CannTrust warns of shortages after regulator flags greenhouse for non-compliance

  • Jul 09, 2019

CannTrust Holdings Inc. shares plunged more than 20 per cent Monday after it was revealed that Health Canada discovered illegal growing operations at a greenhouse and seized thousands of kilograms of the pot producer's inventory.

The licensed producer said Monday that Health Canada notified the company that it found CannTrust grew cannabis in five unlicensed rooms at its Pelham, Ont., facility and that employees provided inaccurate information to federal regulators.

The company said the growing in the unlicensed rooms took place from October 2018 to March 2019 when it had pending applications for the rooms with Health Canada. Licences were issued for each of the five rooms in April 2019. There are 12 rooms in total at the facility.

"(The rooms) were constructed in a very compliant way with Health Canada... Where the mistake was made was plants were put in those rooms before the actual approvals were received," chief executive Peter Aceto said.

Health Canada says it made an unannounced inspection of the facility that resulted in an overall non-compliant rating. The inspection report was hand-delivered on July 3 when it seized 4,327 kilograms of product and obtained samples for further testing.

"The critical observations were for conducting unauthorized activities, namely producing cannabis in unlicensed rooms before obtaining approval from Health Canada, providing false and misleading information to inspectors during the course of the inspection, and inadequate record keeping," spokesman Geoffroy Legault-Thivierge wrote in an email.

Aceto said it is unclear at this stage what transpired, but CannTrust has hired an external firm to conduct a "root-cause analysis," and determine how this occurred.

The company also said some of the product from these previously unlicensed rooms was distributed for sale. These products passed quality control testing at Health Canada certified labs and the company's own quality control processes, CannTrust said.

"CannTrust is clearly acknowledging that mistakes were made here... This is a high priority for us to correct these mistakes, particularly with Health Canada," Aceto said. "We've got a very clear process in place in order to get ourselves back into compliance as quickly as we possibly can."

Aceto said that roughly 5,200 kilograms of product put on hold by Health Canada, combined with 7,500 kilograms of products from its Vaughan, Ont.-facility which CannTrust voluntarily put on hold, represents the "majority" of its inventory.

The discrepancy, according to Health Canada, is due to the fact that it seized finished and unfinished product from CannTrust, some of which was in the final stages of drying and was not weighed in order to avoid product contamination.

CannTrust's total harvested production during its latest quarter ended March 31 amounted to 9,424 kilograms.

Aceto said CannTrust's other inventory on hand amounts to "several days worth of supply," noting that the company continues to grow, cultivate, harvest and sell cannabis.

The firm has a team working to source cannabis to fill supply gaps, Aceto said.

He added that by July 17 CannTrust will provide a written response to Health Canada, including an explanation, mitigating factors and changes the company has made.

One employee who worked at the Niagara-area facility has been terminated, but Aceto would not say what role that person held.

Graeme Kreindler, an analyst with Eight Capital Research, said the amount of inventory on hold represents roughly 71 per cent of its inventory, and 4.2 times its last quarterly sales volume.

He estimated that between $28 million and $69 million in future sales could be at risk.

"There remains a high degree of uncertainty with respect to the potential for future legal and regulatory repercussions," Kreindler said in a note to clients. "This includes a possible license suspension or revocation by the regulator."

Under the Cannabis Act, the regulator may suspend a licence or permit to protect public health or safety.

CannTrust also said Monday it has voluntarily advised Health Canada of "issues that may impact compliance at its Vaughan facility regarding product storage."

The company said the impact of these matters on CannTrust's financial results are unknown until Health Canada completes its quality testing of the held-back product from its Pelham greenhouse. Results are expected in 10 to 12 business days.

Canaccord Genuity analyst Derek Dley said the breach of regulations will likely impact its upcoming quarterly results in a material way.

"We believe it is highly likely the company will be forced to destroy the product that was produced within the non-compliant grow rooms," he said in a note to clients.

However, Dley added that it believes this is a "one-time issue" and the company is "working diligently to ensure it can rectify the situation."

Ryan Tomkins, an analyst with Jefferies, said in the near-term there will "undoubtedly be a financial impact."

"They will have to go to the open market to fill the shortage gap with little bargaining power which means they could pay inflated prices or take inferior product which could lead to lost market share," he said in a note to clients.

In the long-term, there will be an impact on CannTrust's credibility, Tomkins added.

"The fact the company never spotted this, or indeed still doesn't know how it happened, is a concern," he said.

"For us, this will make institutional investors think twice, and could also likely make it harder for CannTrust to attract high quality" partnerships with consumer-packaged goods companies."

CannTrust shares closed down $1.46 or roughly 22.6 per cent at $5 in Monday trading on the Toronto Stock Exchange.

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Note to readers: This is a corrected story. An earlier version cited an incorrect amount of cannabis voluntarily put on hold