---

Disclosure: I 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 ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

---

This uber-ramped but almost insolvent company will not like what follows. Since it is 100% fact based and verified there is little it can do, but if it wishes to threaten me with legal action the response will be “see you in Court Bitchez!”. I shall be ensuring that my numerous concerns are brought to the attention of my good friends at the FCA later today.

I have been assisted in publishing this by collaborators on two continents and they may have short or long positions in the stock. I suspect it will be the former. I have no position and will gain no financial benefit from any movement in the share price up or down. Now read on and enjoy!

BACKGROUND TO RED FLAG ANALYSIS

Name	Zoetic International PLC (ZOE)
Shares in issue currently	195,570,034
Share price	75p
Market cap	£147 million
Low of March 2020	3.05p
Shares in issue March 2020	172,920,034
Market cap low of March 2020	£5.27m
Share price appreciation since March 2020	2359%

Zoetic International PLC (ZOE) was formerly known as Highlands Natural Resources, a resources company which listed on the Main Market of the London Stock Exchange in March 2015. In March of 2019 Zoetic started the transition away from a collection of small uneconomical US based resource assets, and into a business claiming to be a vertically integrated CBD brand business, with operations in the US and UK.

A new management team led by Mr Trevor Taylor and Mr Antonio Russo, as joint CEOs, are now leading the development of a three-pronged CBD strategy:

• The roll out of the Chill brand (chews and hemp/herbal cigarettes infused with CBD isolate) into convenience stores in the USA and Europe.


• The development of the Zoetic brand consisting of 21 SKUs of CBD products in the UK.


• The establishment of a feminised seed genetics business.

Since March 2020, the shares have risen from a low of 3.05p to the current price of 75p, a rise of 2359%, giving it a market capitalisation of £147 million which is, as I shall show, utterly insane. The majority of that rise has come since August 2020 when the shares were still just 8p, seemingly driven by the announcement of store distribution deals in the US and Europe.

With a new pivot strategy underway, yet no company forecast guidance, no broker research published, no known institutions with a reportable position on the cap table, and having inherited a Main List quote, meaning no NOMAD to oversee news release compliance, there is limited information to easily assess the operations and prospects of Zoetic. As such I decided to conduct a red flag analysis of the company to highlight the issues surrounding the company that investors may or may not be aware of.

---

SUMMARY OF RED FLAG ANALYSIS CONCLUSIONS

My extensive analysis and research on Zoetic and the markets in which it operates has been based around:

1. A detailed review of all publicly available information.


2. Independent site visits by associates to a number of Colorado convenience stores stocking its Chill brand between December 2020 and January 2021.

The equity story being promoted by management and certain large investors is based around the following aspects:

• An experienced management team


• A vertically integrated CBD strategy to capture margin at each point in the value chain


• Guidance of a 50% gross margin on products sold to distributors


• CBD-based products sold as a healthier alternative smoking cessation product


• Distribution agreements to reach thousands of convenience stores in the USA and Europe


• A new display case format at US store checkouts to drive unit sales


• A strong brand positioning in UK with Zoetic


• A seed genetics strategy in Europe


• Substantial valuation upside based on future financial potential

However my analysis of Zoetic’s fundamentals unveils a very different story with a significant number of areas of concern across multiple levels. In my, as always humble, opinion these are as follows.

• Chill CBD products and surrounding medical claims appear to be violating US federal FDA & FTC regulation, potentially putting consumers at risk:

• Under federal law the FDA considers CBD products making any unsubstantiated health claims as a new drug requiring FDA approval before it can be sold in the USA.


• Manufacturing facilities for such drugs must be CGMP and approved by FDA.


• Medical claims on the benefits of smoking herb/hemp leaves requires FDA approval.


• Smoking cessation products must also be approved by the FDA.


• Zoetic products and health claims do not appear to comply with any of these federal requirements.
  
  


• Product violations liable to incur US Federal regulatory intervention:


• Other CBD companies making similar health claims to Zoetic have been censured by the FDA including warnings for companies allowing CBD to be inhaled into the lungs in December 2020. Products can be forced off the market with just 15 days warning. ¹ (Link) 


• Unknown distributor and retailer reaction to Chill products if proven to be violating FDA regulation (destocking, refunds, legal action possibilities).


• Given the possible health impacts of its smokable products, there are potential risks to the company from consumer claims. It is not known whether their insurance will cover such claims if sales are deemed to be violating FDA regulation.
  
  


• Major carcinogenic health issues with smokable herbal products identified by FDA:
  


• The FTC considers herbal cigarettes to be as harmful as tobacco to the health of consumers, so tougher federal regulation seems increasingly likely. ² (Link)


• Smoking cessation products must be submitted as a New Drug Application to CDER for approval before being marketed as such.
  


• An increasingly strict regulatory stance by states towards herbal cigarettes:


• States such as Texas, Iowa, Indiana, Kentucky, Louisiana and Hawaii have all already banned smokable hemp.


• Additionally many states require smokable hemp products to be hidden behind the store counter, like tobacco products, not in a point of sale display unit at checkout which is a big part of the Chill strategy to build the brand.

• An undifferentiated distribution deal with AATAC with no sales guarantees:

• There are multiple CBD companies that have executed CBD brand distribution deals with AATAC but have delivered little identifiable revenue traction and some ultimately resulting in JV cancellation.

• Confusion around the Schrader Oil beta stores sales:

• In February 2020 Zoetic claimed it was selling 2-3 packs a day in store; in its September 2020 trading update that it stated that beta  store sales had increased significantly and were consistently increasing month on month, and that the Chill products were the number one non-food selling CBD products in the beta stores. However, in January 2021 interim results state that revenues of £54,000 for the period March to September 2020 were 100% derived from the online stores suggesting that there were no instore sales from the Schrader beta stores between March and September 2020.


• Furthermore it appears that Chill product is now being destocked in beta stores in favour of other CBD brands which is hardly a positive endorsement considering these were the showcase test stores and where Chill was supposedly a bestselling product.

• Lack of wider store roll out across the USA:

• In March 2020 Zoetic talked about its original store distribution with Schrader being expanded to supplying into 500 new stores and building the network from there. In June 2020 it claimed distributions covering 6,000 stores. Yet the January 2021 update revealed zero sales from physical stores to September 2020 and no mention of any store presence numbers.

• Lack of clarity on European distribution deals:

• Zoetic stated in early September 2020 that thousands of stores across Europe were preparing to stock Chill. Nearly five months later the company has not reported any stores stocking in Europe or indeed any sales.

• An unproven management team:

• Management appear to have little consumer brand marketing experience, which the entire Zoetic story is now based around, or public market experience.

• Significant LSE Listing Standards corporate governance shortfall:

• Zoetic does not apply the UK Corporate Governance Code in full, with the only Board members being the two CEOs and not one independent Board member.

• An unknown genetics seed strategy in a crowded seed market:

• Seed prices have collapsed and genetics is a difficult market to differentiate in.

• Lack of differentiation in UK Zoetic CBD products:

• Resulted in a failure to secure any European distribution deals or generate any meaningful revenues.

• A retail investor driven stock with overhyping on bulletin boards:
  


• With no company guidance or broker research, retail investors are posting huge financial potential numbers based on unrealistic aspirational assumptions.

• Misleading and outdated statements both online and in public releases:

• Examples include the website home page where it states it’s a vertically integrated CBD business growing hemp indoors and outdoors in Colorado (untrue now). In fact it owns very little of the value chain, bar the brand.


• London Stock Exchange rules require transparency and for investors not to be misled.


• Class action lawsuits by shareholders in CBD companies are rising, in combination with the 2359% rise in the Zoetic share price in 9 months, misleading marketing statements and possible FDA violations exposes Zoetic to the risk of legal action both in the UK and the USA.

• The potential for listing intervention by the LSE given its products violate US FDA regulation:

• Significant detrimental impact for the equity valuation and liquidity potential of being able to sell shares.

• Significant LSE Listing Standards corporate governance shortfall:

• Zoetic does not apply the UK Corporate Governance Code in full, with the only Board members being the two CEOs and not one independent Board member.

• Lack of funding to deliver significant revenues:

• With only £450,000 of cash as at September 30, it’s difficult to see how Zoetic will fund the aggressive roll out of products to thousands of stores or marketing spend to create brand awareness.


• While in possible breach of FDA regulation, any equity capital raise could be difficult and could lead to legal action if the risks are not highlighted to investors.

• Extremely high valuation vs comparable peers:

• Revenues for 12 months to September 2020 were just £81,000 putting Zoetic on a historic revenue multiple of 1811x.


• Trades at a huge premium to both other listed CBD brand companies with substantial revenues, and the wider cannabis comparable peer group in the USA and Canada.

 

---

 

CONCLUSION

Zoetic is an early-stage company with revenues of just £81,000 in the 12 months to September 2020 and only £450,000 cash to try to create a global consumer branded business predominantly around CBD infused chews and smokable cigarettes. However, there is currently substantial regulatory scrutiny at both the federal and state level around the impact of both CBD and smokable products on consumers’ health. The combination of its inhalable smoking products and multitude of health claims being made across its social media and website leaves it vulnerable to investigation. Its products are in a high-risk category and as a result of the health claims being made, appear to be in violation of FDA and FTC regulations. Its products are likely to be deemed to be new drugs requiring authorisation first before being offered for sale to consumers in the USA.

With a valuation of £147 million, trading on a historic sales multiple of 1811x, the market is pricing in huge future revenues and profits growth. However, I have very real concerns over its financial performance potential given that its products in the USA appear to violate multiple federal agency regulations. With the potential that interstate revenues from these products could effectively be ceased with a 15-day warning letter by the FDA, revenues from the Chill products in the USA could potentially be limited. The knock-on effects of being censured by the FDA, FTC or at the state level could also be highly damaging. This could include extreme difficulties in raising much needed growth capital, listing scrutiny by the London Stock Exchange (suspension or delisting issues), negative reactions from distributors and store owners, and possible investor class action lawsuits over misleading statements. Given the multitude of red flags across the business I have identified, and the risks to future revenue performance, I would take extreme caution after the recent 2359% rise. That is putting it mildly

In my view, in a negative scenario, the equity value of Zoetic could well be zero. However, even in the most optimistic forward revenue scenario this year, based on comparable valuation multiples of other CBD companies in North America, Zoetic would struggle to justify a fair value more than £10 million, equivalent to 5p per share.

---

RED FLAG ANALYSIS

In my Red Flag Analysis, I identify 11 macro areas of concern and a total of over 60 Red Flag risks across these areas:

1. US Products: Federal Regulatory Issues  


2. US Products: State Regulatory Issues


3. US Products: Company Specific Regulatory Issues


4. US Products: Distribution Deal Issues


5. Management & Governance Risks


6. Failure of the Vertical Integration Strategy


7. Zoetic UK Brand Issues


8. Corporate: Equity Ownership Issues


9. Corporate: Lack of Guidance & Misleading Statements


10. Corporate: Financial Concerns


11. Valuation Issues

All information in this document has been sourced via publicly available sources online or through physical research such as instore visits by my collaborators.

---

1. 
   

   US PRODUCTS: FEDERAL REGULATORY ISSUES

   
   

Zoetic’s Chill brand products (www.thechillway.com/shop) in the USA consist of tobacco, nicotine and THC free CBD infused chews and cigarettes being:

• Two herbal (CBD Smokes Mint, Calm CBD Smokes) and one hemp-based, packs of 10 cigarettes; and


• Three flavours of CBD chew punches – mint, peach, and vanilla.

In researching the Chill brand and the markets it operates in, I identify key concerns at the federal, state and company levels which will have a strong bearing of Zoetic’s ability to successfully launch the brand and ultimately generate the significant revenues and profits that are appear to be already built into the current £147 million valuation.

Of all the dozens of red flags I have identified with Zoetic, by far the most serious are that:

• Zoetic has chosen to infuse CBD isolate as the spray on ingredient to differentiate itself and make claims about smoking cessation; FDA considers CBD a ‘new drug’ that requires approval and interstate commerce is prohibited until authorisation.


• Drug products need to be manufactured in compliant FDA inspected facilities which I do not believe is the case for Zoetic’s contract manufacturers.


• Zoetic makes multiple unsubstantiated health claims around the benefits of its herbal leaves and as such sales are prohibited by the FDA without approval.


• The FDA strictly regulates smoking cessation and products require authorisation.


• Zoetic has chosen one of the most scrutinised and increasingly regulated products in the consumer market, given health concerns, around which to try to build a brand – inhalable combustible cigarettes using herbs and hemp.

Each could have a material negative impact on Zoetic’s ability to create a brand and generate meaningful revenues, but combined together, the risks are that its Chill products are potentially in violation of FDA regulation and hence sales could be halted or severely restricted by federal regulators with just 15 days notice.  

Red flag – FDA views CBD as a new drug requiring authorisation before sale

A) Federal regulatory background

In the USA the Food and Drug Administration (FDA) has broad oversight of protecting consumer health. With respect to CBD the FDA states:

“On the federal level, the Agriculture Improvement Act of 2018 (Farm Bill) removed cannabis and cannabis derivatives that are very low in THC from the definition of marijuana in the Controlled Substances Act (CSA). At the same time, that legislation specifically preserved the FDA’s responsibility over such products”  ³ (Link)

Given the lack of scientific research and evidence around the impact of CBD on human health, the FDA currently considers CBD as a potentially harmful product with numerous possible side effects that it believes needs more investigation before it can widely be sold to consumers for ingestion – i.e. taking CBD molecules into the human body via cigarettes. ⁴ (Link) 

It goes on to say:

“In particular, the agency recently updated the public on concerns about potential harm from CBD products, including potential liver injury, interactions with other drugs and male reproductive toxicity, as well as side effects such as drowsiness. In addition, there is still much I do not know about other potential risks. For example, other than the approved prescription drug, I know little about the potential effects of sustained and/or cumulative use of CBD, co-administration with other medicines, or the risks to vulnerable populations like children, pregnant and lactating women, the elderly, unborn children and certain animal populations.” ⁵ (Link)

The FDA make it clear that there is going to be stricter regulation around the sale of CBD products to consumers, especially where medical claims around the positive impact of CBD are being made. Indeed any health claims made by CBD based products also falls under the Food, Drug and Cosmetic Act (FD&C Act) which regulates products “intended to have a therapeutic or medical use, and any product (other than a food) that is intended to affect the structure or function of the body of humans or animals. ” ⁶ (Link). Generally intended use is determined by the claims made in advertising and promotion of the product. So far the only CBD based product the FDA has evaluated and approved for health benefits is GW Pharma’s Epidiolex in 2018.

The FDA states:

“Under the statutory authorities that the FDA has the responsibility to administer, the relevant legal requirements vary depending on which type of product we’re talking about. For example, if a product is being marketed as a drug — meaning, for example, that it’s intended to have a therapeutic effect such as treating a disease — then it’s regulated as a drug, and it generally cannot be sold without FDA approval”. ⁷ (Link)

“In particular, we continue to be concerned at the number of drug claims being made about products not approved by the FDA that claim to contain CBD or other cannabis-derived compounds. Among other things, the FDA requires a cannabis product (hemp-derived or otherwise) that is marketed with a claim of therapeutic benefit, or with any other disease claim, to be approved by the FDA for its intended use before it may be introduced into interstate commerce. This is the same standard to which we hold any product marketed as a drug for human or animal use. Cannabis and cannabis-derived products claiming in their marketing and promotional materials that they’re intended for use in the diagnosis, cure, mitigation, treatment, or prevention of diseases (such as cancer, Alzheimer’s disease, psychiatric disorders and diabetes) are considered new drugs or new animal drugs and must go through the FDA drug approval process for human or animal use before they are marketed in the U.S. Selling unapproved products with unsubstantiated therapeutic claims is not only a violation of the law, but also can put patients at risk, as these products have not been proven to be safe or effective. This deceptive marketing of unproven treatments raises significant public health concerns, as it may keep some patients from accessing appropriate, recognized therapies to treat serious and even fatal diseases”  ⁸ (Link)

This is extremely relevant to Zoetic’s Chill products as the hemp and CBD specialist international law firm Harris Bricken concludes:

“Therefore any health claim made about CBD infused products, including CBD Smokables, will be treated by the FDA as a drug…and thus would require the distributor [I.e. Zoetic] to submit their product to the agency for pre market approval before they can begin selling it in interstate commerce”. ⁹ (Link)

This is made clear in an FDA presentation where on slide 8 it states “Under the FDCA, any product, including a cannabis product (hemp or otherwise), that is marketed with a claim of therapeutic benefit…is considered to be a drug. A new drug must be approved by the FDA for its intended use before it may be introduced into interstate commerce”. ¹⁰ (Link)

Harris Bricken goes on to conclude in an article entitled ‘The future for smokable CBD products is NOT great’ that:

“given the trends over the past few years regarding enforcement and regulation of smokable CBD products, we fully expect the trend to continue in the coming years. More states will without a doubt continue to implement bans or restrictions, and its virtually guaranteed that the federal government will create more roadblocks”. ¹¹ (Link)

The FDA intends to regulate CBD strongly. In October 2020, the FDA set out a guidance paper called ‘FDA Regulation of Cannabis and Cannabis Derived Products, Including CBD’ stating:

“…FDA is aware that some companies are marketing products containing cannabis and cannabis-derived compounds in ways that violate the Federal Food, Drug and Cosmetic Act (FD&C Act) and that may put the health and safety of consumers at risk. The agency is committed to protecting the public health while also taking steps to improve the efficiency of regulatory pathways for the lawful marketing of appropriate cannabis and cannabis-derived products”. ¹² (Link)

Furthermore, even if no medical claims are being made, the FDA considers it illegal to sell ingestible CBD across state borders:

“Food, including dietary supplements, is regulated differently, but with the same overarching goal of protecting consumers. Among other things, it is currently illegal to put into interstate commerce a food to which CBD has been added, or to market CBD as, or in, a dietary supplement. Essentially, the relevant statutory provisions prohibit these uses of CBD because CBD was the subject of substantial clinical investigations into its potential medical uses before it was added to foods (including dietary supplements), and, separately, because CBD is the active ingredient in Epidiolex, an FDA-approved prescription drug product to treat rare, severe forms of epilepsy.”  ¹³ (Link)

”We are aware that there may be some products on the market that add CBD to a food or label CBD as a dietary supplement. Under federal law, it is illegal to market CBD this way”. ¹⁴ (Link)

The FTC is also now taking a firm stance against CBD companies. As recently as December 17th 2020 the FTC issued a public release entitled “FTC Announces Crackdown on Deceptively Marketed CBD Products’ where it stated:

“The Federal Trade Commission today announced the first law enforcement crackdown on deceptive claims in the growing market for cannabidiol (CBD) products. The FTC is taking action against six sellers of CBD-containing products for allegedly making a wide range of scientifically unsupported claims about their ability to treat serious health conditions, including cancer, heart disease, hypertension, Alzheimer’s disease, and others”. ¹⁵ (Link)

Andrew Smith, Director of the FTC’s Bureau of Consumer Protection stated:

“The six settlements announced today send a clear message to the burgeoning CBD industry: Don’t make spurious health claims that are unsupported by medical science,…Otherwise, don’t be surprised if you hear from the FTC”. ¹⁶ (Link)

In short the FDA & FTC believes:

1. CBD could have harmful effects on humans.


2. Unless CBD products go through the full FDA drug approval process they are considered unapproved new drugs and until such FDA approval is granted, the sale of such CBD products is in violation of regulation and may not be sold to consumers.


