Is Marijuana Stock KushCo Holdings' Bad News Good News?

Marijuana stock KushCo Holdings (NASDAQOTH: KSHB) is one of the planet's premier vendors of highly regulated marijuana packaging. Supplying marijuana companies with solutions that keep regulators happy is fueling tremendous growth but the company's experiencing growing pains. On April 9, management admitted an accounting mishap that requires it to restate its 2017 and 2018 financials.

Gaffes like this don't install investor confidence, but there may be a silver lining. Last year, KushCo hired a new chief financial officer (CFO) to get the company's financials into compliance with Sarbanes-Oxley, and this restatement suggests the company's financials will no longer be an impediment to listing shares on a major market exchange someday.

Carving out a niche

KushCo is best known for marketing bottles used by growers and dispensaries to package marijuana for retail sale but it also makes packaging for single-roll products, vapes, and edibles.

Kushco is one of the largest suppliers of packaging that meets regulatory requirements, so demand for its products has skyrocketed following legalization of recreational marijuana use in key markets, including California and Canada. The company works with over 5,000 marijuana companies and, as a result, no one company accounts for over 10% of its top line.

KushCo's revenue jumped 177%, to $52 million in fiscal 2018, and in fiscal Q1 2019, revenue increased 186% year over year, to $25 million. Management thinks revenue will double again in fiscal 2019.

Its growth isn't all from packaging, either. KushCo went on a spending spree last year, acquiring businesses that provide marketing solutions and products used to extract chemical cannabinoids, including cannabidiol (CBD), from marijuana and hemp. As a result, the company's becoming an increasingly diversified and important vendor.

Growing pains

Its rapid growth hasn't come without hiccups. Kushco was once a profitable company, but increasing demand has outstripped inventory and production, causing supply shortages that have boosted expenses.

To fulfill surging demand, KushCo had to invest in new facilities and in some cases, use expensive shipping methods to make sure products reached its customers on time. Because of these costs, KushCo's gross profit margin fell to 12.8% in fiscal Q1 from 34.8% one year ago, resulting in a net loss of $8.1 million. For comparison, it posted a profit of $95,000 on $8.8 million in revenue in the same quarter last year.

It turns out supply problems weren't its only growing pains, though. In the past, KushCo's CFO duties were handled by the company's chief operating officer (COO), and that may have contributed to an accounting misstep following its acquisitions.

In November, KushCo hired Christopher Tedford as its full-time CFO, adding significant experience to its C-suite. Previously, Tedford's served as chief accounting officer at Confie, a personal and commercial insurance broker and CFO of Pacific Sunwear of California, a specialty retailer. He's also held senior level jobs at KPMG LLP and Deloitte & Touche LLP.

One of Tedford's main goals at KushCo is establishing Sarbanes-Oxley Act compliance, a target necessary to deliver on KushCo's plans to list shares on a major market exchange. As part of this process, it appears he discovered problems with how the company accounted for non-cash items related to its acquisitions of CMP Wellness, Summit Innovations, and Hybrid Creative.

Instead of recording contingent consideration relating to earn-out arrangements as liabilities, with fair value changes recorded on its operating statements, it recorded them as equity. Correcting this mistake will require KushCo to file amended annual reports that:

  • Increase its net loss from $10.2 million to $24.3 million during its fiscal year ended August 31, 2018.
  • Increase its net income from $0.1 million to $1.7 million during its fiscal year ended August 31, 2017.

Management says the changes have "no impact on its net revenue or gross profit for any of the restated fiscal periods, and no impact on its cash flows from operations for any of the restated fiscal periods."

Why this may be good news

To be clear, investors should be concerned that prior controls weren't in place to make sure this mistake never happened. However, the silver lining in this appears to be the only error identified by the CFO and a national accounting advisory firm hired by KushCo in February to "assist with the design and implementation of its internal controls over financial reporting." If so, then the company's made headway toward compliance with Sarbanes-Oxley, opening the door to an eventual uplisting of its shares and other opportunities requiring financial due diligence, such as mergers and acquisitions.

Management plans to discuss the details of its restatement during its fiscal second quarter 2019 earnings conference call on Thursday, April 11, so investors will want to tune in to see what's said. If this is the only accounting snafu, then investors might want to chalk this up as an unfortunate accounting oversight by a young, fast-growing company.

Investors will also want to pay attention to see if separating the CFO and COO roles allowed the company to make progress on addressing its supply shortages. If management's reduced the need for expensive measures like overnight shipping, it could help its bottom line considerably. Last quarter, KushCo's management said it hopes to deliver improving gross margins in the "second half of fiscal 2019," so it will be important to see if that timeline changes.

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Todd Campbell owns shares of KushCo Holdings. His clients may have positions in the companies mentioned. The Motley Fool recommends KushCo Holdings. The Motley Fool has a disclosure policy.