Hemp-derived CBD oil was and remains one of the most hyped-up alternative ‘treatments’ available to Americans. Its long list of benefits includes pain relief, depression and anxiety reduction, acne clearance, sleep enhancement, neuroprotection, and diabetes prevention. Against this impressive list of accolades, it was easy to see why CBD companies and their related peer companies enjoyed significant investor enthusiasm in the aftermath of the passage of the 2018 Farm Bill. This saw the United States legalize the cultivation of hemp and the sale of its derivative products.
You would not have been misplaced to expect strong consumer demand with a subsequent surge in sales for the relevant CBD companies. Hence, it came as a shock when CV Sciences (OTCQB:CVSI) published results for its fiscal 2020 first quarter that showed a near 45% reduction in year-over-year revenue. Competitive pressure from the rush of new entrants into the low barrier to entry sector was expected to weigh down on revenue, but consumer demand should have been able to reduce the extent to which this negatively impacted on the sales of one of the most foremost CBD brands.
What happens now? Sales are cratering, investor sentiment towards the sector continues to wane, and the stalking spectre of a pandemic induced recession threatens to dry up what’s left of the capital available to the sector. The existential threat this poses is compounded by the lack of empirical evidence to support CBD’s health claims. This might not be entirely reflected in short term demand, but longer-term it would totally undermine consumer trust and confidence in the sector. This would permanently relegate CBD entirely to the realm of pseudoscientific treatments. The impact of waning confidence can already somewhat be seen as hemp-derived CBD sales have been dropping amidst the virus-induced sales boom for health supplements.
The lack of scientific evidence to support the efficacy of CBD in treating health conditions has heavily reduced the legitimacy of the industry. Charlotte’s Web, a larger competitor, has taken steps to address this with the creation of CW Labs. This is a research and development led initiative to build the science around hemp-derived CBD for the treatment of several health conditions. The results of double-blinded, placebo-controlled human clinical trials will help develop the narrative required to provide confidence in the sector. This would potentially help soften the hawkish stance taken against CBD by the U.S. Food and Drug Administration.
Financials Continue To Go Wrong
CV Sciences’ earnings for its fiscal 2020 first quarter saw the company realize revenue of $8.3 million, a YoY decline of 45% and a QoQ decline of 11%. During the quarter’s earnings call the company blamed the fall on higher levels of competition. This is despite a 42% increase in the number of retail stores they are stoked to 5,799 stores, from 3,308 stores in March 2019.
Revenue has now declined sequentially for three straight quarters while cash from operations remained negative at $1.7 million. However, this was an improvement from the previous quarter by $2.9 million, presenting a bright spot in what otherwise was a torrid financial statement.
Gross profit during the quarter at $4 million was down 62% YoY and 4.8% QoQ. Further, total operating expenses at $9.3 million was an increase of 13% from the previous quarter despite the decrease in both revenue and gross profit. A rise in SG&A from $6.9 million to $7.8 million was the main contributor to this increase.
While CV Sciences has done a good job of reducing its operating expenses over the last few quarters, the widening divergence between gross profit and operating expenses will put pressure on its liquidity position.
The severity of this is displayed with the dwindling cash balance set against negative free cash flow. And while the company has more than a few quarters of cash left, the uncertainty introduced by the pandemic and the continued instability of the CBD market could materially increase its burn rate.
The Future Of CV Sciences
CV Sciences filed a preliminary prospectus on April 21 to raise $100 million through a mixed shelf offering. The final cash amount raised will provide a crucial lifeline for a company rapidly teetering towards the precipice of bankruptcy. Prospective longs must ask what the end goal for the company is here. Burn through the raised cash until competitive intensity dies down? Or to just simply weather the coming pandemic induced recession? Indeed, the latter might prove to be a near term saviour by catalysing a wave of corporate CBD bankruptcies. This would help stabilise what has been a value-destroying market.
In the longer term, CBD remains an unproven treatment with an evidence base primarily made up of anecdotes. The sheer ease of starting a CBD brand will also mean the market remains in a forever state of instability. It’s hard to see how CV Sciences reverses what will soon be a near year-long decline in the quality of its financials. Against this protracted state of decline, the future of the company is not likely to be an improvement on its past.
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.
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