3. Any product making medical claims (including online or social media) must seek FDA approval.


4. The manufacturing process and facilities of these unapproved CBD containing drug products must also be subject to FDA review.


5. US regulators are increasingly active and focused on companies marketing cannabis products that are in violation of regulation, prioritising those that pose the greatest risk of harm to the public (we don’t see a higher risk than the delivery of CBD into the lungs via cigarette smoke inhalation).


6. Warning letters including fines, marketing restrictions and product removal from sale are all part of the punishment handed down to companies violating.

 

B) Unpacking Zoetic’s CBD therapeutic claims

As part of Zoetic’s pivot from a resources company to a CBD company, Zoetic announced the launch of its Chill brand on 14th June 2019, at the very early stages of the FDAs scrutiny on CBD. Zoetics core marketing proposition is that its herbal and hemp cigarettes are organic and nicotine free and are a healthier alternative to smoking tobacco leaves. Furthermore, with CBD isolate sprayed onto the herbal leaves, when smoked the molecules of CBD get into the human system which may have an impact on nicotine cravings and hence help people stop smoking. These smoking cessation claims are made across its website, RNS releases and its social media accounts.

In my view this is a major problem for Zoetic as its products are marketed as playing on the health aspects of herbs vs tobacco and of CBD and its ability to have a therapeutic effect on the brain to help people stop smoking.

1. On the Zoetic US website the ‘Our Mission’ statement talks of a “strive to produce the purest and cleanest CBD products” while the ‘Our Difference’ states “our products are always natural…we commit to provide clean and pure CBD products”.¹⁷ (Link) 

2. The CBD isolate around which it makes therapeutic claims is not even natural to the hemp leaves. It is sprayed onto the cigarettes in order to add what the FDA perceives as a ‘drug’ ingredient, around which smoking cessation claims can then be made. 

3. Critically Zoetic states in its May 29th 2020 trading update “This patent-pending method also includes a variation smoking cessation product, employing combinations of nicotine and CBD, which is also THC-free… The Company believes that CBD may play a rapidly increasing role in smoking cessation aids and that its Chill branded…products are well placed to take an increasing share of this market… It is the Board’s intention to focus the Company on non-nicotine smoking cessation products as part of its portfolio of CBD products”.¹⁸ (Link) 

4. On the home page of its website it states “A Chill way to quit tobacco and experience CBD”. ¹⁹ (Link) 

5. On Twitter it states “Are you a tobacco dip or chewing tobacco user? Are you looking for an easy way to quit or looking for a healthier substitute? Then you are in luck”. ²⁰ (Link) 

6. On the Chillway website it states “Another method is to replace tobacco and nicotine with more relaxing and less addictive alternatives like the Chill Way’s CBD smokes and chews”. ²¹ (Link) 

7. On the Chillway website it states “Chewing CBD pouches is a great way to satisfy your craving…Lets take a look at some of the major benefits of using CBD chews…many benefits have been found. These include Managing chronic and non chronic pain; Increasing relaxation; Reducing stress and anxiety…CBD can be effective to help with depression and anxiety.” ²² (Link) 

8. On the website under ‘Can CBD Smokes Help you Relax? it states: “The simple answer to this question is yes. CBD has several different benefits, and one of those benefits is relaxation. CBD has been shown to have relaxing qualities and to help fight stress and anxiety. When used regularly, it can even help with depression ”. ²³ (Link) 

Medical claims that infused CBD isolate can help reduce nicotine dependency and act as a smoking cessation aid appears to be a product being marketed by Zoetic to ‘prevent or mitigate’ smoking related diseases. Zoetic is making marketing assertations that its CBD smokes can help people fight stress, anxiety and depression. Given FDA regulatory guidance, my view is that these CBD based medical claims must therefore be first approved by the FDA which considers it as a drug. I believe that Zoetic’s products are therefore being marketed in violation of federal regulation which means that they, may not be sold until approved, and are therefore subject to FDA enforcement at any point.

While Zoetic has, in my opinion, failed to alert consumers, investors and the London Stock Exchange to this fundamental issue, other CBD companies do indeed flag this critical regulatory issue. For example CBD focused company Earth Sciences Tech notes in its 2019 SEDAR filings under the risk section:

“The formulation, manufacturing, processing, labelling, packaging, advertising and distribution of our products are subject to regulation by several federal agencies, including the Food and Drug Administration (“FDA”), the Federal Trade Commission (“FTC”), the Consumer Product Safety Commission, the U.S. Department of Agriculture (“USDA”) and the Environmental Protection Agency (“EPA”)…The FDA has not approved cannabis, marijuana, industrial hemp or CBD derived from cannabis or industrial hemp as a safe and effective drug for any indication. The FDA considers these substances illegal Schedule 1 drugs…at some indeterminate future time, the FDA may choose to change its position concerning products containing cannabis, marijuana, or CBD derived from industrial hemp, and may choose to enact regulations…In this hypothetical event, our industrial hemp-based products containing CBD may be subject to regulation. In the hypothetical event that some or all of these regulations are imposed, we do not know what the impact would be on the cannabis industry in general, and what costs, requirements and possible prohibitions may be enforced. If we are unable to comply with the conditions and possible costs of possible regulations and/or registration as may be prescribed by the FDA, we may be unable to continue to operate our business”. ²⁴ (Link)

In Zoetic’s case, you have to go to the website disclaimer section of the Chillway shipping policy copy before there is any acknowledgement by Zoetic as to the risks to its entire Chill revenue model where it states:

“The products and claims made about specific products on or through this site have not be evaluated by the FDA (United States Food & Drug Administration) and are not approved to diagnose, treat, cure or prevent disease” ²⁵ (Link)

It seems misleading that as a public company, Zoetic makes open positive health claims about its products on its home page website, social media and in public press releases, yet then bury the actual position of the FDA’s attitude towards its products in a disclaimer

Unfortunately for Zoetic its pivot, in June 2019 into CBD infused cigarettes, perhaps unwittingly took it directly into a market that the FDA is now extremely focused on and clamping down on.

C) Impact on Zoetic?

I believe that the implications for Zoetic are two-fold. Firstly, Zoetic appears to be violating FDA regulation by promoting its products based on unproven medical claims. Secondly, while the FDA does not yet specifically flag cigarettes as a CBD ingestion delivery mechanism, the FDA is looking to limit the interstate sales of ingestible CBD until additional safety research has been conducted. I believe that the FDA is unlikely to allow a loophole around non tobacco cigarettes to be exploited to allow humans to ingest CBD given its stated “overarching goal of protecting consumers” ²⁶ (Link). If that is the case, then the Chill range of CBD cigarettes and chew products, compounded by the associated medical claims, will be violating the FD&C Act and Zoetic could be subject to enforcement by the US FDA and Department of Justice (DOJ). Enforcement proceedings by both bodies could include:

• Need for premarket authorisation – Product withdrawal from interstate commerce until all safety tests have been proven.


• Regulatory warning and rectification letters of violations such as product recall from the market; examinations and inspections; issue of cease trading orders.


• Non-compliance referral to the DOJ’s Office of Consumer Litigation Department for product seizures, injunctions, civil penalty proceedings or criminal prosecutions.

In particular the guidance states:

“FD&C Act regulated articles that are already in distribution may be “recalled” or removed from market if FDA identifies FD&C Act violations that present consumer safety issues”. ²⁷ (Link)

The FDA has continued to issue warning letters (the most recent batch on December 23rd 2020) to companies that were selling products containing CBD in ways that violate the FD&C Act around public safety concerns, specifically stating:

“Unlike drugs approved by the FDA, there has been no FDA evaluation of whether these unapproved CBD products are effective for their intended use, what the proper dosage might be, how they could interact with FDA-approved drugs, or whether they have dangerous side effects or other safety concerns.” ²⁸ (Link)

“Meanwhile, we will continue to monitor and take action, as needed, against companies that unlawfully market their products — prioritizing those that pose the greatest risk of harm to the public.”  ²⁹ (Link)

The impact on such companies receiving a warning letter is that:

“The FDA has requested responses from the companies within 15 working days stating how the companies will correct the violations. Failure to correct the violations promptly may result in legal action, including product seizure and/or injunction”. ³⁰ (Link)

For Zoetic this could mean that within 15 days of receiving a letter from the FDA its Chill products could be pulled from the market.

Indeed warnings have been issued by the FDA to other CBD focused companies across a number of areas which appear to make the same medical claims as Zoetic does:

1. Koi CBD

1. FDA warning letter

• “Based on our review of your website…your products are drugs under Section 201(g) (1) of the FD&C Act 21 U.S.C 321(g)(1), because they are intended for use in the diagnosis, cure, mitigation, treatment or prevention if disease. Examples of claims observed or your website www.koicbd.com that establish the intended use of your products as drugs include, but are not limited to: CBD RELIEVES PAIN AND INFLAMMATION…. Several pre clinical reports show anti-tumour effects of CBD… [Your] products are not generally recognized as safe and effective for the above referenced uses and, therefore, the products are “new drugs” under section 201(p) of the FD&C Act, 21 U.S.C. 321(p). New drugs may not be legally introduced or delivered for introduction into interstate commerce without prior approval from the FDA, as described in sections 301(d) and 505(a) of the FD&C Act, 21 U.S.C. 331(d) and 355(a). FDA approves a new drug on the basis of scientific data and information demonstrating that the drug is safe and effective. There are no FDA-approved applications in effect for any of the above-mentioned products.”  ³¹ (Link)

2. Zoetic claims similarity

• On the Zoetic website under ‘What is CBD’ it makes the statement “”..thus far, CBD shows potential for general wellness. It appears that CBD has an anti inflammatory effect, which may be why it shows promise to manage chronic pain”.  The inference therefore is that smoking the Chill CBD infused products could help with anti inflammation and pain and is therefore likely to be viewed as being sold as an Unapproved New Drug which is a violation of FDA regulation until such effects are proven and its authorised by the FDA. ³² (Link)

 

2. Mr Pink Collections

1. FDA warning letter

• Warned for similar Unapproved New Drug reasons after stating: “CBD is a natural deterrent to inflammation which is known to supress diseases such as depression and anxiety”. ³³ (Link)

2. Zoetic claims similarity

• On the Chillway website under What is CBD it makes the statement “there is also a growing body of research on CBD for anxiety disorders that support the idea that CBD can be used for relaxation”. Here Zoetic is even more direct in stating “our hemp products offer the opportunity to relax, without all of the toxic chemicals.” Again the inference is that its CBD product is a drug that can help anxiety and relaxation which is what Mr Pink was warned for. ³⁴ (Link)

 

3. Daddy Burt Hemp

1. FDA warning letter

• Warned for making numerous claims stating: “Using CBD for Depression – the Benefits – In research studies CBD has been effective in helping to relieve depression”. ³⁵ (Link)

2. Zoetic claims similarity

• On the Chillway website under What is CBD page it makes the statement “…CBD is currently being studied for its promise in helping with many different health concerns from heart health, to depression to dementia”. Again, a clear inference that their CBD product is a product that can help for conditions that Daddy Burt Hemp was warned for. ³⁶ (Link)

 

4. Bee Delightful

1. FDA warning letter

• Multiple claims including the FDA citing “Your website also contains evidence of intended use in the form of personal testimonials found on the home page under “Share your Experiences” recommending or describing their use of your product for the cure, mitigation, treatment or prevention of disease. Examples of testimonials include: i)“I have found this product to help relieve stress, anxiety, depression, pain and ii)“Love this CBD honey!..1tps at night and I’m sleeping soundly and actually have less anxiety…. Your “Canna Bees Rescue Blend” products are not generally recognized as safe and effective for the above referenced uses; therefore, these products are “new drugs” under section 201(p) of the FD&C Act, 21 U.S.C. § 321(p). New drugs may not be legally introduced or delivered for introduction into interstate commerce without prior approval from the FDA”. ³⁷ (Link)

2. Zoetic claims similarity

• On the Chillway home page under Reviews ³⁸ (Link):

1. “Using to stop smoking”.


2. “Great stuff after a few days I noticed the calming effects”


3. “My co-workers and I have all quit smoking and chewing tobacco using these products”


4. “You guys product have saved my life with my anxiety”


5. “This product is GREAT!. I am a very busy person with lots on my plate, this product keeps me relaxed and definitely helps curb anxiety”

 

5. NextL3vel Services & Wellness BioSciences

1. FDA warning letter for Next L3vel Services

• The warning letter specifically identified its inhalable CBD vape product as particularly concerning, stating “In addition, your CBD Vape products are particularly concerning to the agency because the ingredients and potential impurities in oral inhalation products may trigger laryngospasm and bronchospasm and may be toxic to the tissues in the upper or lower airways. Inhalation products that are intended to act locally in the respiratory system also may be absorbed and exert undesirable systemic effects, such as increased heart rate or elevated blood pressure”. This letter was issued on December 23rd 2020 which indicates that the FDA is now concerned about the potential harm of CBD being inhaled into the lungs, regardless of the medical claims. ³⁹ (Link)

2. FDA warning letter for Wellness BioSciences

• The warning letter again took specific issue with its WBRx Metered Dose Inhaler intended to deliver CBD through oral inhalation again stating “This product is particularly concerning to the agency because the ingredients and potential impurities in oral inhalation sprays may trigger laryngospasm and bronchospasm and may be toxic to the tissues in the upper or lower airways. Inhalation products that are intended to act locally in the respiratory system also may be absorbed and exert undesirable systemic effects, such as increased heart rate or elevated blood pressure”. ⁴⁰ (Link)

3. Zoetic claims similarity

• What is apparent from the warnings to NextL3vel and Wellness Bio is that the FDA considers the delivery of CBD into the human body via inhalation to the lungs as an area of heightened concern, both from the unknown impact of CBD but also to the possible toxicity of the ingredients to the tissue. With the FDA also noting that combustible herbal smoking is just as harmful and carcinogenic as tobacco smoking, I believe that Zoetic’s sprayed on CBD delivery method of inhaling via smoking leaves is likely to see its products be at similar risk of FDA scrutiny.

Across the Zoetic websites, in promoting its CBD based products, it makes similar claims to those that caused the FDA to investigate and warn other CBD product companies. In my view it is likely that, given the above regulatory guidance and warning case studies, that Zoetic’s products could come under FDA scrutiny.

The FDA will be alerted to this. I am a good citizen

I believe that the harmful nature of herbal smokes on consumers, together with its unauthorised CBD health claims is likely to draw federal regulators’ attention with or without me. Being a publicly traded company in the UK and US will potentially make it even more high profile, which I believe further enhances the risk of attention as the FDA looks to make examples of companies violating the regulation on CBD and marketing unapproved new drugs under section 505(a) of the Federal Food, Drug, and Cosmetic Act (the FD&C Act), 21 U.S.C. 355(a).

Red flag – FDA approval needed for any products making health claims

Without scientific proof and a full FDA authorisation process, any ingestible products (CBD based on not) may not make medical claims. Any health claims:

• must contain the elements of a substance and a disease or health-related condition;


• are limited to claims about disease risk reduction;


• cannot be claims about the diagnosis, cure, mitigation, or treatment of disease; and


• are required to be reviewed and evaluated by FDA prior to use.

The FDA states, in answering the question whether it reviews health claims:

“Yes. All health claims, whether authorized or qualified, require pre-market review by the FDA. Under federal law, the FDA approves by regulation authorized health claims for use in food labelling only if the substance/disease relationship described by the health claim meets the “significant scientific agreement” standard. For qualified health claims, the FDA issues letters of enforcement discretion when there is credible evidence to support the claim”. ⁴¹ (Link)

By way of example, the FDA sent a Warning Letter on December 2nd 2020 to Smokey Mountain Naturals stating that it takes online orders for products ‘Evening Primrose Oil’ and ‘Beta Glucan’ but that:

“the claims on your website establish that these products are drugs under section 201(g)(1)(B) of the Federal Food, Drug, and Cosmetic Act (the Act) [21 U.S.C. 321(g)(1)(B)] because they are intended for use in the cure, mitigation, treatment, or prevention of disease. As explained further below, introducing or delivering these products for introduction into interstate commerce for such uses violates the Act”.

