's revenue composition provides an evidence base for the move towards deeper integration with larger MSOs and LPs. 80% of Q2 revenue was derived from this more stable and creditworthy customer base, which KushCo defines as core customers. These are accounts that spend more than $500,000.

Source

Trailing 12-month core customers as at the end of the last reported quarter increased to 52, a 24% increase from two quarters ago. The quarterly growth of KushCo's core customers combined with its cost-saving efforts points to a possible future state where the company generates positive adjusted EBITDA and operates at cash flow breakeven.

But the road to this is fraught with difficulty. The growth of core customers has slowed, rising only 7% QoQ during Q2 2020 versus a rise of 18% in the previous quarter. However, future tailwinds could come in the form of an easing of vaping fears stoked by the late 2019 lung injury outbreak.

Packaging A Better Future

KushCo continues to occupy a central position within the broader North American cannabis ecosystem. And while the industry is currently in the middle of extreme disruption brought about by over expansion and a liquidity cash crunch, it is still projected to grow over the medium to long term.

Is bankruptcy a possibility? Yes. The company's cash position is precarious, and there is no certainty that its cost-savings measures will translate to tangible near term gains against a sustained decline in revenue. KushCo now faces a great struggle for survival as it tries, perhaps for the final time, to navigate its way to the brighter future it deserves.

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.