Big things are happening in the marijuana industry on a pretty regular basis. Thanks to Canada becoming the first industrialized country in the world to give the green light to recreational weed in October, we're witnessing product innovation and capacity expansion galore to our north, as well as a pretty steady stream of legalization activity among select U.S. states and in international markets. Today, more than 40 countries worldwide have legalized medical marijuana, with 33 U.S. states doing so, too.
This rapid acceptance of cannabis and the lofty annual revenue figures attached to this broadening appeal are largely what's pushed marijuana stocks into the stratosphere. Both direct and ancillary players have benefited, with Wall Street expecting to see green across the board.
Of course, things don't always go as planned. Just ask the shareholders of ancillary player KushCo Holdings (OTC:KSHB).
KushCo drops an accounting bombshell
Last week, KushCo announced that it'd be reporting its second-quarter results on April 11. But this traditional ho-hum press release announcing an earnings date also came with a nugget of unwanted news: namely, that the company had uncovered accounting errors that would cause its 2018 and 2017 financial results to be restated.
According to the press release, the accounting errors regarded a "certain shared-settled contingent consideration relating to its acquisition of CMP Wellness in May 2017, Summit Innovations in May 2018, and Hybrid Creative in July 2018." This contingent consideration wound up being recorded as equity by the company, but should have been accounted for as a liability, with changes in fair value recorded on respective income statements from the company.
As noted by KushCo, the restatements are expected to increase the company's net loss in fiscal 2018 from $10.2 million to $24.3 million, while increasing its net income in 2017 from $0.1 million to $1.7 million.
Additionally, the company notes that it has engaged a national accounting advisory firm as of February 2019. This is certainly a smart strategic move, as it's pretty apparent that sufficient financial controls weren't in place during 2017 and 2018.
Accounting errors have been common among pot stocks
Obviously, this announcement has shaken faith in KushCo's management team and its accounting practices. We've seen quite a few instances in recent months where internal controls weren't up to par, and the companies in question suffered mightily.
For example, Namaste Technologies (OTC:NXTTF) has been on a precipitous downtrend since October, following allegations of fraud from noted short-seller Citron Research. Although an independent committee found that most of the allegations were untrue, one proved accurate: Namaste Technologies' former CEO, Sean Dollinger, had sold assets to a related party without disclosing this interest in the company's quarterly or annual report. Namaste wound up terminating Dollinger with cause, but all faith has been seemingly lost in management for the time being.
The same was true, for a while at least, with Aphria (NYSE:APHA). In December, short-seller Quintessential Capital Management and forensic analysis company Hindenburg Research released a report claiming fraud at Aphria. In particular, they alleged that Aphria had grossly overpaid for three Latin American assets. Although an independent review didn't find this to be fact, it did note that certain insiders had vested interests in these deals. Ultimately, CEO Vic Neufeld and two other execs stepped aside following this bad press.
Shaken, not stirred
However, investors in KushCo should understand that while their faith in the company's accounting practices might be shaken, the pot (pardon the pun) hasn't been stirred -- KushCo's cash flow, sales, and cash on hand aren't impacted by this restatement. Sure, investors will want to pay very close attention to any further acquisition activity and how the company recognizes it on future income statements, but this is no way detrimental to the company's underlying business model.
How do we know this? Just take a look at KushCo's second-quarter operating results, released on Thursday, April 11.
For the quarter, revenue rose to an all-time record of $35.2 million, representing 39% sequential sales growth from the first quarter, and 240% year-over-year growth. Furthermore, KushCo signed long-term supply agreements with three large new customers that could be worth up to $75 million over the next three years. Not surprisingly, the company upped its full-year sales guidance to a new range of $140 million to $150 million, from a previous range of $110 million to $120 million.
Remember, this is a company that provides packaging and branding solutions to more than 5,000 cannabis growers in 25 countries. As the market for cannabis becomes crowded, KushCo will really be able to separate itself from the competition with its branding and marketing prowess.
If there is one thing that investors should be genuinely concerned about, it's not internal accounting controls. Rather, it's what the company's aggressive expansion has done to gross margin. Having previously focused on a gross margin of at least 30%, KushCo once again reported a subpar gross margin of 20% on an adjusted basis. It should be noted that, according to CEO Nick Kovacevich, free shipping has been eliminated, the company has renegotiated terms with certain vendors, and a new inventory management system has been put into place.
With these new margin-driving controls, more eyes on the company's internal accounting, and Canada just months away from legalizing new alternative-consumption products that will assuredly boost KushCo's vaporizer business, things aren't nearly as bad as you'd think.