The FDA’s evidence was that on the website they had stated “Evening Primrose Oil is effective at reducing inflammation…and has been traditionally used for Eczema, high blood pressure, Inflammation”.

As such it concludes:

“Your “Evening Primrose Oil,” and “Beta Glucan” products are not generally recognized as safe and effective for the above referenced uses and, therefore, these products are “new drugs” under section 201(p) of the FD&C Act, [21 U.S.C. § 321(p)]. New drugs may not be legally introduced or delivered for introduction into interstate commerce without prior approval from FDA, as described in sections 301(d) and 505(a) of the Act [21 U.S.C. §§ 331(d), 355(a)]”. ⁴²  (Link)

Zoetic, rather similarly, on its Chillway website under Natural Herbs ⁴³ (Link), makes the following cure, mitigation or treatment statements regarding the herbs used in its smokable products:

1. Damiana herb

• “…it is primarily used for its anti anxiety, anti depressant and libido-stimulating properties”

2. Lavender herb

• “…you may not realize you can smoke it…it is thought to be effective in relaxing anxiety and stress, addressing sleep issues, aiding skin and hair care, providing an anti-inflammatory effect and in promoting heart health”.

3. Lobelia herb

• “Lobelia has a long history as a nicotine replacement and has many homeopathic uses….it is effective for easing smoking cravings…and for a variety of respiratory issues, and it may help relax muscles and promote blood flow”.

4. Motherwort herb

• “…may offer a whole bevy of benefits to your health. Some include helping with anxiety and panic disorder, insomnia, and heart conditions. It is know to be anti-inflammatory and analgesic and it is used to treat a wide variety of women’s issues”.

5. Mugwort herb

• “…are used to treat a wide variety of medical concerns, including digestive issues such as diarrhoea and constipation, women’s issues such as irregular periods or other menstrual problems, and mental health issues such as depression and anxiety”.

6. Mullein herb

• “…is believed to be beneficial for disorders of the respiratory tract, gastrointestinal tract, skin, veins, and locomotor system”.

7. Passion flower

• “Today, passion flower shows great promise in treating generalized anxiety disorder. Passion flower stabilizes mood, promotes better sleep, controls muscle spasms, and lowers blood sugar.”

8. Red Raspberry Leaf herb

• “It’s known to lower blood sugar, ease pain from childbirth, increase fertility, enhance collagen production in the skin, and it produces a sedative effect”.

9. Bearberry herb

• “It is used in homeopathy to treat a variety of conditions, including urinary tract infections, contact dermatitis, and arthritis.”

It states under the ‘Ways To Relax When Stress Hits’ webpage that:

“If you smoke, one way you can alleviate your stress is with THC Free CBD Smokes Calm.  They promote relaxation and calm through the mixture of safe and natural herbs that create the unique blends they offer” ⁴⁴ (Link)

It states under ‘What are the benefits of CBD Chew?’ webpage that:

“…studies on CBD are still in the early stages but…include Managing chronic and non chronic pain; reducing stress and anxiety; taking the place of nicotine…you will see for yourself how CBD can work wonders for you and your body”. ⁴⁵ (Link)

It states under the ‘How to Use CBD Dip’ webpage that:

“Our CBD dip is filled with, you guessed it, CBD! So what is CBD and why is it known for providing some great health and wellness benefits to its users? Relaxation; Stress and anxiety; helps with depression; relieves chronic pain…these benefits, and many more, are just some of the many reasons why using CBD dip is better than tobacco dip”. ⁴⁶ (Link)

It states under the ‘Will CBD Smokes Help me Relax’ webpage that:

“CBD smokes are an excellent alternative to smoking cigarettes, as they still give you the sensation of smoking, but rather than harmful chemicals, you are smoking natural herbs which may offer benefits… CBD has been shown to have relaxing qualities and to help fight stress and anxiety. When used regularly, it can even help with depression… Using CBD smokes can be a great way to fight anxiety, as well as take the edge off. CBD can also help with pain relief and is the perfect alternative to nicotine.”  ⁴⁷ (Link)

Zoetic is clearly promoting its products based on the premise that a significant number of health conditions can be cured, mitigated or treated with the CBD and herbal leaves used in its cigarettes and chew pouches. However I believe all these health claims are NOT clinically proven and Zoetic has NOT sought authorisation from the FDA to make such qualified health claims. Zoetic’s cigarette and chew products and associated claims make them a new drug products under Section 201(p) of the FD&C Act and are therefore ,in my view, in breach of FDA regulation leaving it in danger of enforcement, product removal from the market and fines. Furthermore in Zoetic’s case it also raises critical questions about the London Stock Exchange listing given revenues could be coming from products that are violating US FDA regulations.

Red flag – Increasing Federal FDA and FTC scrutiny on tobacco alternatives

The US FDA and Federal Trade Commission (FTC) have the authority to regulate the sale, manufacture and marketing of tobacco products under the 2009 Family Smoking Prevention and Tobacco Control Act. One of the many regulations imposed are both strict label health warning and the requirement that all tobacco cigarettes to be stocked behind the counter behind closed doors to prevent consumers from being enticed to purchase combustible cigarettes.

Zoetic states that its Chill smoke products are able to be stocked visibly on the counter. It also openly markets that smoking hemp and herbal cigarettes, with CBD, is both a healthier and safer option and one likely to help consumers stop smoking tobacco.

However it is widely accepted that all forms of smoking and inhalation into the lungs are simply not healthy and in particular the FTC has already cracked down on this issue with other herbal cigarette companies ⁴⁸ (Link):

• The FTC has already passed judgement on one herbal cigarette brand called Herbal Gold requiring it to add to all packaging “Herbal cigarettes are dangerous to your health. They produce tar and carbon monoxide”.


• A further two companies – Alternative Cigarettes and Santa Fe Natural Tobacco Company – were forced to discontinue advertising claims that their cigarettes were safer with the FTC alleging that Alternative Cigarettes “falsely implied that smoking its herbal cigarettes did not pose the health risks associated with smoking tobacco cigarettes”.


• Jodie Bernstein, Director of the FTC’s Bureau of Consumer Protection, “These cigarettes are marketed with a ‘natural’ aura, but they’re neither healthy nor safe. The new disclosures should make it clear that herbal cigarettes and cigarettes without additives are not safe to smoke. The fact is, there’s no such thing as a safe smoke.“ 

There is a growing consumer recognition that herbal cigarettes are just as bad for health as normal tobacco cigarettes with a number of health focused websites setting out their position, such as Everyday Health which states:

“Herbal cigarettes are sometimes touted as a safe, non-addictive alternative to tobacco smoking. After all, herbal cigarettes contain no tobacco and therefore no nicotine, the drug in cigarettes that causes people to become addicted. Many people even smoke herbal cigarettes as an aid to stop smoking regular cigarettes. In fact, herbal cigarettes are as harmful as tobacco cigarettes, because any vegetable matter that’s burned produces tar, carbon monoxide, and other toxins. When you breathe in the smoke of an herbal cigarette, you’re breathing those harmful toxins directly into your lungs. Herbal cigarettes are required by the Federal Trade Commission (FTC) to carry warning labels saying that they’re harmful to your health”. ⁴⁹ (Link)

The American Cancer Society advises that:

“Even herbal cigarettes with no tobacco give off tar, particulates, and carbon monoxide and are dangerous to your health”. ⁵⁰ (Link)

The same trend holds true in other countries around the world. For example Tobacco in Australia states:

“Herbal and other non-tobacco cigarettes may erroneously be considered as a safer alternative to smoking, or an aid to quitting smoking, and are actively promoted as such by some manufacturers… Cigarettes that do not contain tobacco or nicotine may still produce toxic substances including carcinogens. A 2015 study assessing the safety of mainstream smoke from herbal cigarettes, compared with a generic tobacco cigarette, concluded that some harmful components—specifically, tar, carbon monoxide, benzo(α)pyrene, and phenolic compounds including hydroquinone, resorcinol and catechol—exist in the mainstream smoke of herbal cigarettes in large amounts similar to a tobacco cigarette. Although tobacco-specific components such as nicotine and nitrosamines were not detected, the study showed smoke condensates of herbal cigarettes have mutagenic potential similar to that of tobacco cigarettes arising from combustion of the product… A 2009 study conducted in China… concluding that herbal cigarettes did not deliver less carcinogens than regular cigarettes and that the Chinese tobacco industry should avoid misleading the public by promoting herbal cigarettes as safer products.”  ⁵¹ (Link)

In the EU, the Tobacco Products Directive came into force in May 2016 for all EU countries which bans promotional and misleading elements on herbal products for smoking and health warnings must cover 65% of the packaging. ⁵² (Link)

These governmental and regulatory positions sit at odds alongside the positive claims Zoetic makes on its website:

• “Are you looking for a way to kick your nicotine habit? Whether you chew tobacco or smoke cigarettes, our CBD products offer an alternative for you.  When you smoke our CBD pre rolls or chew our CBD pouches, you go through the same ritual as you do with tobacco, but you have organic herbs instead of the tobacco and nicotine.” ⁵³ (Link)


• “Tobacco controlling your life? Our hemp products offer the same opportunity to relax, without all the toxic chemicals that come with tobacco…”. ⁵⁴ (Link)


• “A Chill way to quit tobacco…” ⁵⁵ (Link)


• “Smoking can be a very addictive habit, yet most people know that it is not a very healthy one. However, hundreds of thousands of people still smoke tobacco all over the world. But what if we told you that there are new alternatives potentially healthier to smoking tobacco? What if we told you that hemp smokes could satisfy your cravings and may be good for your overall well-being? Yes, that’s right! Chill Hemp Smokes contain no tobacco or nicotine and approximately 100mg of CBD per pack for micro daily relief.” ⁵⁶ (Link)


• “While smoking anything can have negative effects on your lungs, there are certain products such as Chill CBD smokes that are all natural and made with only organic products. Even the paper is 100% natural hemp. There are never any additives or chemicals in Chill CBD smokes so you can smoke in peace and ease your mind. You should always keep in mind the side effects of smoking, but Chill CBD smokes are an excellent alternative to smoking cigarettes which contain carcinogens and many other harmful, toxic chemicals.” ⁵⁷ (Link)


• “Are you looking for an alternative to smoking cigarettes? Do you like the idea of smoking, but don’t want the nicotine and other harmful substances contained in cigarettes? Interested in trying CBD? Well, then The Chill Way has what you are looking for.”  ⁵⁸ (Link)


• “This means that when you smoke a Chill CBD pre roll, you are putting organic substances into your body rather than damaging carcinogens and substances such as nicotine.” ⁵⁹ (Link)

Furthermore, in what appears to be a blatant effort to mislead consumers over serious health issues, Zoetic then contradicts all its positive marketing messages about smoking its products by warning on their packets:

“Keep away from children. Not for sale to minors. There may be long term physical or mental health risks from use of hemp extract. Consult with physician for women who are or may become pregnant or are breastfeeding. Use of hemp extract may impair your ability to drive a car or operate machinery. Smoking causes lung cancer, heart disease, emphysema and may complicate pregnancy. Cutting smoking now reduces serious risk to your health”.

Further, the online disclaimer in the Shipping Policy states:

 “Smoking Warning – SURGEON GENERAL’S WARNING: Smoking Causes lung cancer, heart disease, emphysema, and may complicate pregnancy. Smoking by pregnant women may result in foetal injury, premature birth, and low birth weight. Cigarette smoke contains carbon monoxide. Quitting smoking now greatly reduces serious risk to your health. Zoetic (Chill) does not recommend smoking to anyone.”  ⁶⁰ (Link)

In my view there is a clear intent to portray to consumers that their products are safer and better alternative replacement to tobacco which, per above, the FTC categorically refutes. While it actively promotes the supposedly health benefits of its herbal leaves and CBD as a cessation aid in its consumer marketing messages, it subversively then warns that smoking is bad for consumer health and that “Zoetic does not recommend smoking to anyone”. These statements are contradictory and around the serious issue of human health.

However, critically, in making such ‘Modified Risk’ claims, it is likely to be in breach of FDA regulations. The point in case was an FDA warning letter sent to www.buy-sigarettes stating that the Center for Tobacco Products of the US FDA had reviewed its products and identified Modified Risk Tobacco Violations highlighting:

“A tobacco product is also considered a “modified risk tobacco product” under section 911(b)(2)(A)(i) of the FD&C Act (21 U.S.C. § 387k(b)(2)(A)(i)) if its label, labelling, or advertising explicitly or implicitly represents that (1) the product presents a lower risk of tobacco-related disease or is less harmful than one or more other commercially marketed tobacco products; (2) the product or its smoke contains a reduced level of a substance or presents a reduced exposure to a substance; or (3) the product or its smoke does not contain or is free of a substance. Under section 911(a) of the FD&C Act (21 U.S.C. § 387k(a)), no person may introduce or deliver for introduction into interstate commerce any modified risk tobacco product without an FDA order in effect under section 911(g) of the FD&C Act (21 U.S.C. § 387k(g)).“ ⁶¹ (Link)

The FDA has also taken to sending Warning Letters to 55 retailers for selling newly regulated tobacco products to minors. Convenience stores distributing Chill products therefore could come under the spotlight. ⁶² (Link)

The one thing that seems increasingly likely is more stringent regulation around Zoetic’s smokable products. For an indication as to where this can go, the very first information on Altria’s home page is a clear box stating “A Federal Court has ordered Altria to make these statements 1. Health effects of smoking 2. Addictiveness of smoking and nicotine…” ⁶³ (Link). In time I believe Zoetic may need to list all the health problems associated with its products on its home page and much more visibly on actual products vs hiding them in the disclaimer page.  Zoetic will increasingly have to comply and the critical issue for Zoetic, as a start up with a new unknown brand, limited capital and greater regulatory scrutiny, is how does it promote itself to consumers to create revenues against the ever stricter regulation around smoking.

In conclusion I believe:

• Zoetic Chill smokes do not carry the warnings about smoking that the FTC has imposed upon other herbal cigarette companies;


• Zoetic’s product is increasingly being recognised as harmful and dangerous to health as tobacco cigarettes which are in structural sales decline;


• Zoetic makes contradictory claims stating in its visible marketing materials that its products are ‘safe’, ‘potentially healthier’ and ‘do not contain the toxic chemicals’, they do not ‘contain harmful chemicals’, they may ‘offer benefits; and are a good way to ‘quit’…but in the hidden small print states that ‘there may be long term physical or mental health risks’, that ‘cutting smoking reduces serious risk to your health’ and ‘Zoetic does not recommend smoking to anyone’. This is misleading and exactly the kind of anti consumer behaviour that regulators target.


• Other companies making such Modified Risk claims that their products are better than tobacco have been warned by the FDA.
  
  Red flag – FDA strictly regulates smoking cessation products

Zoetic is making health and prevention of tobacco smoking disease claims about its CBD based products. For example it states on the ‘How to Quit Tobacco for Good’ webpage that:

“CBD may be just what you need.  The Chill Way offers a variety of products that can easily take the place of tobacco and give you the satisfaction of smoking or chewing without the harmful chemicals…if you are ready to turn your life around, then check out Chill CBD products and stop using tobacco today. You will get the same sensation of smoking and chewing, but will be filling your body with natural, organic herbs rather than harmful, toxic chemicals”. ⁶⁴ (Link)

It goes on to state under Smoking Cessation:

“Because herbal smokes are much better than tobacco, they can be used to quit tobacco. In many cases, the herbal smoke can eliminate the urge to smoke tobacco completely. Unfortunately, you will still experience nicotine withdrawal, but herbal smokes can help curb the cravings more quickly.” ⁶⁵ (Link)

On the ‘Best way to smoke CBD’ webpage it states:

“Smoking CBD is a great alternative to cigarettes because CBD has shown to have some important health benefits, whereas cigarettes are full of carcinogens and harmful chemicals… These pre rolls are excellent if you prefer the feeling of smoking a cigarette, but don’t want the nicotine and harmful chemicals. Chill CBD Smokes are one of the best options for smoking CBD as they are already rolled and packaged, don’t contain any harmful chemicals, and contain all organic, natural substances.”  ⁶⁶ (Link)

As discussed already, the FDA and FTC disagree that herbal cigarettes don’t contain any harmful chemicals and at the same time also regulate CBD and medical claims as new drug products. Health claims around a drug requires the FDA to investigate and ultimately approve it as a drug before it can be marketed or sold as such. The FDA lists several smoking cessation products which have all been through approval, none of which are smoking based. The FDA is taking this very seriously and has issued numerous Warning Letters to companies with unapproved new drugs. I believe Zoetic should not be making any reference to its products as being a smoking cessation aid nor healthy and not containing harmful substances. ⁶⁷ (Link)

Furthermore, Green Light Law points out:

“Section 911(a) of the Food, Drug, and Cosmetic Act (FD&C Act) prohibits the introduction into interstate commerce of any “Modified Risk Tobacco Product” (MRTP) without an FDA order in effect for that product. Section 911(b)(2)(A)(i) defines MRTP as “tobacco product if its label, labelling, or advertising explicitly or implicitly represents: (1) the product presents a lower risk of tobacco-related disease or is less harmful than one or more other commercially marketed tobacco products; (2) the product or its smoke contains a reduced level of a substance or presents a reduced exposure to a substance; or (3) the product or its smoke does not contain or is free of a substance.” The term MRTP includes Nicotine Replacement Therapy (NRT) products that are used to help existing tobacco smokers quit smoking or reduce their overall usage and there are products with and without nicotine approved by FDA. The classic example of an NRT is nicotine gum or patches.”

