The largest marijuana growers are benefiting the most from optimistic investors, but vendors supplying the industry are also enjoying rapid revenue growth, including KushCo Holdings (KSHB). KushCo just updated investors on how the opening of Canada's recreational adult-use market and expanding use in legal markets in the U.S. is impacting its business. Although it's experiencing growing pains, its top line skyrocketed 240% last quarter from one year ago. Here's what you should know about this cannabis company's latest performance.
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KushCo Holdings results: The raw numbers
| Metric | Fiscal Q2 2019 | Fiscal Q2 2018 | Year-Over-Year Change |
|---|---|---|---|
| Sales | $35.2 million | $10.4 million | 240% |
| Cost of goods sold | $30.7 million | $7.5 million | 309% |
| Gross profit | $4.5 million | $2.9 million | 55% |
| Gain (loss) from operations | ($8.6 million) | ($7.6 million) | N/A |
| Net income (loss) | ($8.9 million) | ($7.6 million) | N/A |
Data source: KushCo Holdings.
What happened with KushCo this quarter?
Acquisitions last year contributed to KushCo's quarterly sales growth, but the biggest driver of the company's increasing revenue is growing demand for marijuana products in Canada and the United States. Canada's recreational adult-use market opened on Oct. 17, and in the fourth quarter, adult-use sales totaled 302 million Canadian dollars there. In the U.S., maturing markets like California resulted in legal medical and recreational sales of $8.4 billion.
Growing retail demand that's driving packaging sales higher isn't the only thing that happened at KushCo last quarter, though. The most notable developments were:
- An internal review of its accounting practices resulted in the need to restate its fiscal 2017 and fiscal 2018 financial statements.
- KushCo appointed Rodrigo de Oliveira as interim chief operating officer, Jason Vegostsky as chief revenue officer, and Carmen Lam as senior vice president of Kush Supply Co.
- The company entered long-term supply arrangements-in-principle with three large, well-known new customers.
Perhaps having to restate its financials is the most surprising development. Last year, the company hired an experienced chief financial officer to make sure its financial reporting is up to snuff, and in February, it brought on an accounting consultant to help it establish financial processes and practices. As part of a review of its books, it was determined that KushCo had inadvertently categorized contingent considerations relating to earn-out arrangements associated with previous acquisitions as equity, when they should've been recorded as liabilities, with fair value changes recorded on its operating statements. Fixing this misstep requires KushCo to amend its annual reports, which will:
- Increase its net loss to $24.3 million during its fiscal year ended Aug. 31, 2018, from $10.2 million.
- Increase its net income to $1.7 million during its fiscal year ended Aug. 31, 2017, from $0.1 million.
The company says the restatements won't impact its previously reported net revenue, gross profit, or cash flows.
KushCo's rising revenue in the quarter, plus $75 million in new revenue over the next three years from its new supply agreements, prompted management to increase its fiscal 2019 sales guidance from at least $110 million to at least $140 million.
Gross margin remains a headwind, though. Despite efforts to bring production in line with demand, its gross profit margin was 12.9%, down from 28.1% last year. Last quarter, it was 12.8%, down from 34.8% in the year-ago period. Among the steps KushCo is taking to get improve margins is eliminating free shipping and passing through tariffs. Last quarter, it absorbed $1.4 million in tariffs for its customers, so passing along those costs should be helpful in the future. Management's goal remains to get back to 30% gross margin and achieve profitability in fiscal 2020.
What management had to say
In addition to highlighting sales growth, CEO Nick Kovacevich addressed the ongoing cost situation, stating:
We continued to execute a number of strategic initiatives that have improved our cash flow during the quarter, including the elimination of free shipping, renegotiated terms from vendors and new inventory management systems that are improving operational efficiencies as we scale the business. We have introduced a number of measures to additionally enhance our gross margins. Improving gross margins will continue to be a priority as we execute on our growth plan.
On the company's quarterly earnings conference call, Kovacevich also discussed the financial restatements:
Unfortunately, our previous finance team and technical advisory consultants missed this issue in previous periods, dating back to May of 2017. I commend Chris and his team for flagging this issue and working swiftly to make the appropriate corrections while addressing it head on.
As we continue to mature the company while striving to be best-in-class in all areas, it is extremely important that we continue to upgrade our financial controls and overall compliance. To this matter, we have retained a national accounting advisory firm to assist the company in developing and implementing its internal control structure in accordance with [Committee of Sponsoring Organizations] and [Sarbanes-Oxley] 404.
Looking forward
KushCo's most important market is California, where revenue increased 273% year over year to $20 million, accounting for 58% of its sales. California's importance is likely to continue because it's the biggest U.S. marijuana market, but the company's also excited about growing demand in Canada and in the northeastern U.S. states. The opening of recreational markets in Massachusetts resulted in Northeast sales increasing 788% last quarter from last year, and management's guiding for "100% growth in Massachusetts each quarter this fiscal year."
The potential to serve maturing and future marijuana markets in the U.S., Canada, and elsewhere could become even bigger if regulators sign off on novel cannabis-based consumer products. In Canada, regulatory approval for the sale of vapes, edibles, and beverages could happen this year. In the U.S., there's growing optimism that barriers to distributing products derived from hemp, a form of cannabis sativa, will fall, driving packaging demand higher, too.
