We’ve been all over Aleafia since their inception, our curiosity sparked by the entry of Julian Fantino as one of the founders.

They’re an outfit that has ambitious plans – with plans to be or already in recreational flower, medical, medical clinics to path new customers, outdoor, indoor, greenhouse, R&D, among other segments (and for any company with any ambition to speak of….the obligatory sublingual strips). Just like a ‘Zenabis ($ZENA)’ – the ambitions are based upon this very year – with all of it driven by expected sales expansion, a significant production ramp coming online, a processing facility operationalized, and presumeably a ton of SKUs and marketing to support it.

GoBlue covered their last quarter, while my thoughts on their year end and the latest capital raise to get them through the year……are detailed in the links provided.

I’ve said that they’ll need to see an intense sales ramp to absorb existing inventory, anticipated production, and a widely increased product array. Now that they’re reporting the second quarter of 2020, we should be seeing some movements in sales, and hints about how their business plan is progressing.

To the financials!

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• How about sales? Revenues are off 35%, with ‘consultation’ services coming in halved, and cannabis sales at $9MM (versus $13.5 Q previous)
• Margin on cannabis down to 33%. Most of the sales decline came from their wholesale segment, with a modest increase in recreational (up 22%), and medical up as well (43%) QoQ.
• Margin in the wholesale segment cratered, dropping from 91% (!) to 30%. The decline was attributed to reduced selling price, and the COGS spiking because of the material being extract.
• Tough thing about those increases: adult recreational is only at $870k for the quarter. Medical is their strongest segment, but its’ revenues were only $2MM. Channel penetration and throughput is – in general – unchanged. More below.
• We remarked at length on their forward product swap last fall, and the level of inventory they were packing at $34MM. Now, they’re at $36MM, with another $18MM in ‘Value added product manufacturing & purchases’ added during the quarter. The term’s a bit vague though, more below.
• SG&A up to $2.5MM in the quarter (to $8.5MM from $6MM prior). Not unexpected as tooling and processes and manufacturing presumeably come online.
• This is a great example of how costs ramp during operationalization, and is unavoidable. Think about this when a company is thin on cash but claim to be close to the finish line but don’t have products at the ready to sell. $AH should be funded, but there are other’s we’ve seen go down who weren’t. Another note is that having a ton of working capital tied up in inventory that’s not immediately sellable stresses cash flows and financial ratios. Running out of working capital has been the end of many dreams.
• A convertible for $25MM moved into current liabilities last quarter, and it’s accreting. Currently at $22.6MM, February 2021 has a red circle around it on the CEO’s calendar. As mentioned, $AH is heading to a moment: a surge in production and product readiness heading into the fall, with the bills coming due shortly thereafter.
• I can see $AH proposing a re-price and extension of them, and it being discussed as I type. Given that they have a couple more months of sales data, $AH will have a pretty good idea if they’re tracking. These financials say they’re not.

Ok. There’s more errata, but it’s not as germane to their current state. Which can be described as ‘what if you build a business and no-one is buying your products?

That may sound a little facetious – they did have $9MM in sales in the quarter. But, with 380MM diluted shares in the float (that’ll increase if a reprice is incoming) and $11.5MM in expenses this Q, $9MM isn’t going to do spit.

Regarding the segmented revenues above, medical sales to patients is an apparent strength….in that sales are up and the services provided by their clinical model and consumer data (under ‘Research’) do appear to be pathing new business in the door. There’s a few challenges here though. The clinical model requires payments to doctors who get paid if one of their patients buys the product (so it only carries a 20% margin), the problem is it’s only $100k/month in revenue. The increases in medical are cause for optimism, but the absolute level of it at $8MM/yr isn’t good. Regarding ‘Recreational’….. these guys aren’t even on the map yet.

In Inventory, we see them preparing for 2.0 by purchasing additional input materials and processing, yet the question of why $18MM was brought in. Despite a $3MM write-down (due to declining net realizable prices, natch) and moving 2,500kg in the quarter, total inventory went up by $3MM. Was this in value addition/transformation? Hard to tell:

I see a couple of notable things in that paragraph. First, that they require additional input materials to complete products. The cost isn’t split out, but I can’t see them picking up millions of dollars in carrier oils or vape cartridges, so more likely it’s cannabinoids or terpenes. That the inventory is ‘largely composed’ of extract (likely from that forward product swap), implies there’s going to be more completion costs as it gets consumed, which will feedback into margins. And given their existing throughput, it also means they’re gonna have that gear lying around for a loooong time. Another possibility is they did another product swap. Given the enhanced cost, one could guess that it was secondary refinement of the initial bulk crude – a forward on the forward. I can’t tell. The answer is if the buyer of their wholesale was the seller of the extract. And…..they aren’t saying.

We accurately predicted that the biomass swap they did brought physical length of extract heading into a period of price compression. Those lofty margins of yesteryear are essentially being reversed. Also notable is that last quarter, their assumptions around their outdoor product was a transfer price of $1.25/ gram with a yield of a kilo from each plant. This quarter, it’s now at $0.25 with a yield of 750 grams. Perhaps a learn from last year, perhaps adjusting to the results they’re seeing during the 70 acre outdoor grow this year.

An investment in some sort of JV intended to build out retail stores seems to be fallow. Note 12. Unless I’ve missed something the company is completely silent on the status of it.

Well, nothing much more to add. These guys need to pull a rabbit that’s increasing in size every month out of a hat that’s getting smaller as time passes. With most of this quarter already booked, should we see a re-price of the debentures in September, it’ll signal that plans aren’t materializing. The hard part is that they’ve loaded so much production and deployment into fall/winter 2020….it’s going to a moment.

Look for that re-price, and some sort of desperately needed shot in the arm of sales. Medical – which is their strongest segment – isn’t going to float a popsicle stick at $9MM a year. Should wholesale dry up next financials, these guys are in for a rough ride. In a general sense, the business condition $AH is currently facing is where $ZENA was in the summer of 2019.

That’s no place a company – nor a shareholder – wants to find themselves in. The runway is running out.

The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds no position in $AH.