Green Light Law concludes:

“If you sell hemp products as a replacement for nicotine or tobacco use, you must submit a New Drug Application to CDER for approval as a smoking cessation product.” ⁶⁸ (Link)

The FDA, FTC and other regulatory bodies are now taking a very different view to CBD and smoking products. The FDA goes on to state:

“As we move forward, we are currently evaluating issuance of a risk-based enforcement policy that would provide greater transparency and clarity regarding factors the agency intends to take into account in prioritizing enforcement decisions.” ⁶⁹ (Link)

I believe that Zoetic’s claims are likely to see it fall under FDA and/or FTC scrutiny. The risks in my opinion are as follows:

1. Zoetic should not be advertising its Chill products as helping people stop smoking tobacco unless approved by the FDA.


2. The FDA or state regulators could require Zoetic’s smokable products to be stocked with all other smokable products behind the counter and out of sight. If consumers can’t see the Chill cigarettes, and they have little brand recognition yet, the impact on sales potential would be significant.


3. If seen as an unapproved new drug product, which falls under regulation of the FDA and FTC, Chill cigarettes and pouches will require pre-market approval. This a lengthy and costly multiyear process and would unlikely be granted until further evidence can be provided to substantiate its claims which itself could be years. Critically it would mean that Chill products cannot be sold until such approval and while the products are violating FDA regulation, Zoetic would be at risk from an enforcement letter and subsequent action.


4. Being a hemp product sold as a replacement to tobacco use, Zoetic should submit a New Drug Application to CDER;


5. Based on the FDA’s new approach focused on a risk-based enforcement policy around CBD and consumer protection, being in a dangerous smokable product, it is likely to be in a high-risk category.


6. As recently as the January 28th 2020 Zoetic stated “Early studies have linked CBD to many benefits, including the cessation of tobacco use, and it is on this ground that we continue to build the business”. This appears to be a type of medical claim that could put Zoetic at risk of action from the FDA and a risky area around which to build its business. ⁷⁰ (Link)

---

 

---

2. 
   

   US PRODUCTS: STATE REGULATORY ISSUES

   
   

The Federal regulatory bodies’ concerns around CBD and smoking alternative products is already starting to filter down to each of the 50 US states resulting in tighter regulation at the state level too. In particular the issues for Zoetic are:

• Many states have now banned hemp cigarettes sales outright


• Many states are imposing stricter hemp cigarette regulation around age, labelling and the requirement to remove product from sight


• States are imposing tobacco level taxes on hemp smokes
  Red flag – US states starting to scrutinise health aspects of tobacco alternatives

US states are also empowered to introduce their own laws to protect their consumers and, having enacted strict tobacco regulation, they have been getting increasingly active around the alternative smoking category where Zoetics products sit. For example:

• In 2019 Texas passed law through legislation specifically prohibiting the manufacture of hemp products intended for smoking or vaping and the Texas Department of State Health Services extended the ban from August 2020 to forbid the retail sale of any smokable hemp products. ⁷¹ (Link) 

• Elsewhere Louisiana, Iowa, Kentucky, Hawaii and Indiana have all banned inhalation based smokable hemp product sales. Iowa classifies possessing, using, manufacturing, marketing, transporting and distributing hemp meant for inhalation as a ‘serious misdemeanour’ punishable by fines and up to 1 year in jail. ^72 73 (Link 1, Link 2) 

• New York has just introduced strict measure to protect consumers, particularly minors, from herbal cigarettes (see below).

Law firm Harris Bricken produce the Hemp CBD Risk Matrix which now shows that smokable hemp is legal, technically legal, or at least not prohibited in only 27 states, while 8 states now prohibit or severely restrict smokable hemp. In the remaining 15 laws regarding smokable hemp remain unclear, complicated, or currently under legal dispute. ⁷⁴ (Link)

In Canada, the Canadian Lung Association states:

“The inhalation of smoke is harmful to lung health as the combustion of materials releases toxins and carcinogens. These are released regardless of the source – whether it is burning wood, tobacco or cannabis. Knowledge about the long-term effects of cannabis smoke is still limited but early research studies have demonstrated harm that can lead to chronic bronchitis”. It goes on to recommend the Government should “Regulate the advertising, sponsorship and promotion of cannabis. Products packaging should adhere to the same regulations as tobacco products”. ⁷⁵ (Link)

The risks for Zoetic are that a growing number of US states ban smokable hemp products or legislate that they can only be sold behind the counter and out of sight like tobacco. This will also have a serious knock-on impact on consumers’ attitude towards purchasing such products generally given the health implications, and the absence of nicotine which is the primary driver for consumers to purchase smokable products. Zoetic’s addressable market across the USA is likely to be shrinking not growing. While Zoetic reports nationwide distribution agreements across the USA, it fails to point out that its products will be restricted from being placed in thousands of stores in the states where hemp smokes are banned.

Red flag – US states recognising herbal smokes as a gateway to youth smoking

As non-tobacco alternatives can currently be displayed on the counter and do not have a 21-age restriction in many states, it is intuitive that cool named and flavoured smokes could prove to be a gateway product for young people to start smoking and then move up to more harmful tobacco products.

The Washington Times quotes Dr Anne O’Donnell, associate professor and chief of pulmonary critical care at Georgetown University Hospital as saying:

“Any smoking has the potential for medical problems and an addiction to the smoking itself… The physical act of smoking and starting on that path, especially as a child, would make someone more likely to pick up the habit [of smoking tobacco cigarettes”. ⁷⁶ (Link)

It is likely that in addition to stringent tobacco and vape regulation around gateway access for minors, that herbal cigarettes will increasingly come into the firing line globally. Unsurprisingly US states are starting to increasingly implement legislation to prevent the sale of herbal cigarettes to both minors and under 21s. Virginia lawmakers affirmed in February 2020 that it’s illegal for people aged under 21 to smoke hemp⁷⁷ (Link) and Tennessee banned the sale of smokable hemp to minors in 2019.⁷⁸ (Link)

On November 13th 2019 the New York State Public Health Law introduced the Adolescent Tobacco Use Prevention Act which in Article 13 1339 stating that 80% of smokers start smoking before the age of 21 and therefore:

“Sale of tobacco products or herbal cigarettes, rolling papers or pipes to minors is prohibited. Any person operating a place of business wherein… herbal cigarettes, liquid nicotine, shisha or electronic cigarettes, are sold or offered for sale is prohibited from selling such products, herbal cigarettes, liquid nicotine, shisha, electronic cigarettes or smoking paraphernalia to individuals under twenty-one years of age”.

“Keep all tobacco products, herbal cigarettes…and other vaping products behind a counter in an area accessible only to employees or in a locked container”. ⁷⁹ (Link)

“Do not use or accept ‘price reduction instruments (i.e. the acceptance of coupons, vouchers, rebates) and other means of charging less than a products listed price”.

Self-service displays are prohibited, and a 2002 New York State law made it illegal for common carriers such as FedEx®, UPS and DHL to ship cigarettes to New York addresses, except to an address licensed to sell cigarettes. The 2010 National Prevent All Cigarette Trafficking (PACT) Act prohibits delivery of cigarettes and smokeless tobacco through the U.S. Postal Service. These laws work to curtail the sale of cigarettes and other tobacco products over the internet, and require internet sellers to affix tax stamps and pay all federal, state, local or Tribal tobacco taxes. ⁸⁰ (Link)

Similar laws are starting to be enacted around the world such as Australia which states that the display of herbal cigarettes in retail outlets is banned. They must not be visible and “not on a counter where consumers are served and in a way that smoking products cannot be accessed by consumers”. ⁸¹ (Link)

In my view this demonstrates an increasingly global regulatory view that:

• Herbal cigarettes are not considered as safe


• They are perceived as a gateway product to tobacco smoking for minors


• Regulation of herbal cigarettes generally is moving towards full tobacco like regulation meaning herbal cigarettes will have to carry all the warnings and be stocked behind closed doors.

I believe there are immediate issues for Zoetic:

1. Mystery shopping has revealed that sales to young people seems to be a source of sales in its beta stores in Colorado. Mystery shopping several Schrader Oil convenience stores in Colorado selling Chill smokes, and in talking with the checkout employees, several stated that it was mostly university attendees that were buying the Chill brand. This is less surprising when the footprint of the Schrader stores is considered – many surrounding a Colorado University. 

2. Zoetic appears to be contravening state law with its interstate shipping of CBD based smokable products. When my associates went online to www.thechillway.com and ordered a pack of the Chill Mint smokes to a New York address, there were no questions directly asked about age needing to be 21 before selling the product. This sits uncomfortably against a statistic from T. Rowe Price showing that 18% of children from 8 to 14 were carrying credit cards as guests on their parents’ accounts in 2017.  ⁸² (Link) 

3. Furthermore, buried in its Terms and Conditions page Zoetic states “By agreeing to these Terms of Service, you represent that… you are the age of majority in your state or province of residence and you have given us your consent to allow any of your minor dependents to use this site”. Why is Zoetic providing language that allows minor dependents i.e. children to use a site that allows them to buy harmful flavoured smokable products that can be a gateway to tobacco smoking, in contravention of many state laws? ⁸³ (Link) 

4. When purchasing the Chill CBD smoke Mints I was offered a pop up that asks us to enter an email and “Join for 50% off your next order” with a quote saying “Sometimes later becomes never. Do it now”. Discounting the next purchase of herbal smoke contravenes New York state law which stipulates people should not use or accept price reduction instruments on cigarette  products. 

5. Zoetic is possibly contravening terms of its stated carriers like UPS, DHL and FedEx. UPS states that the Shipper must sign, agree to, and comply with all applicable federal, state, provincial or local laws and must be licenced to do so. UPS will not ship cigarettes direct to consumers regardless of the destination state and it requires the use of UPS Delivery Confirmation Adult Signature. ⁸⁴ (Link) FedEx includes “Hemp plants, hemp leaves, hemp oil, hemp seed oil and CBD derived from hemp” in their list of prohibited items. ⁸⁵ (Link) 

6. Zoetic’s visible display units at the point of sale counter could soon be banned in more states in the US and across Europe. Without a recognised brand consumer will not know to ask for a Chill product. 

7. Logistics for complying with all the differing regulation across the USA and Europe in terms of warnings on packs of herbal cigarettes will be extremely time consuming and expensive. For example, every state and every country will likely have different requirements. Slovakia, which is of relevance as you will see below, will likely have differing requirements than surrounding countries. Compliance, labelling and manufacturing for distribution into multiple different markets will be extremely challenging. ⁸⁶ (Link) 

1. Zoetic’s strategy of looking to sell tobacco alternative products online may come under greater scrutiny given the potential loopholes vs the strict in store policies that states are increasingly putting in place.
   
   Red flag – CBD hemp and herbal smokes to be taxed like tobacco

As regulators and states wake up to the fact that that herbal and hemp-based smokes are as potentially harmful as tobacco cigarettes, as well as a possible gateway for minors to tobacco smoking, new laws are being brought in the tax these products punitively to deter purchases both at the Federal and state level.

In Europe, smokable hemp is already banned outright in the UK and France, and tougher stances are being enacted elsewhere. For example, the Government of Belgium’s Federal Public Service Finance signed a decree in April 2019 stating “the products destined to be smoked and in which the THC content is inferior to 0.2% are considered as tobacco products and will therefore be taxed as such”. This imposes a retail tax change of 25% and also requires then to comply with tobacco retailing laws such as being hidden behind the counter. ⁸⁷ (Link)

It seems apparent that around Europe the product will either remain prohibited or punitively taxed. I believe Zoetic’s margins and product sales will be significantly impacted as taxes rise, as was the case with all the tobacco companies.

Red flag – Some US states imposing stricter content and labelling laws on inhalable products

Driven by the 2019 e-cigarette vape crisis in the US that caused dozens of deaths and thousands of people to be hospitalised from lung illness, states are starting to take a far stricter stance on any products that are inhaled to the lungs. Recent actions include:

• In December 2020 the Oregon Liquor Control Commission adopted new regulations requiring companies to disclose more detailed information about ingredients in their inhalable products and banning certain chemicals which will become effective April 2021. ⁸⁸ (Link) 

• Effective January 3rd, 2021 California is mandating new health warnings for all cannabis related products sold. The intent is to warn consumers of the possible health impact of cannabis smoke. This includes publishing a list of all chemicals known to cause cancer of birth defects and label warnings on all products that contain the chemicals. ⁸⁹ (Link)

The article also notes that the “mandate will likely create a wave of new product liability lawsuits targeting marijuana and hemp companies” which could have an even larger impact on Zoetic.

On the basis that the FDA and FTC have already cited that herbal cigarettes are” dangerous to your health…they contain tar and carbon monoxide”, I believe that it is likely that herbal cigarettes will be caught up in all these new state regulatory moves to protect the health of consumers. This could be particularly damaging for the Chill cigarette revenue potential and will add significant costs associated with compliance and monitoring going forward.

A point in case was the FTC’s Decision and Order Letter to a herbal cigarette company called Alternative Cigarettes Inc requiring it within 45 days “after the date of service of this order, an exact copy of the notice attached hereto as Attachment A to each retailer, distributor, or other purchaser for resale to whom respondents have supplied Pure or Glory tobacco cigarettes, or Herbal Gold or Magic herbal cigarettes, since January 1, 1998” requiring such retailers, distributors or purchasers for resale to cease using or disseminating misleading advertising related to the health benefits of the alternative cigarettes. ⁹⁰ (Link)

The Order went on to mandate that:

“IT IS FURTHER ORDERED that respondent Alternative Cigarettes, Inc., and its successors and assigns, and respondent Joseph Pandolfino shall deliver a copy of this order to all current and future principals, officers, directors, and managers, and to all current and future employees, agents, and representatives having responsibilities with respect to the subject matter of this order, and shall secure from each such person a signed and dated statement acknowledging receipt of the order”.

Were this to be the case for Zoetic, this in turn would potentially become an issue for the UK and USA  exchanges on which it is listed. It goes on to say:

“IT IS FURTHER ORDERED that respondent Joseph Pandolfino, for a period of ten (10) years after the date of issuance of this order, shall notify the Commission of the discontinuance of his current business or employment, or of his affiliation with any new business or employment”.

Once a company or person falls foul of the FTC laws, they remain on their radar for 10 years.

---

3. 
   

   US PRODUCTS: COMPANY SPECIFIC REGULATORY ISSUES

   
   

Aside from the looming Federal and state level regulatory scrutiny which will make trying to build a new brand from scratch much more complex, expensive and risky, the Zoetic Chill brand also has numerous company specific issues.

Red flag – A limited number of products and innovation

Going to the website reveals just three products of a chew pouch (3 flavour SKUs of mint, peach and vanilla), one packet of hemp smokes and two herbal based smokes (one normal called Calm one mint flavoured).

• This is an extremely limited set of products from which to try to drive any meaningful revenues to support a large valuation;


• These were the same SKUs at launch into 18 stores in Colorado in April 2019 suggesting that there has been no product innovation or expansion in the last 18 months. ⁹¹ (Link)

Other listed CBD brand businesses, with significantly more revenues yet much lowlier valued, often have hundreds of SKUs and ongoing brand innovation, R&D and formulation programmes. Without that, it’s difficult to generate meaningful revenues, pivot to new products in demand in the rapidly changing consumer landscape and to compete against other very similar products.

Red flag – Product mislabelling in Colorado

The 2018 Colorado House Bill established that hemp products must comply with Colorado’s Food and Drug Act which imposes certain labelling requirements around hemp products. The product label must clearly identify hemp as an ingredient and if there is CBD, the amount of CBD and whether it is an isolate.

The Chill cigarette packets are already in breach of Colorado state regulation as they do not state that the ingredient is CBD isolate.

Furthermore, each state will have their own requirements across a whole host of differing local laws and labelling to remain compliant, which will present Zoetic with significant logistical and packaging issues to be considered and it is already in breach in its home state of Colorado.

Red flag – No evidence for use as a smoking cessation aid yet evidence of harm exists

The Chill brand is being built around the message that CBD smokes and chew pouches are safer and a way to help people stop smoking. Zoetic says that it believes that “CBD may play a rapidly increasing role in smoking cessation aids, and that its Chill branded tobacco-free, THC-free and nicotine-free products are well-placed to take an increasing share of this market… It is the Board’s intention to focus the Company on non-nicotine smoking cessation products as part of its portfolio of CBD products”. ⁹² (Link)

However, the primary reason people smoke tobacco-based cigarettes is owing to nicotine addiction. The American Cancer society state “Nicotine is the known addictive substance in tobacco. Regular use of tobacco products leads to addiction in many users. Nicotine is a drug that occurs naturally in tobacco and it’s thought to be as addictive as heroin or cocaine”. ⁹³ (Link)

I do not believe Zoetic has conducted any clinical research to prove these claims and therefore no such claims can be made in the marketing message. Clinical research to prove those claims would be expensive and take years to undertake. As such, the Chill claims are simply hearsay and the FDA is on a clear path to prevent such products and marketing messages. Nevertheless, on the Chill website home page (www.thechillway.com) states “A chill way to quit tobacco…”. 

The British government website published a document discussing herbal cigarettes as a way to stop smoking stating:

“Although herbal cigarettes are sometimes perceived as safer because they do not contain tobacco or nicotine, they produce the same toxins as a traditional cigarette; for example carbon monoxide and tar. Smoking herbal cigarettes is also unlikely to be an effective way to stop smoking as they do not help deal with nicotine withdrawal. A further concern is that children are attracted to herbal cigarettes because, as they do not contain tobacco, by law they are not required to carry health warnings. What is more there is no age restriction…meaning they can be purchased by anyone under the age of 18…. there is no such thing as a safe cigarette.” ⁹⁴ (Link)

On the US FDA website it has a page called Want to Quit Smoking – FDA Approved Products Can Help. There is no mention at all of CBD infused herbal or hemp cigarettes. ⁹⁵ (Link)

In Europe, researchers from the University of Vienna found that nontobacco cigarettes produced a level of carbon monoxide similar to that of tobacco cigarettes and concluded that they a “potential health hazard” prompting BBC News to state:

“Herbal cigarettes designed as an aid to quit smoking are a potential health hazard themselves researchers have warned”. The Chairman of the British Lung Foundation summed up “If you are burning herbal cigarettes, all you are doing is substituting the burning leaves of one sort of a plant for another. A lot of people try herbal cigarettes because they think that as they don’t contain nicotine they are safer. In fact they are giving up the one bit of tobacco that doesn’t do you much harm. Nicotine is addictive but it’s the other stuff that gives you lung cancer and emphysema”. Action of Smoking and Health state that using herbal cigarettes in unlikely to be an effective way to give up smoking “Herbal cigarettes contain all the nasty chemicals in cigarettes, but they do not provide any help in dealing with nicotine addiction”. ⁹⁶ (Link)

As a final point, if indeed in time CBD is proven to help people to quit nicotine dependence, then I believe there will be a significant number of safer and FDA regulated ways for people to intake CBD as opposed to smoking it in another inhalable cigarette product which is as dangerous as the tobacco product that people are trying to get away from for health reasons.

In short, Chill products are marketed as smoking cessation aids but the smokable products are still fundamentally unhealthy and have not been authorised as being able to be marketed as smoking cessation products.

Red flag – Flavoured smokes products designed to attract younger people

The purpose of the FDA requiring smokable products to be stored behind the counter in closed doors is to deter both adults and children alike. Children in particular are susceptible to ‘cool smoke products’ and especially if flavoured. In its September 2020 update Zoetic in fact points out the “the regulation of tobacco based menthol cigarettes which are now banned in Brazil, Canada…the European Union and the UK” ⁹⁷ (Link). That is because they are inherently unhealthy, but then so is smoking herbal cigarettes. The FDA banned clove and all fruit flavoured cigarettes in 2009 to reduce teen smoking in the USA stating “These flavoured cigarettes are a gateway for many children and young adults to become regular smokers”  ⁹⁸ (Link). Zoetic only has three smoke SKUs with one being CBD Smokes Mint. Flavoured products in tobacco and vapes are already under regulatory scrutiny and being banned and the same will likely hold true for any smokable flavoured products, its just that flavoured herbal smokes is such a small market that it hasn’t likely yet drawn attention like tobacco. As Zoetic distributes its CBD Smoke Mint packs across the USA it could quickly draw regulatory scrutiny on their Mint flavoured smokes as a gateway for young people into smoking.

To this point I note that in July 2020, the Colorado Department of Law (Colorado is where Chill is primarily distributed currently) launched a case to sue Juul citing that:

• it targeted young smokers (Zoetic can sell to under 21s)


• with attractive flavours (Zoetic sells Mint) and designs (see Chill name and face in sunglasses depicting coolness)


• pitching Juul as a smoking cessation product (the exact marketing strategy of Chill). ⁹⁹ (Link)

Chill appears to be squarely in the sights of the kind of products that regulators are clamping down on and law makers are starting to sue.

Red flag – A rise in class action lawsuits against CBD companies

Law firm Goodwin Law warns that hemp derived CBD companies are increasingly facing class action litigation claims by both consumers and investors driven by product claims, regulatory uncertainly and preventable mistakes by companies themselves. It notes that the primary cause of claims are when shareholders look to recover investment losses after a company’s stock price drops following corporate disclosures. Plaintiffs asset claims are based on allegedly false and misleading statements made by the company and its officers. Dating back to the beginning of 2018, there have been 19 securities class actions filed against companies in U.S. federal courts against publicly traded companies operating in the cannabis or CBD sector. ¹⁰⁰ (Link)

Zoetic’s stock is up 2359% since March which puts it in the firing line considering the assessment of:

• Misleading product claims – e.g. that herbal and hemp cigarettes infused with CBD can act as a smoking cessation product where there is no evidence.


• Regulatory uncertainty – e.g. the FDA considers making therapeutic claims around CBD to be a regulated business needing authorisation first before any product can be sold so current product in the market may be being sold in violation of FDA regulation.


• Preventable mistakes by the company – e.g. having a website making inaccurate and outdated claims about the business being vertically integrated and that it grows hemp indoors and outdoors in Western Colorado; or online product marketing saying cigarettes are hand crafted using organic plant from Colorado (they are not); or provided financial metrics from beta store trials about gross margins (when staff are being paid separately to push the products), number of stores stocking (e.g. European distribution agreements where apparently “The Agreement will see the Company’s premium CBD offering reach consumers in over 15 markets across the European Union, with thousands of stores making preparations to stock the Chill range…”; or that beta store sales were ahead of expectations and sales increasing month on month, yet in January 2021 Zoetic then announces that in fact all reported sales were 100% from online suggesting no instore sales.

Zoetic Investors purchasing Zoetic shares on the LSE and OTC exchanges over the past year during the strategy pivot could well have done so based off some of the company assertations listed above. Accordingly, I believe there is a risk that investors could feel they were misled and that could be the basis for class action lawsuits, both in the USA and the UK.

Red flag – PRODUCT liability claims and a question of insurance

In Zoetic’s Annual Report for year end to March 2020 it claims one of the risks facing the group is ‘Product Liability’ stating:

“The Group’s products will be produced for sale directly to end consumers, and therefore there is an inherent risk of exposure to product liability claims, regulatory action and litigation if the products are alleged to have caused loss or injury. Accordingly the Group maintains a product liability insurance policy”. ¹⁰¹ (Link)

As established above, given the FDA and FTC consider herbal cigarettes no safer than tobacco/nicotine cigarettes and have already forced Herbal Gold to state on its packets that smoking herbal cigarettes are dangerous to consumer’s health, the risks to litigious claims from selling unhealthy products to people in the US are high. As the Chill product doesn’t have a 21-age limit, Zoetic can sell what is deemed to be a dangerous product by regulatory bodies to 18 to 20 year olds. This business model carries a wide variety of risks.

The major tobacco companies have all been embroiled in health-related litigation costing them hundreds of billions of dollars. Individual litigation awards have run into $10s of millions. Recently litigation has now moved into the vape sector with Juul now facing claims mostly brought by parents of teenagers who claim lung damage and seizures.

The issue for Zoewtic may be threefold:

1. Litigation from US consumers at some point given that regulators believe that combustible herbal cigarette products are “neither healthy nor safe”;


2. Has Zoetic, with limited capital, taken out sufficient insurance coverage against such a high-risk business where large claims are regular?


3. History suggests that insurance claims are generally not covered if sales are derived from products violating FDA regulation.

Litigation cases where companies are not sufficiently covered has driven many companies into bankruptcy.

Red flag – Herbs vs hemp leaf demand small in USA

Market research firm Nielsen projected the smokable hemp market will reach $70-80 million in 2020, which includes categories such as loose CBD flower, hemp-CBD pre-rolls, cigars and other inhalable products. Zoetic’s market cap is currently more than twice the size of the entire US market.

So, Chill smokable products can only compete for a share of that spend in:

• Pre-rolls (Zoetic does not supply loose flower or inhalables)


• Convenience stores (Zoetic products are not sold in supermarkets, dispensaries and other traditional purchase points)

If the entire addressable market share of spend on pre-rolls in convenience stores was 10% of the $70-80 million total market, then Chill’s addressable market in 2020 was just $7-8 million nationally. If it could take 10% share of all hemp cigarette brands, then its revenue potential would be $700,000 to $800,000. Chill only has one hemp smoke SKU and was effectively only sold in Colorado in 2020, therefore taking a 10% share seems extremely unrealistic. Additionally, the herbal smoke market is likely to be therefore even smaller.

There is a risk that retail investors, in driving Zoetic’s market capitalisation to £147 million, in the absence of guidance, are materially overestimating the revenue potential of a brand with 3 SKUs in a competitive and small market, even if it was to be able to successfully build the brand out nationally. The early evidence suggests this to be the case given that total 12 month sales to September 2020 were just £81,000.

Red flag – Unfounded uniqueness claims in alternative smokes

Zoetic makes claims about the uniqueness of its smoke products in a 29th May 2020 update “The Company is not aware of any other tobacco-free, THC-free, nicotine and nicotine/CBD containing products in the market”.

However, a simple Google search reveals that there are many companies offering CBD containing tobacco/nicotine free smokes with low or no THC ¹⁰² (Link).

• Blaz


• Colorado Gold


• Sativa


• Redwood Reserve


• Chief Stix


• Toast Emerald


• Aspen Valley


• Hemp Zone


• Lucky Leaf


• Plain Jane


• Tillmans


• Wild Hemp

In my view fact there is little to differentiate the Chill smokes brand or product from an extremely crowded market of alternative CBD smoke suppliers, many of whom have been around for decades and have already built brands. There is limited shelf space and inevitably competition will quickly bring down margins.

Furthermore, I believe being ‘THC free’ is not really relevant to consumers as all CBD products across the USA have to contain less than 0.3% THC as dictated by the 2018 Farm Bill Act. Zoetic seems to play up THC free as regulation in the UK means that without a Home Office licence (which Zoetic does not have) then a company operating or listed in the UK may not generate any revenues from any products that contain any THC traces, even at 0.3%. However, consumers of alternative smokes are extremely unlikely to care whether herbal or hemp leaves contain 0% or 0.3% THC so the Chill differentiation to multiple other brands in the eyes of consumers is in reality negligible.

Red flag – Consumers are moving away from smokable CBD products for health reasons

Zoetic’s strategy presents a paradox. Part of the equity story is based around the fact it operates in the fast-growing CBD space. However, the CBD growth story is based around the health aspects of CBD molecules. Thousands of wellness brands and products have emerged to tap into the health aspects of the product. However, there are multiple issues around smokable products. Zoetic’s Chill smokes strategy is based around offering people access to the health benefits of CBD (still being disputed by the FDA), yet via an unhealthy delivery method of smoking.  

The recognition that smoking generally is unhealthy regardless of the type of leaf being smoked has seen a huge shift away from smoking combustible leaves to other consumption methods for their intake of CBD such as vaping, edibles, tinctures, patches etc.

The switch away from smoking as a method of cannabidiol intake is likely to be accelerated further by Covid. A July 2020 survey by TVape reported revealed that consumers “are also shifting towards vaporizer use and away from combustion…attributed the shift to concerns over their lung health”. Incredibly the survey found that the number of people who predominantly smoked fell from 16.67% to just 6.11% in 2020 amid Covid fears. ¹⁰³ (Link)

Zoetic’s products are inherently in the unhealthiest segment of the delivery routes and the market will almost certainly continue to see a secular shift by consumers in a post Covid era away from smokes as a desirable way of consuming CBD, towards other products, even without the interreference of the FDA and other regulatory bodies. If just 6% of consumers choose to take CBD via smoking, and Zoetic operates in a niche segment of herbal smokes, with its product in only a fraction of possible retail outlets, the ability to generate any sort of meaningful revenues must be limited.

Red flag – Manufacturing scaling issues and FDA compliance requirements

If the promised demand for Zoetic’s products does materialise ( and I think that most unlikely), it will have to scale its outsourced manufacturing capability significantly. Scaling, particularly on a global basis, is extremely difficult and fraught with risk. Indeed, I note that in the September 2020 trading update Zoetic stated “Following significant demand for its Chill brand products, Zoetic is pleased to have restocked its range of tobacco alternative CBD smokes online. With hemp, calm and mint varieties now back in stock…”. This suggests that Zoetic is already struggling to manage its inventory supply even at the current very low levels of demand as indicated by its limited financials. ¹⁰⁴ (Link)

The company states that it is exploring its manufacturing options but provides little details as to the companies it is working with, its ability to scale or indeed its costs. Furthermore, managing international manufacturing capabilities or trying or import CBD smoke products from the USA to European countries is likely to present significant barrier and regulatory hurdles given concerns around CBD products.

A particular problem for volume manufacturing is around labelling issues. Increasingly states around the US and each European country are bringing in their own rules around package labelling requirements and what can, can’t and must be stated on cigarette packages. This will involve significant legal advice and then printing complexity for its products being distributed to 50 states in the USA (minus the states where they are already banned) and 15+ countries around Europe. I would question whether Zoetic is resourced and funded to maintain strict compliance and the logistical headache this will present for a start-up. Again, this further highlights the issues around the smoking space that Zoetic has decided to pursue as its strategy vs other CBD companies that chose to operate in far less regulated products.

Furthermore, if the FDA considered Zoetic’s products as unapproved drugs, then it will also scrutinise the manufacturing processes and facilities to the same level that it would expect drugs to be produced to. In a recent warning letter sent to Herbal Doctor Remedies the FDA stated:

 “…because your methods, facilities, or controls for manufacturing, processing, packing, or holding do not conform to CGMP, your drug products are adulterated within the meaning of section 501(a)(2)(B) of the FD&C Act, 21 U.S.C. 351(a)(2)(B)…. You have manufactured, prepared, propagated, compounded, or processed drugs that were being offered for commercial distribution in the United States while your drug manufacturing facility, Herbal Doctor Remedies at 497 Cumbre Street, Monterey Park, California, was not an FDA registered establishment”. ¹⁰⁵ (Link)

It would appear unlikely that the current manufacturers of the Zoetic Chill range, in spraying CBD into products that are being marketed as having medical benefits, are aware that:

1. they are creating a product that the FDA considers an unapproved drug; and


2. their facilities must be CGMP standard FDA registered establishments with obligations under section 510 of the FD&C Act with failure to do so prohibited under Section 301(p), 21 U.S.C 260 and 331(p). Without this all drugs manufactured are misbranded under Section 502° of the FD&C Act.

Guidance for contract manufacture of drugs is extremely strict and onerous. ¹⁰⁶ (Link)

Red flag – Questions around a strategy of bespoke display cases

Zoetic believes that by showcasing its CBD smokes in display cases on the point-of-sale counter, it will increase brand awareness and opportunistic purchases. It claimed in the February 2020 trading update:

“Moving forward, the Company is introducing display cases which hold 48 of its products.  These are typically placed on the sales counter and, by increasing brand awareness, management estimates that the introduction of these cases could potentially double daily sales given the prominence they give to the Chill brand and products.” ¹⁰⁷ (Link)

I believe there are multiple issues here:

1. As with all retail, the counter is a premium space that is often expensive to secure given the competition.


2. Trying to roll out display cases to thousands of stores across the USA will also require material capex and Zoetic currently only has £450,000 cash, if that. There is also no certainty that stores will take the cases or indeed what they will charge Zoetic to put them in.


3. Display cases for smokable products are now being banned in many states and in fact herbal cigarettes are increasingly being regulated like tobacco in that they will have to be stored behind the counter in a closed box so there will be no brand recognition or impulse purchases.

Contrary to Chill products becoming increasingly visible via display cases and on store shelves, I believe they are likely to become increasingly invisible behind the counter. That would be a major problem for a company with no existing brand or funds to advertise to create a brand. Consumers walking into a convenience store will have to know and recall the Chill brand or they simply won’t know that its stocked there to ask for it.

Red flag – Headwinds to building a consumer brand in the cigarette category

It will be extremely hard for Zoetic to create a well-known brand around Chill. Issues will include:

• Inability to market it as a smoking cessation product (FDA violation) which nullifies the primary marketing objectives of the Chill products and makes it extremely hard to build a brand if you can’t tell consumers the reason to purchase your product.


• Growing need to put health warnings on the cigarette packaging – any possible health benefit of CBD will be outweighed by being forced to tell people that the smokable product is unhealthy and harmful. It is only consumers addiction to nicotine that allows them to look past this issue with tobacco.


• The growing requirement forcing herbal cigarettes be stocked behind closed doors so unless consumers specifically ask for the Chill smokes, there won’t make any impulse sales.


• Lack of capital to spend on marketing the brand generally. The cost of building a cigarette brand in a crowded market will be an extremely expensive upfront cost that Zoetic just does not have the capital for or, will be very dilutive to shareholders if it needs to be raised through stock issuance.

Currently (as of 27th January 2021) the Chill Way Twitter account has 162 followers and 487 on Instagram which makes it almost irrelevant and shows there is no ‘cult’ brand being built even at the smallest level in Colorado after a year and a half of being in the market.

---

4. 
   

   US PRODUCTS: DISTRIBUTION DEAL ISSUES

   
   

With cultivation, extraction and manufacturing all outsourced now, the revenue growth potential of Zoetic is heavily dependent on retail store distribution deals that it can put in place. A number of such deals have been announced but in each case no metrics or guidance are provided.

MAJOR Red flag – Bonus payments in Schrader Oil beta stores & destocking

Zoetic’s only distribution deal of note prior to September 2020 was with Schrader Oil/Ox Distributing, billed as its beta store test. On April 1st, 2019 Zoetic signed a 2 year distribution deal for its CBD products to go into their 18 convenience stores. However, even though Schrader Oil owns 12% of Zoetic and would therefore be highly incentivised to proactively market hard to ensure strong sales, Zoetic recently announced in January 2021 that it has achieved zero in store sales in the six months to September 2020 which I struggle to tally with prior comments about the success they were having in the beta stores.

When my comrades mystery shopped several Schrader Oil stores, in talking to store employees they were informed that they get paid a bonus for pushing the Chill brand onto consumers. I am not sure whether Zoetic or Schrader is paying this staff bonus commission, but it would seem logical that any other store owners around the USA, which do not own Zoetic shares, are highly unlikely to pay staff a bonus specific to selling Chill products vs thousands of others in their stores. As such the stated beta KPIs of 2-3 packs a store a day (slide 8 of presentation in link below) are likely to be highly misleading when extrapolated to stores outside the 18 strong Schrader networks. ¹⁰⁸ (Link)

With the Schrader Oil stake in Zoetic now worth £17.6 million, it is likely to be more valuable than its entire 18 store portfolio. My belief is that this bonus scheme could be in place so Zoetic’s management can report strong beta results of 2-3 packs a day to investors. However, given the beta KPIs in store are all that they have guided on, I believe that this special bonus scheme should have been disclosed as it is relevant to statements made such as in the March 2020 year end trading update where Zoetic states:

“The Directors of the company are pleased to report that the consumer reaction to the Company’s Chill branded products has exceeded their expectations; in stores where Chill has been on sale for several months, they have experienced consistent increased sales month on month”. ¹⁰⁹ (Link)

Furthermore, Zoetic also states a margin of 50% on packs, but I do not know if these bonus payments have been included in calculating that margin. If Zoetic product marketing is being subsidised by payments from Schrader Oil to its employees, then that should also be disclosed as it will have an impact on the real margin as well as the pack sales numbers. 

Nevertheless, despite this statement above in March year end results, in the recently reported September 2020 interim results, Zoetic states that “The Period only saw limited initial sales of our CBD products as we were seeing online only, and the physical store roll out had not yet begun”.

This guidance that sales to September 2020 were 100% online is perplexing. Prior guidance has been that the 18 stores should have been selling 3 packs a day between March and September 2020 and wholesale prices are 50% of retail of $10, i.e. $5/pack. As such, on that basis during the March to September period the Schrader beta trial should have generated 18 stores x 3 packs x 182 days x $5 wholesale= $49,000 of revenue.

The online only comment also does not tally with the March 2020 year end trading update or the February 02, 2020 trading update that stated “The Company’s realistic objective is to supply around 500 new stores per month, subject to customer demand and manufacturing constraints, and so management estimate that it is likely to take up to two years for products to be rolled out across the entire network [12,000 stores]” and, per above, that in Schrader stores sales were increasing month on month. ¹¹⁰ (Link)

Finally, I note that in November 2020 EG Group acquired the Schrader Oil chain of 18 stores and they are being rebranded Loaf N Jug. Under new ownership this bonus scheme to drive sales of the Chill brand is likely to be ended as EG Group does not have any incentive to try to drive sales of that brand out of the hundreds on sale without the added incentive of Zoetic equity. To test this theory, in subsequent visits to the stores in December 2020 and January 2021 I was advised by staff in several of the shops that in fact, under the new owners, the Chill brand was being de stocked and is being replaced by a new CBD brand called Solari Hemp. (Read reports Loaf n Jug has another brand going in)

Red flag – AATAC distribution deal lack of transparency or uniqueness

Much of the dramatic share price performance in H2  2020 seems to have been driven by expectation around a deal with Asian American Trade Association Council (AATAC) with the 24th November 2020  announcement stating “This transformational deal will facilitate the introduction and recommendation of the Company and its products to over 88,000 AATAC partners and will pave the way for the Company’s Chill brand to be sold from eye-catching new point of sale display stands at high footfall convenience stores, gas stations and corner stores in all US states”. ¹¹¹ (Link)

However I see several critical issues behind the headline announcement:

1. Actual stores numbers that will stock Chill? – The AATAC lists thousands of products in its brochures for its 88,000-distribution network of convenience stores to select from. The ultimate purchase decision typically lies with the store owner. There is no guarantee any stores will order Chill products. Promoting the brand will require traditional marketing spend which the company currently lacks, and an effort from AATAC salespeople which themselves need training and incentivising which does not appear to be the deal Zoetic has struck. 

2. Favoured products – AATAC has a preferred vendors area for cigarettes and smoking products but Chill does not feature. ¹¹² (Link) 

3. Margins – The retail bulletin board discussions are factoring in margins of 50% in line with the following statement from February 2020 trading update “Retail prices for both products will remain in the sub-US$10 range and Zoetic will sell to the distributors at around half of that price.  Depending on volumes, the Company expects to earn around a 50% gross margin”. While that may be the margin, it got through a handful of independent Schrader Oil stores, AATAC are likely to be significantly more expensive for providing distribution as that’s its business model. While I don’t know the details of the deal done, I believe it is highly likely that the net margins to Zoetic will be significantly lower than in the beta stores in Colorado. ¹¹³ (Link)

Critically, even spending significant sums training and marketing around the AATAC agreement is no guarantee of success. Indeed, my research has found that distribution deals for CBD products via the AATAC are not unique at all and in most cases seems to have little impact of the companies’ financial performance post agreement.  

1. Harvest Health & Recreational (CSE: HARV)

• In June 2019 Harvest Health & Recreational, a CSE listed cannabis company with a market cap of US$780 million and $100 million cash on the balance sheet, also announced a deal with AATAC to sell its wide range of its CBD brand products. The company stated “This exclusive partnership enables a massive advance in distribution for Harvest-owned CBD brands and follows our strategic path of expanding the scale of our wholesale and retail distribution nationally. Demand for CBD is unprecedented and delivering leading products in 10,000 accessible locations gives us an unparalleled reach to consumers”. ¹¹⁴ (Link)


• The partnership included extensive training for store employees, in store shelf space and marketing promotions. I.e. a much more significant deal than Zoetic. Within 6 months Harvest terminated the relationship citing that it was uneconomical. This strongly suggests that once AATAC fees are included, margins on once profitable products are quickly eroded.  

 

2. Isodiol (CSE: ISOL)

• In February 2019 another CBD listed company called Isodiol International signed a distribution agreement with AATAC for multiple CBD SKUs distribution paying an ‘undisclosed sum’ stating “ Isodiol today announced the launch of its convenience store (C-Store) retail program into the first 1,250 locations, starting in markets such as Florida and Arizona, through its partnership with the Asian American Trade Associations Council (AATAC).  Once the initial test rolls out and is approved for expansion by AATAC, Isodiol will be able to expand up to 10,000 additional locations.” ¹¹⁵ (Link)


• The relationship seems to have had no material impact on revenues over the past 18 months and Isodiol trades at a $1.6 million market cap.

 

3. Vertical Wellness (private)

• In November 2018 Vertical partnered with AATAC to launch Instant CBD Strips products across the AATAC network.


• Since that date I can’t find any further information on the partnership or related announcements. In a December 2020 presentation under ‘Company Highlights’ it references a national distribution contract with Southern Glazers with a reach of 600,000 outlets and under the Multiple Distribution Channels page it lists lots of partners, but there is no mention of AATAC at all in the presentation. ¹¹⁶ (Link)

 

4. Zen Drops (private)

• A private company selling CBD gummies and tinctures that are organic and THC free did a deal with AATAC for distribution. ¹¹⁷ (Link)


• No further news, releases or mention of the relationship can be found on Google.

 

5. Better Choice Company (OTCQB:BBTR)

• The animal health and wellness CBD company in June 2019 announced it has signed an “agreement through a TruDog Implementation Program (TIP) Entity to supply the Asian American Trade Associations Council (“AATAC”) network of stores and retailers, one of the country’s largest trade associations for independent convenience stores and gas stations, its pet CBD products in thousands of retail locations across the U.S…Better Choice’s line of products is expected to arrive in stores across the country in the summer of 2019 and may expand to 30,000 locations by the end of the year. Additionally, the agreement will include training for store clerks and associates, an educational campaign about CBD and other cannabinoids and in-store dedicated shelf space and marketing promotions”. ¹¹⁸ (Link)


• The current market cap is $48 million having recently raised $21.7 million in October 2020 so the Enterprise Value is $26 million. No further reference to the AATAC deal can be found in searches or their quarterly releases.

 

6. Earth Science Tech (OTC:ETST)

• ETST focuses on CBD, nutraceutical and pharmaceutical products with CBD hemp grown in Oregon. In June 2018 the company announced that it had signed an “agreement to work collectively with AATAC to present the “ETST” product like to their vast network of approximately 90,000 retail outlets throughout the U.S…AATAC will be the Company’s High Grade Full Spectrum Cannabinoids line within its 90,000 outlets reach. Coupled with the growing consumer interest in the category and positive feedback received from their network, AATAC anticipates a high volume of pre orders once an official release date is set…. This could lead to huge exponential growth for ETST’s sales in the next few months”. ¹¹⁹ (Link)


• Revenues for the full year to March 2020 some 18 months later were $526,000 and the current market capitalisation of ETST is $2 million.

 

7. Kona Gold Solutions (OTC:KGKG)

• A hemp lifestyle brand focused on product development in the functional beverage sector with partnerships with over 60 distributors in 36 states. In January 2018 it announced it had partnered with the AATAC for its CBD energy waters. The AATAC stated “Kona Gold produces innovative products at the intersection of two categories: the proven energy drink market and emerging hemp-based offerings.  We are excited about the consumer reception of Kona Gold hemp energy drinks and Highdrate CBD energy water in our network stores.” ¹²⁰ (Link)


• Two years later full year 2019 revenues were just $1.6 million and no further reference can be found to the AATAC relationship despite the CEO letter referencing multiple other distribution deals. The market capitalisation is $20 million. ¹²¹ (Link)

 

8. NewLeaf Brands Inc (CSE:NLB)

• A health and wellness CBD company announced a deal with New Implementation Programme (NIP) in September 2019 to provide distribution services and sales of NLB’s CBD branded products to NIPs vast community of operators, partners, retailers and distributors in the USA for an initial 10,000 retail locations. NIP is an entity of the Association Partners Organisation and the AATAC, both national trade associations. The CEO commented “We couldn’t be more ecstatic about striking this deal with the C-Store powerhouse of AP who reaches groups like the AATAC”. ¹²² (Link)


• A year later the company had changed its name to Mydecine Innovations to focus on mushrooms for mental health and no further mention of AATAC can be found.  

 

The conclusions that I draw from the above is that:

• There is nothing unique about a distribution deal with AATAC – lots of CBD brand companies have done the same deal.


• There appears to be no success stories in terms of meaningful revenue growth from any company that has signed a similar distribution deal with AATAC and the largest, Harvest, cancelled the agreement citing it simply uneconomical despite all the marketing dollars put towards the relationship.


• If Zoetic does not have money to pay upfront fees like Isodiol, Chill will not be a favoured product.


• If it hasn’t agreed wider promotional terms such as staff training, like Harvest, then it will not likely get any special sales treatment to sell into the stores network.


• Without upfront payments then the only way AATAC makes money is through taking a larger share of the pie so Zoetic margins will likely be much be lower than their only previous market guidance of 50%.


• Without multiple SKUs and scale like Harvest, which still could not make the economics work, it may be difficult for Zoetic to also make the numbers work at the profit level regardless of top line revenue.

Zoetic announced its partnership with AATAC deal on 24th November 2020 with CEO Trevor Taylor stating “This game-changing partnership represents a real watershed moment for Zoetic. With a reach across tens of thousands of retail outlets, the Company will have unprecedented access to the market and can continue on its mission to bring the Chill brand to the local stores and pockets of every consumer”.

The evidence from numerous other companies is in fact that there may be little if any impact. Nevertheless the stock jumped 35% from 43p and ran up to 75p adding £62 million of market value to Zoetic on this one distribution deal. If I put sales on the 3x average multiple other CBD brands trade at, the market priced in £21 million of revenues from the AATAC deal. Based on the financial evidence of at least 8 other CBD companies, I believe this would be an astounding achievement. ¹²³ (Link)

Red flag – Betterment distribution agreement

Zoetic announced an agreement on June 1st, 2020 that Betterment will market Chill products to its network of outlets. However, no metrics or terms were provided. Some eight months later January 29th update there was still no mention that any such roll out had started to its network.

Red flag – Mr Checkout agreement

Zoetic announced a partnership with Mr Checkout in October 2019 – a national group of distributors in the US for direct store distribution for 150,000 independent retail members – with a trial with 15 distributors. In February 2020 update Zoetic commented that “Progress with MrCheckout has surpassed expectations”. Since then, there has, as far as I am aware, been no further mention of the relationship and whether it has led to anything.

Red flag – New Age Beverage corporation reference

In the 5th February 2020 trading update the company stated “Zoetic has developed interest from New Age Beverages Corporation, a Nasdaq listed distributor of healthy, natural products”. Nothing has been mentioned since.¹²⁴ (Link)

I am surprised at this information being disseminated and could be an example of news being put out just to keep retail investors interested. In my thtree decades of experience most other Main List companies only announce deals of this nature once signed to avoid embarrassment that a deal doesn’t materialise, as appears to be the case here.

Red flag – European distribution agreements void of any information

On 6th July 2020 Zoetic announced a distribution agreement covering Czech Republic and Slovakia for the Chill brand ¹²⁵ (Link). On 10th September 2020 it announced a second agreement with an unnamed distributor to take the Chill tobacco brand into 15 markets across Europe. It claims that “The Agreement will see the Company’s premium CBD offering reach consumers in over 15 markets across the European Union, with thousands of stores making preparations to stock the Chill range” ¹²⁶ (Link). However again there are no metrics or KPIs except for the guidance that thousands of stores are preparing. They key question I have is how, and on what basis, did management have that confidence to report to the Stock Exchange that thousands of stores in Europe were preparing to take its product, and why, half a year later there still isn’t any announced product in stores anywhere in Europe?

I suspect that, as with US distribution deals, there are no guarantee of minimum sales orders, numbers of outlets that will purchase or any other metric with which to judge the impact of these deals, or such crucial metrics would likely be announced by Zoetic to give confidence. It is also that in both European distribution deals the company declines to name who the partner is.

In addition, there is also no commentary around issues such as:

• Differing regulation around importing CBD cigarette products into different European countries;


• Timelines to registering smokable products with regulatory authorities and bodies;


• Packet labelling legislation in different European countries;


• Logistics around the need for multiple different languages on packaging;


• Production and shipping costs;


• Marketing needs to promote the products into multiple different countries;


• Differing tax rates across Europe and the impact on margins;


• Competitive positioning in each market and market share expectations. For example the Belgium government recently published a list of herbal products for smoking in the country which spans hundreds of different brands and SKUs indicating significant competition in the herbal cigarette markets. ¹²⁷ (Link)


• It may well be the significant complexities around the above issues that is partly the reason that there is still little to no traction in Europe six months on from the first deal.

Red flag – Unrealistic store rollout guidance

In the February 2020 interim results the company guided that “the Company’s realistic objective is to supply around 500 new stores per month” ¹²⁸ (Link). In June it said that guidance was delayed owing to Covid but that things were improving  ¹²⁹ (Link). There has been no further guidance on actual store numbers ordering and stocking its Chill products but the 6 month results to September revealed that sales were “online only” for the period ¹³⁰ (Link).

Red flag – Inaccurate & outdated statements on online distributors websites

Zoetic has a relationship with a distribution company called Mr Checkout which makes statements on its website like:

• “Chill smokes are hand crafted for your alternative smoking pleasure”. They are not hand crafted; they are mass produced in a factory by third party manufacturers.


• “Our signature hemp strains are cultivated from our no-till-living soil farms in Palisade, Colorado”. They are not as they have closed the Colorado cultivation facility. ¹³¹ (Link)

It also have a partnership with LeafyQuick where again the distributor claims that it is “grown and hand crafted in Colorado”. Strangely it also offers CBD vape cartridges on that site, but that product does not appear on its own www.thechillway.com website or anywhere else that I can find.

Interestingly however LeafyQuick makes the following statement in response to a posed question “Does CBD hemp flower relieve common aches? “The FDA requires us not to mention any specific benefits or make any claims to treat or cure any illnesses”. ¹³² (Link)

---

5. 
   

   MANAGEMENT & GOVERNANCE RISKS

   
   

Background

The old Highland Natural Resource management team of Robert Price and Paul Mendell left Zoetic and, in September 2019, Nick Tulloch stepped up from Finance Director to become the new CEO to oversee the pivot into a CBD business. However, On April 29th 2020 Mr Tulloch also stepped down to be replaced by Trevor Taylor and Antonio Russo who have become CO-CEOs to drive the new CBD branded business strategy.

Red flag – Lack of management prior track record

Prior to Mr Taylor’s involvement in Zoetic, he was CEO of District 8 Holdings, a private Colorado based cultivation facility that also had an organic pre roll brand. Prior to that he was COO of Old West Oilfields Services, a small fluids and fracking logistics services business. Mr Russo was also previously working at District 8 Holdings as Chief Compliance Officer.

District 8 has no website, no presence on LinkedIn and I can’t find any information on the business on Google. It is unclear what has become of the business though it may indeed be the indoor facility that Zoetic then took over the lease from, and which has now subsequently been closed.

In any respect, I believe growing hemp for seeds or oil fracking businesses bring limited expertise or skill sets for a company looking to develop a US and international consumer brand building strategy.

I cannot find either Mr Taylor or Mr Russo on LinkedIn to provide any further details on their business history.

Red flag – Lack of public market expertise

Neither Mr Taylor nor Mr Russo appear to have any public market CEO experience. There is likely to be a steep learning curve to go from growing hemp plants in Colorado to running a business with global consumer brand aspirations and a London Stock Exchange Main Board listing. From my experience, new management teams in new businesses, combined with the added pressure of having to comply with a public market listing, often have to go through an educational process where operational and public market mistakes are made, and certain things overlooked. An outdated and misleading website would be an obvious example.

Red flag – No independent board directors and an admission of governance short fallings

In the Zoetic Annual Report to March 2020 the Directors were listed as:

• R Price – Executive Chairman – resigned 3rd September 2019


• JM Davies – FD & Company Secretary – retired 1st May 2019


• N Tulloch – FD & Company Secretary – resigned 30th April 2020


• P Mendell – Chairman – resigned 30th April 2020

Both Mr Taylor and Russo were appointed as Co-CEOs on 30th April 2020.

As such, the Board consists of just two executive Directors and no independent Board members to look after general shareholder interest or oversee separate Remuneration, Audit or Nomination committee issues.

Furthermore, the Annual Report states:

“The Company has decided not to apply the UK Corporate Governance Code in full given its current size… Company is a small company with modest resources. The Company has a clear mandate to optimise the allocation of limited resources to support its acquisition and future plans. As such the Company strives to maintain a balance between conservation of limited resources and maintaining robust corporate government practices.” ¹³³ (Link)

Zoetic is a Main Board listed company valued at £147 million which has chosen to disapply critical principles of the UK Corporate Governance Code such as:

Principle G – “The board should include an appropriate combination of executive and non-executive (and, in particular, independent non-executive) directors, such that no one individual or small group of individuals dominates the board’s decision-making. There should be a clear division of responsibilities between the leadership of the board and the executive leadership of the company’s business”

Principle M – “The board should establish formal and transparent policies and procedures to ensure the independence and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial and narrative statements” ¹³⁴ (Link)

The Corporate Governance Code is there for shareholder protection and ignoring it owing to having ‘modest resources’ is a real concern in our view, especially against the backdrop of not having a NOMAD to help oversee compliance with listing rules as it trades on the Main Market not AIM. In short the current situation of just two operational Directors running and deciding everything with no independent oversight at the Board level is exactly the situation the Corporate Governance Code is there to protect against. The alarm bells sound even louder against the backdrop of the 2359% share price rise which has taken the value of the two co-CEOs stock of 13 million shares from £409,000 in March 2020 to £9.75 million now.

Red flag – Lack of ‘risk capital’ exposure

Mr Taylor and Mr Russo actual own cash skin in the game is limited. Of their total combined 13.9 million shares (6.95m shares each), 13 million shares or 93% were issued at par value as part of an incentive agreement when Zoetic took the lease on the indoor Colorado facility in 2019. That incentive was to run the facility which was in fact subsequently then closed.

Furthermore, both the CEO’s are on annual rolling contracts with just 2 months’ notice. As they are the only two senior management and the only two people on the Board, there is an inherent risk to the ongoing viability of the company if they chose to walk away.  

Red flag – Old CEO didn’t last long and is already competing in the UK

Upon his departure in April 2020, Mr Nick Tulloch was stated as continuing to partner with Zoetic by leading a new joint venture in the UK to build the Zoetic brand there given Zoetic had failed to secure any European distribution partners. However, by July 2020 Zoetic reported that the relationship had been terminated. Mr Tulloch appears to now be running his own CBD business in the UK called Voyager which will compete with the Zoetic brand in the UK. With no distribution agreement and nobody in the UK overseeing the Zoetic brand, which has no USPs or differentiation to thousands of other products, the chances of success in the UK are about the same as my chances of shagging Cheryl Cole this weekend.

Red flag – No full time CFO

According to LinkedIn a Mr Paul Ferguson acts as VP of Corporate Finance. He only joined in November 2020 and is likely still familiarising himself with the business and financial numbers. This is likely one of the reasons that, despite all the positive headline announcements through 2020, they have lacked any substance in terms of financial guidance and the company has failed to provide the market with any forward forecasts. Against a large valuation and public market financial reporting requirements, not having a full-time experienced CFO is usually a strong red flag. Not having a full time CFO usually indicates that either there are limited financials associated with a business that warrant a full time CFO (like only generating £54,000 revenues in the six months to September 2020) or that a company can’t afford to have one. I suspect both apply here.

Red flag – Limited number of employees to scale the business

The Annual report and accounts to March 2020 year end highlights that there two Directors and 8 employees ¹³⁵ (Link). It seems unlikely that the number of staff has changed much since then given the cash balance of the business. I find it difficult to see how Zoetic can deliver the aggressive revenue growth the stock price is indicating with what appears to be a skeleton crew of staff.  

---

6. 
   

   FAILURE OF THE VERTICAL INTEGRATION STRATEGY

   
   

While Zoetic continues to describe itself as a vertically integrated CBD company in public releases and on its website home page, this is in fact not the case. The 33,000 sq. foot indoor genetic seed business and 16-acre outdoor hemp grow facility, both located in Colorado, have ceased operations. Instead, the raw products of herbs and CBD isolate, package manufacture and retail distribution are all outsourced to third parties. In essence Zoetic has a brand called Chill with just 6 SKUs which it contracts manufactures and then tries to sell into distribution networks to reach a consumer audience in convenience stores. It is very much not vertically integrated.

Red flag – Indoor seed genetics grow facility in Colorado now mothballed

The company stated in its interim results on 23rd December 2019 that feminised seed production “remains on target to sell into the 2020 grow season” ¹³⁶ (Link). In March 2020 it announced that it had launched its new website www.zoeticorganics.com to advertise and sell its feminised seeds. It also announced that:

“seed harvests have exceeded expectations and Zoetic now holds an inventory of 2,925,573 feminised hemp seeds.  The focus of the team in the USA has moved to seeking buyers for these… Discussions with prospective buyers in both the US and internationally are ongoing”. ¹³⁷ (Link)

Interestingly clicking on the www.zoeticorganics.com link takes you to a website owned by GoDaddy which offers to sell the domain for £407.08. ¹³⁸ (Link)

In March 2020 Zoetic paid the investment hookers (they will do anything for cash) Progressive Equity Research to write a report which stated:

“Management believes that it could reach the maximum capacity of its indoor facility which is currently conservatively estimated at 12 million seeds/year. Based on 2019 prices these could command a price of up to US$1/seed before broker’s and distribution costs.” ¹³⁹  (Link)

In April 2020 it stated that it was continuing to develop sales channels for its hemp seed in the US and elsewhere but that it was reducing costs via staff reductions, a reduction in planting and utility costs ¹⁴⁰ (Link). In the May 2020 trading update it stated “The prospective wholesale hemp seed business has made significant progress towards commercialisation….negotiations have commenced on distribution agreements for seeds both in the USA and overseas”. ¹⁴¹ (Link)

However in July 2020 it stated that it had established a seed testing partnership with GVB Biopharm in Oregon (a CBD extracts wholesale supplier for hemp products industry) and it had signed a JV with a European cultivation partner (not named), but simultaneously it was terminating the indoor genetics lease of its Colorado facility ¹⁴² (Link). The price of feminised seeds in the USA collapsed in 2020 from $1/seed in 2019, making many seed genetics business unprofitable. It also appears to be an extremely competitive market with numerous companies offering feminised seeds for sale with little differentiation. ¹⁴³ (Link)

It is uncertain what the European genetics partner’s strategy is, whether it haS a grow licence, where it will grow in the UK and who they will sell seeds to, or why Zoetic still believes it makes sense to try to grow establish a seeds genetic business in Europe.

It seems highly unlikely that the genetic seed sale strategy will deliver any meaningful revenues, if at all, in 2021. It also makes little logical sense as to why a branded consumer products business would spend time or capital trying to develop a genetics seed business with little experience or USPs in a complex market where, in Europe, there are many well established genetics business, all also seemingly struggling to sell seeds. Management appears to be trying to perpetuate the vertical integration story.

Red flag – Wholesale hemp business in Colorado closed

Despite currently having a video on the Zoetic home page detailing the 16-acre hemp grow site, press releases state that Zoetic is no longer cultivating in Colorado given the wider issues faced by hemp farmers across the USA. The lease has been exited and the cultivation terminated. Zoetic now buys CBD Isolate off a wholesaler, no different to most other companies in the space.

Red flag – Inaccurate & outdated statements about vertical integration

Across its website and public market releases Zoetic continues to describe itself as “A vertically integrated CBD business”. Vertical integration has become the buzz word in the industry. Companies in the CBD space like to infer vertical integration based around a story of capturing margin and profits at every stage from genetics to cultivation to extraction to manufacture and ultimately retail distribution. Zoetic is in fact the complete opposite of a vertically integrated player as it now has to pay away 3rd parties to fulfil every other step from cultivation, extraction, manufacture and distribution:

• GVM Pharma cultivates and extracts CBD isolate and captures that margin by selling finished product CBD isolate to Zoetic


• Zoetic outsources the manufacture of products to 3rd party contractors who capture that margin


• Distribution is also then outsourced to 3rd parties’ networks which capture that margin selling the product onto the convenience store retailers

In fact, Zoetic only appears to capture margin acting as the middle entity by buying its products from the contract manufacturer and then selling it on to the wholesaler distributors.

Red flag – Risks to the stated 50% product margin

Zoetic stated in a February 2020 presentation that it captures a 50% margin through original distribution via 18 Schrader Oil stores in Colorado ¹⁴⁴ (Link). I believe this is likely to be based on:

• Own supply of CBD isolate from its own hemp cultivation – now stopped


• Own small scale manufacture facility – now being outsourced


• Own distribution deal via Ox Distributing/Schrader Oil stores which, as a 12% owner in Zoetic, is unlikely to represent a commercial agreement at scale.

Now most parts are outsourced to 3rd parties all needing to make their own margin, and larger distribution deals likely to be on significantly worse terms that whatever was agreed with one of its shareholders, Ox Distributing, maintaining a 50% margin for fulfilling just one role in the value chain will be extremely difficult.

Much of the upside speculation on the Zoetic bulletin boards comments are based around this high 50% margin figure, multiplied by a large number of stores (which the distribution agreements actually provide no certainly on) selling a few packs daily (guidance that strangely appears to have been withdrawn on the basis sales are only online), that leads to the astronomical profit potential that seems to have driven the share price rise in 2020. I believe that all three multipliers are significantly wrong in those assumptions.

The January 28th 2021 interim results reported a gross margin of only 30% so the trend is already tracking below prior guidance. Furthermore, that is the margin from online sales (as that was the only sales reported). Margin when having to pay for physical distribution is traditionally much lower than the more efficient online channel so again the 50% margin target may be much harder to achieve. ¹⁴⁵ (Link)

---

7. 
   

   ZOETIC UK BRAND ISSUES

   
   

The company’s UK Zoetic brand had 21 SKUs including oral tinctures, soft gel gummies, massage oil and skin care products. It also offers Chill CBD gummies (the smokes and pouches are not on sale in the UK as its not allowed). The Zoetic brands are only being sold online in the UK.

Red flag – A lack of interest for Zoetic brand distribution in Europe

In its 29th April 2020 trading update the company unveiled that:

“…the Company has fallen short of its aspirations to secure distribution of its products to major retailers in Europe.  The Board believes that the prospects of this division will be enhanced by a more dedicated focus on local opportunities and so it has asked Mr Tulloch to work alongside Zoetic in a joint venture, effective immediately, to build its brands in Europe and continue grow this division”.  The Company believes this new joint venture structure will enhance value for its shareholders, not only by reducing its operating costs in the UK, but by potentially enhancing its revenue opportunities outside of its core US business.” ¹⁴⁶ (Link)

In fact, there has been limited progress and Mr Tulloch has already exited the joint venture to launch a competing CBD brand called Voyager Life Limited. ¹⁴⁷ (Link)

There are thousands of CBD branded products on the market across Europe and the Zoetic range has no distinguishing USPs.

Red flag – Lack of capital to market brand online

In my experience, online sales are typically a function of brand marketing spend. Zoetic has very limited capital to effectively market its Zoetic range of products online in the UK.

Red flag – Zero presence on physical store shelves

A year after launching itsZoetic range, the brand has still not broken into physical retail stores unlike hundreds of other CBD branded competitors in the UK. This is despite Interim results comment from December 23rd, 2019 stating:

“the attractions of the Zoetic brand in the UK and Europe have increased and we are seeing considerably more traction with retail outlets, particularly those larger organisations that have a preference for few suppliers but with multiple product lines”. ¹⁴⁸ (Link)

In a February 2020 presentation Zoetic stated, “the company is now getting more traction with retailers…several stores now selling products”.

A year later there appears to be no store presence, suggesting the few stores that did stock have now destocked, and only a vague mention that discussions are being had with an un-named group.

Furthermore, the big distribution deals with the likes of Boots, Holland & Barrett have already been tied up by other larger CBD companies. I believe the chances of Zoetic now being able to break into mass retail distribution with undifferentiated products are…. see previous comments about myself and Britain’s leading chanteuse.

Red flag – A lack of differentiation of products in a highly crowded market

There are hundreds of CBD brands for sale in the UK both online and via stores. Differentiation is extremely difficult, certainly without a marketing budget. A search for ‘CBD products UK’ did not feature Zoetic in any of the first 10 pages on Google. Nor did it feature on any of the best CBD oils lists on the first two pages of Google when ‘top UK CBD oil’ on Google:

• Observer top 7 listed – no Zoetic ¹⁴⁹ (Link)


• Evening Standard top 15 listed – no Zoetic ¹⁵⁰ (Link)


• Readers Digest top 8 listed – no Zoetic ¹⁵¹ (Link)


• Discover Magazine top 8 listed – no Zoetic ¹⁵² (Link)


• Manchester Evening News top 6 listed – no Zoetic ¹⁵³ (Link)


• The Mirror Top 7 listed – no Zoetic ¹⁵⁴ (Link)


• Get the Dose top 12 listed – no Zoetic ¹⁵⁵ (Link)


• Top Deals CBD top 10 listed – no Zoetic ¹⁵⁶ (Link)

Not does it feature on Amazon searches for UK CBD or for Zoetic specifically. ¹⁵⁷ (Link)

Red flag – Premium product focus reduces market penetration potential

The Zoetic range is aimed at the premium end of the market. This is typically defined by a much smaller target market audience and higher prices. The sector has seen significant price compression of retail products so Zoetic products will now either look expensive or they will have to reduce prices hurting margin. The premium end focus also suggests much slower and lower revenue potential than the mass market CBD brands.

Red flag – Minimal revenues to date from UK business

The Zoetic brand launched in August 2019 with tinctures and has rolled out additional wellness products since. However, revenues across the entire CBD sales brands including Chill are still minimal.

While Zoetic does not split out Chill vs Zoetic brand sales, the combination of both only generated £54,000 of sales in the six months to September 2020 and the emphasis appears to be on the Chill online sales. ¹⁵⁸ (Link)

Red flag – Novel Foods regulation uncertainly and cost

In the Zoetic range there are five oral tincture products and one Chill gummies offering. Any product not in foods widely consumed pre 1997 falls under regulation of the Food Standards Agency (FSA) which now requires any CBD based product that are consumed to go through a Novel Food application to prove its safety. Businesses need to submit, and have fully validated, novel food authorisation applications by 31st March 2021. Any products that do not receive authorisation may not be sold to consumers in the UK. ¹⁵⁹ (Link)

The cost and complexity of this process is prohibitive. It is estimated that attaining Novel Foods regulation to allow products to be sold post March 2021 is in the region of £500,000 to £700,000 and there is no certainly of authorisation, which is also expected to take 18 months post March 2021. Zoetic does not appear to have the capital to progress through this expensive process. Even if it does, while many products will have to stop retailing to consumers, there are many other well-funded companies also progressing and as such, post March 2021 I believe it will still be a crowded market with little product differentiation.

Sales for Zoetic’s ingestible products are therefore not a given and even if, post this expense, they can be sold, again there is still no certainly of sales in a crowded market, especially when many other products have already done deals with the large physical retailers such as Boots, Holland & Barratts etc. The return on investment to allow Zoetic to sell six ingestible SKUs could take years, if at all.

Red flag – Isolate versus full spectrum debate

While it is recognised that CBD molecules have multiple beneficial implications for human health, there is a belief that isolate, with only pure CBD, is not as effective as full spectrum distillate which contains multiple cannabinoids and terpenes from the whole plant which creates the entourage effect for the best therapeutic outcomes. Zoetic uses isolate as by UK law there can’t be any THC molecules, but that could mean its products are perceived to be less effective or are in less demand vs distillate products. As consumer awareness improves, it may be that the Zoetioc product range is marginalised in favour of full plant products that are all available online and their key marketing message is their full spectrum advantages over isolate.  

---

1. 
   

   CORPORATE: EQUITY OWNERSHIP ISSUES
   

   
   Red flag – Schrader Family/Ox Distributing stake

The Schrader Family/Ox Distributing own 24.75 million shares or 12.72% of Zoetic. Ox Distributing is, however, the company’s primary distribution partner in Colorado where the CBD infused cigarettes and chew pouches are being beta trialled via their 18 Schrader Oil convenience stores. With their equity position in Zoetic being worth £18 million, it begs the question as to what sort of preference the Chill products get in the self-owned outlets in terms of shelf positioning and marketing and more importantly whether that will be matched by other convenience stores around the USA which have no other incentive to stock or push the products. Management claims that the beta test sales in Schrader Oil stores have been a success with 2-3 packs sold a day on a 50% margin. The mystery shop  by my comrades in Amderica of several stores reveals that staff are being paid a bonus to sell Chill products. As such I believe the pack sales figure is likely to be misleading when extended outside the Schrader stores where staff will not be paid bonuses.

Red flag – Unusually large retail positions held via spread trading firms

The second and fourth largest shareholders of the company, per the Zoetic website, are SPREADEX LTD (23.7 million shares; 12.1%) and InterTrader Ltd (10.3 million shares; 5.3% of the company) ¹⁶⁰ (Link). Both are UK spread betting companies meaning that over 30 million shares are held by predominantly retail investors using spread betting leverage to own the shares.  I believe that part of the phenomenal run in the share price has been driven by unsophisticated retail investors leveraging purchases through spread trading accounts. This has the effect of squeezing prices up on relatively low volumes. However, as has been witnessed in many other stocks, when the price begins to fall, retail investors get margin calls from the spread trading firms which typically results in retail investors being unable to fund the margin calls and are therefore forced to sell. Forced selling at any price to get out of margin positions forces the price down further and triggers further margin calls on other retail investors. From our experience, highly valued stocks with forced sellers usually result in a rapid capitulation of the share price.

Red flag – Retail investor ‘ramping’ on the bulletin boards

Against the absence of any formal forward guidance on financial performance potential, retail investors have been left to speculate as to what the recently announced distribution agreements could mean for the stock price. Into a void of real numbers (revenues to date from brand sales totalled just £54,000 for the six months to September 2020), speculation is rife across the bulletin boards. With the vast majority of retail investors long only traders, they are therefore susceptible to so called ‘pump and dump’ tactics by other long investors. Recent comments on ADVFN Zoetic chat boards include:

“It’s going to £2 if it’s not taken out before at a higher bid by a big pharma as it’s a threat to their fantasy drug regime. Great chance of a further update this week. Zoetic will imo hit multiples of today’s sp, we need numbers reporting but they are all but confirmed with research. We could be the share of 2021” ¹⁶¹ (Link)

“8,000 [stores] X 5 [packs] X 10 [dollars]= $4.4m a day at 50% margin – $2.2m a day = $803m a year at a pe of 20 =$16.06 billion market cap. At £=$1.33 = £12 billion or £63.6 per share!!!!!!!!!” ¹⁶² (Link)

Pump and dump tactics, described as taking a long position then disseminating misleading positive information…with a view to increasing its price, falls foul of the FCA’s market manipulation rules.

Red flag – Absence of institutional ownership

Despite the significant increase in value, the company has not issued a Shareholding Notification release flagging that any institution owns over 3% of the business. It is highly unusual for a £147 million market capitalisation Main List company to not have any major institutional shareholders which in my opinion:

• Strongly flags that this is a retail driven stock price rise;


• There will be little buying support on the downside that institutional investors can provide to stabilise price drops;


• The company does not have any large investors on its cap table capable of providing much needed growth capital.

---

1. 
   

   CORPORATE: LACK OF GUIDANCE & MISLEADING STATEMENT
   

   
   Red flag – Absence of capital markets regulatory guidance

Zoetic has inherited a London Stock Exchange Main List quote through its pivot away from a resource company into a CBD focused company. As such, I believe that Zoetic has been able to issue statements that may not have otherwise been allowed by a NOMAD – had it been AIM listed – which has contributed to the fuelling of retail investment excitement and extrapolation of expectations.

For example, the company made statements such as the September 2020 Second International Distribution Contract Signed where it states:

“The Agreement will see the Company’s premium CBD offering reach consumers in over 15 markets across the EU, with thousands of stores making preparations to stock the Chill range”. ¹⁶³ (Link)

A NOMAD would question such a statement being made without evidence that thousands of stores were making preparations

Zoetyic is also unusually active on making Regulatory News updates to the market, making 19 update releases since March 2020 outside of scheduled reporting requirements and it made as many as five market updates between 29th April and 1st June 2020¹⁶⁴ (Link). While there is no limit on a company’s ability to update, this is certainly excessively regular news flow, often with little relevance to actual trading, possibly designed to keep stock price momentum going. In my experience, large, listed companies make meaningful updates every few months whereas small companies sometimes look to be very active on every little piece of news to try to entice retail investors to trade.

Red flag – Misleading information on the corporate website

There are multiple misleading pieces of information on the corporate website (https://zoeticinternational.com/):

• Its home page describes itself as a “vertically integrated CBD business…growing hemp indoors and outdoors in Western Colorado” – however with genetics, cultivation and extraction in Colorado mothballed, this is not true.


• The Zoetic elevator pitch on the home page starts with the CEO introducing himself as Nick Tullock (he is no longer the CEO and departed well over six months ago), states it grows hemp outdoors in 16 acres which they can sell as biomass or CBD (not true it has closed the cultivation), has a 33,000-sf indoor facility of feminised seeds (not true now exited as failed to sell any seeds).


• The ‘About Zoetic’ page is again riddled with misleading statements about its Colorado grow operations being able to provide all the CBD it needs for its own use.


• The US website’s (www.thechillway.com) strapline is “a chill way to quit tobacco” – making claims a product can help people stop smoking which is unsubstantiated and would require regulation by the FDA.


• Under the Board & Management page there is a bio of Melvyn Davies as the interim CFO which is not the case.


• On the Investor Relations page it has commissioned research by a company called Progressive Equity Research. The last research note was published in March 2020 which provides potential investors with old information such as being on target to supply up to 12 million feminised seeds to the market and discussions of $1/seed. ¹⁶⁵ (Link)

In short, the website and information provided is both outdated and, in cases, is misleading to investor trying to understand the business and its valuation potential. Given the unprecedented 2359% share price rise in less than a year and the lack of broker research or company guidance, investors really only have the website and new releases to form their investment decisions. Having so much inaccurate information must surely be misleading investors.

While Zoetic is listed on the main London exchange, even companies that list on the junior exchange, AIM, have to comply by the following governance guideline. Were Zoetic an AIM listed company it would likely be in breach of the AIM Rules for Companies. Rule 26 states:

“Each AIM company must from admission maintain a website on which the following information should be available, free of charge: — a description of its business and, where it is an investing company, its investing policy and details of any investment manager and/or key personnel; — the names of its directors and brief biographical details of each, as would normally be included in an admission document; — a description of the responsibilities of the members of the board of directors and details of any committees of the board of directors and their responsibilities; — its country of incorporation and main country of operation”. ¹⁶⁶ (Link)

Principles of Disclosure 10 also state:

“An AIM company must take reasonable care to ensure that any information it notifies is not misleading, false or deceptive and does not omit anything likely to affect the import of such information”.

Breaches on AIM under Precautionary Suspension 40 states:

“the exchange may suspend the trading of securities where it considers that the Company has failed to comply with these rules”.

Zoetic, as company listed in the UK, is subject to the continued obligations imposed by the Financial Conduct Authority and the London Stock Exchange. Some of the Key Principals include:

“UK Corporate Governance Code A.1: Every company should be headed by an effective Board” ¹⁶⁷ (Link)

“FCA Premium Listing Principle 2: A listed company must act with integrity towards the holders and potential holders of its premium listed shares” ¹⁶⁸ (Link)

“FCA Premium Listing Principle 6: A listed company must communicate information to holders and potential holders of its listed equity shares in such a way as to avoid the creation of a false market in those listed equity shares.”  ¹⁶⁹ (Link)

“FCA Handbook Listing Rules: 1.3.3 – Misleading information not to be published. An issuer must take reasonable care to ensure that any information it notifies to a RIS or makes available through the FCA is not misleading, false or deceptive and does not omit anything likely to affect the import of the information.”  ¹⁷⁰ (Link)

It would appear that Zoetic may be in breach of multiple requirements in the FCA Handbook given that:

• Zoetic does not have an effective Board


• Zoetic has multiple areas of misleading statements on its website that investors may be relying on regarding share purchase decisions


• Zoetic could be generating revenues in the USA from activities that are in violation of the FDA and FTC regulation and hence require prior approval.

For investors in the equity of Zoetic this could be particularly concerning given the FCA’s Handbook rules clause 5.1 Suspending Listing where it states:

“5.1.1: The FCA may suspend, with effect from such time as it may determine, the listing of any security if the smooth operation of the market…is necessary to protect investors”. ¹⁷¹ (Link)

As discussed earlier, there has been a significant rise in shareholder class actions against CBD companies for making misleading statements. Based on the above, it would appear that Zoetic is potentially vulnerable to such legal activity.

Red flag – Stock exchange suspension or delisting possibility

In addition to corporate governance and transparency issues, the FCA and the LSE require companies to conduct business to high standards under the Listing Standards rules. If Zoetic is violating FDA and FTC regulation through its health claims around its cigarettes, there is a material potential risk of Zoetic being investigated by the exchange with one possible outcome being suspension or ultimately delisting.  I note that other companies that were alleged to be conducting illegal activities have been suspended such as United Cacao. ¹⁷² (Link)

Red flag – Absence of any recognised broker research

Allenby Capital acts as the Broker to Zoetic. It is my understanding that Allenby has not conducted a site visit to company HQ in Colorado and as of yet has not published any research. This is unusual for a company with a £147 million market capitalisation. This suggests that either:

1. the broker is not yet comfortable with the business model or the financials to print market research for distribution or;


2. the management team are uncertain at this stage as to what the 2021 budget looks like and are unwilling to provide any guidance that could be missed.

The upshot of the lack of company financial guidance and broker research is that investors have no fundamental way to value the business leaving the shares exposed to retail investors simply buying on news flow of apparent headline progress without any underlying numbers to support.

---

1. 
   

   CORPORATE: FINANCIAL CONCERNS
   
   

   
   Red flag – Absence of any material revenues

Revenues from the new CBD brand strategy have been very slow.

• 2019 interim results reveal that between June 2019 and December 2019 CBD revenues were £65,000. ¹⁷³ (Link)


• Zoetic announced full year revenues to March 2020 of £92,606 from the sale of CBD sales progress. ¹⁷⁴ (Link)


• Interim results to September 2020 reveal total online sales of £54,000.

Accordingly, sales for the 12 months to September 2020 total c.£81,000. It seems astounding that investors would ascribe a market cap of £147 million to a new CBD business where, to date, there is virtually no evidence of what kind of revenues or growth profile Zoetic can deliver from a negligible base. On the basis that the genetics seed and UK Zoetic brand business will deliver little meaningful revenue in 2021, the onus for growth comes from the Chill brand and there is a real risk that those products could at any point be pulled from stores were the FDA takes action and issues a 15-day Warning Letter.

Red flag – Revenue recognition risks

The annual accounts to March 2020 state that the group records revenues from the sale of CBD products when the product has been delivered to the purchaser under the terms of the contract. However in brand retail there are often product return clauses. I am unable to determine what the distribution deal contracts state about returns. I am concerned and would want to know how Zoetic has recorded these revenues and how they may change in future periods.

Red flag – Absence of tangible financial guidance

Zoetic has never issued any forward-looking financial guidance against which investors can judge performance or value the business. As such it has not had to issue any cautionary or warning guidance like many other companies through Covid hit 2020. The only news has been positive headline statements with little to no financial or key metrics guidance. Quotes from the September trading update include:

“The directors of the Company are pleased to report that the consumer reaction to the Company’s CHILL branded products has exceeded their expectations.  in stores where CHILL has been on sale for several months they have experienced consistent increased sales, month on month”. ¹⁷⁵ (Link)

What were the expectations? How is the consumer reaction measured other than by revenue? What are the sales increases? Indeed, based on that comment i struggle to understand why management then state that the revenues for the period March to September were 100% derived from online sales.

“The Zoetic brand has also picked up sales momentum.  Online sales have increased over 300% in the month to date.”  ¹⁷⁶ (Link)

From what base? How many products sold? What revenue generated etc.

“Following a successful trial in a selected beta stores, the Company has received a significant order under one of its existing distribution contracts to roll out stock of its Chill range of tobacco-substitute CBD products in a number of convenience store outlets throughout the USA.” ¹⁷⁷(Link)

Again, on that basis, I cannot understand why then in January 2021 it states that the revenue from the March to September 2020 period was only from online.

The interim results statement from January 2021 continues the trend of not providing any actual figures, rather stating revenues are up 90% since the year end from an unknown figure.

In part I believe this is because to date:

• Revenues from sales have been negligible and so its difficult to disappoint on the downside


• Management would appear not to know the possible level of demand from the new distribution deals and as such are struggling to budget for 2021 and hence provide guidance.

All that is understandable for a small start-up one year into a new business, but sits uncomfortably against a business that has shares that have soared by 2359% to give a market capitalisation of £147 million. I believe management is now in a very difficult position. Unless it gives guidance for very significant revenues in 2021, investors are likely to be disappointed. If they do that, then they will almost certainly struggle to meet the extremely high expectations.

Red flag – Extreme balance sheet weakness and need to finance

The reported period end cash position for year ending September 2020 was £450,000 ¹⁷⁸ (Link).  The only other source of capital inflow is a monthly payment by Ox Distributing (owned by Schrader Oil) of £118,750 per month as part of a loan scheme to purchase 23,750,000 shares at 5p/share struck in March 2020 for a total of £1,187,000. The 10 monthly instalments completed on 31st January 2021 so there will be no more capital injections from that source. Zoetic also took a $290,000 US Covid loan which is repayable over two years but remains outstanding and may be forgivable.

With the market cap currently discounting significant revenues in 2021 from essentially a standing start, Zoetic does not appear to have the working capital needed to fulfil the production needs to deliver any sort of meaningful revenues. Management has given no guidance as to how this hiatus is the be addressed. With the new consultant CFO only just getting to grips with the business, and management uncertain as to any level of demand from the planned roll out, there remains a major question as to how Zoetic can finance any growth.

I believe that bank debt will be extremely difficult to obtain. Currently, in the US very few banks will lend to small companies involved in the cannabinoid sector and given the possible federal violation nature of its CBD sales, Zoetic is unlikely to be a strong candidate amongst banks that are lending.  Asides from some sort of invoice financing (difficult for start-ups and an expensive way to fund growth) it seems almost a given that Zoetic will need to conduct an equity or convertible placing in the short term to fund any sort of growth in 2021. Combined with the absence of any financials and corporate governance issues, it is hard to believe that the placing will be done with institutions which then begs the questions as to what quantum of capital could be raised from retail investors to try to fulfil the sorts of revenues needed to justify an £147 million market cap.

---

11. 
    

    VALUATION ISSUES

    
    

In the absence of any management financial guidance or broker research, it is difficult for investors to establish the correct valuation for Zoetic. All figures below are in US dollars and the data is from January 22, 2021.

Red flag – Valuation is substantially out of line with direct CBD comparables

I have identified a basket of listed and private companies that are like Zoetic in the context of their CBD product offerings. All the companies have consumer brand businesses focused on CBD products aiming at distribution deals across the US, Canada, Europe and Australia. In comparison to these companies, Zoeticlooks highly overvalued.

Key points are:

1. The average Enterprise Value of the 11 companies with sub $20 million revenues is $25 million.


2. There are 5 companies with last 12 months revenues above $20 million that have considerably lower valuations than Zoetic.


3. The only companies with a higher valuation than Zoetic are Charlotte’s Web and KushCo, two established leaders in the sector with $91 million and $134 million in revenues in the last 12 months respectively.


4. The average LTM (last 12 months) revenue multiple for the basket is 36.1x, although this is skewed by Green Hygienics and Plant & Co brands. Excluding these two gives a multiple of 6.7x compared to 1811x for Zoetic.

^179]

Below I highlight some further details on a few of the companies, to demonstrate the unexpected valuation differential.

• CbdMD (NYSE.YCBD): NYSE listed CbdMD has multiple CBD brands across tinctures, capsules, gummies, topicals and pet products that are distributed across 6,000 retail outlets. The company reported revenues of $41.9 million for full year to September 2020, has $15 million of cash and no major debt. EV of $188 million is 10% lower than Zoetic. 

• Chemesis International (CSE.SCI): Facilities in Puerto Rico and California of cultivation and manufacturing. Products include tobacco-free smokeless cannabis chew and white label and own branded hemp cigarettes which “will be distributed through the US and European markets”. LTM revenues of $11 million. Market cap of $26 million is 87% lower than Zoetic. 

• Kona Gold Solutions (OTC.KGKG): Hemp and CBD lifestyle brand focused on the beverage sector. 30,000 sq. foot distribution centre; signed over 60 distribution agreements in 36 states plus an international agreement; multiple brand line extensions and new products. LTM revenues of $1.1 million. Market cap of $21 million is 90% lower than Zoetic. 

• Veritas Farms Inc (OTC.VFRM): Veritas Farms is a vertically integrated agribusiness focused on the production of full spectrum hemp extracts with naturally occurring cannabinoids located in Colorado. Active for the last 5 years, the company has 50 different SKUs and is sold in over 7,500 outlets , producing revenues of $6 million in the last 12 months. Market cap of $9 million is 95% lower than Zoetic. 

• Redwood Reserves (private): “Seed to smoke” with hemp from Oregon formulated into multiple hemp smoke cessation products to establish itself as one of the largest and best established US hemp cigarette brands being sold in over 1,600 smoke and convenience stores in the USA. Redwood is a more established brand and business than Zoetic acquired for a fraction of Zoetic’s current valuation. Last valuation of $2.75 million is 99% lower than Zoetic!
  
  Red flag – Valuation is out of line with the wider CBD/cannabis universe

I also look at a basket of sub $250 million market cap US and Canadian listed companies operating in the cannabis sector to get a comparable understanding as to what these companies trade at in terms of EV/Revenues and EV/EBITDA.

Key points include:

• Of the 30 US peer group basket, the average EV/Revenues multiple for 2021 is 3.3x vs Zoetic at 1811x


• Of the 30 Canadian peer group baskets, the average EV/Revenues multiple for 2021 is 3.0x vs Zoetic at 1811x


• To trade at the peer group average Zoetic will have to deliver revenues of £49 million. have i mentioned something about Cheryl Cole?


• Most companies with no revenues (excluding the pharma focused ones which are being valued based on their IP) typically trade in the market cap range of $10-$40 million. 180

CONCLUSION:

Even in the most bullish revenue scenarios for 2021, I believe it is highly unlikely to see how Zoetic could deliver sales of more than £4 million revenue this year. On that metric, against more established listed cannabis and CBD brand companies, it should then trade at 3x revenues or £12 million market cap suggesting a 6.14p per share. However, as identified throughout this report, I have identified many risks to Zoetic’s 2021 plan and revenue could be significantly lower. Indeed it could be wiped out by regulatory issues. 

At this juncture, against the backdrop of all the identified risks, and in the absence of any real revenues 18 months after the brand launch, I would estimate Zoetic’s current fair value at between zero and 5p/share.

 

 

 

---

---

Filed under:

• red flag
• zero
• Zoetic
• ZOE
• CBD
• see you in court bitchez
• Highlands Natural Resources
• FCA

---

All ZOE Stories