There’s been changes recently at Aleafia, and we expressed our thoughts on the departures. I will say the initial release was worded curiously, in that Raffee and Julio had ‘indicated their intention’ to resign.

The passive tone is a curiosity to me. When 2 founders leave an outfit so early on, usually there is some sort of framing put around the departures. That one is leaving the company to spend ‘more time with family’ or similar. Usually accompanied by the people saying that the company is in ‘good hands’ and that its’ ‘future couldn’t be brighter’ sort of thing.

Here, all we have is an indication to walk after another pay cycle. A guy’s gotta wring all he can out of that dishrag, right?

I’m doubtful the resignations (at least, their ‘intention’ to resign) was of their own volition, but. Perhaps that’s just hopeful yearning on my behalf. Stories behind changes in the front office are not often fully revealed, but maybe we’ll get lucky with these two and find out someday that they did something very, very, very wrong (more hopeful yearning).

In our last look at Aleafia, we saw the launch of Port Perry as mission critical, the need for more recreational penetration (as medical channels are tracking to being size/volume constrained), and if their outdoor grow would bring lower costs into COGS.

Let’s catch up with their 2019 fiscal year end, and see how they’re making out. We might get lucky, and see if there is anything that might have presaged Raffee and Julio’s long walk off the short plank.

To the financials!

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• $4.4MM in cannabis sales during the quarter, $988 COGS recorded against it for a margin of 77%. Well then. Did outdoor go through during the quarter?
• Looks like it might have in bulk wholesale, $2.8MM of it, at a screamingly good margin. They advise they sold 1,100kgs of it in Q4, and another 4k kgs in Q1 2020. That’s good.
• Hmm. Checking inventory, it’s gone from $7.8MM to more than $34MM by the end of the year. Wow. More below.
• SBC was $1MM during the quarter. All that could be struck appears to have been. At-the-money RSU’s are now the flavour of the day, we’ve seen this in others. 2MM were issued over the year.

• That Emblem deal really stands out in Note 8 (Share Capital). At the time – way way back 13 months ago – $301MM for $75MM in net tangible assets. Litigation attaches to it (Note 16), with lawsuits flying.
• This sort of thing appears relatively common across M&A’s in the cannabis space. $ALEF states they don’t see much liability coming from it. The $APHA litigation is apparently fast-tracked, and heading to arbitration in the fall.
• They sold land somewhere along the way in 2019, but its’ not mentioned other than in numbers. It’s in their MD&A & SCFP at $8.7MM, but PP&E (Note 8) says it was $7.2MM. Ugh. It seems like Blue and I have been coming across things like this far too often lately.
• Investments are negligible, and any operations around a 10% holding in a retailer appear fallow.
• They’re still spending on shareholder communications: this fish wrapper coming out just the other day. And by God, it’s awful.

Ok.

Good disclosure on sales splits. Main takeaways to me is that medical is their strength, and that they should find a different accountant:

They claim $149k in excise in Q4 2019, but the YTD delta between Q3 & Q4 only increased by $41k.

That inventory bulge around their waist is interesting. One would have expected a bump from the outdoor harvests, as well as their own production. What we find is that they purchased some $20.4MM in dope in the last quarter of the year:

And in a percentage skewed that I haven’t seen anywhere else, the vast bulk of it being in Finished Goods:

The absolute level of inventory reflects the sector, but I am curious about why the $20MM purchase, and how much ready to go product they have. Were they anticipating a 2.0 run? At $4.4MM in sales last quarter, that $34MM is a heck of a lot of working capital to have bound and gagged on a balance sheet.

The bio-assets pulled in of $16MM corresponds to their outdoor harvest. There remains $22MM in ‘Prepaid deposit for supply agreement’ – a remnant from APHA’s firm supply deal with Emblem that’s currently working its’ way through arbitration (examined in our last Structure).

Ultimately, if I was a shareholder, I’d be concerned about that inventory spare tire…..inasmuch as that single quarter addition represents 4 quarters of sales. It would normally indicate something big was/is anticipated. We’ll get to see what’s going on with it, but I’d guess they’re planning to have a stable supply of biomass in-house to cover the next three quarters of sales and growth, as Niagara gets stabilized and outdoor comes in in the fall.

Speaking of which, their Niagara facility was finally (finally!) licensed. Going to their conference call – one can feel the relief they have for getting the paper. That conference call fills in a couple of financial statement blanks, but not many. It seems that lack of Health Canada license and diminishing biomass availability led to product shortages in medical from November of last year until February. Non-medical sales were off too – with a lack of supply also being blamed for product shortages.

Well, with the inventory they’ve picked up, Niagara finally going, and plans to expand outdoor this year (to 86 acres no less), I doubt they’ll see those same product shortages repeated in the near term.

In some ways, they’re not in a bad position. They have no debt, no assets pledged (that I can see), and $41MM bucks. They’ve got $25MM debentures due in early 2021, so they’ve got some runway. Sales potential appears there, even if they screwed themselves by running out of product in an inventory top-heavy environment.

One might muse that the presence of Fantino and Souccar gave them a bad rep in industry, and that outfits wouldn’t deal with them because of it. While it wouldn’t surprise me, I’d think that’s doubtful. Business is business after all.

Which brings us back to Julio and Raffee one last time.

This outfit has a highly respected guy in Michael Verbora, they got licensed, sales are increasing, and they’ve got some runway. Sure, sales are no hell, but they’re in the right direction, and this is the best look $ALEF has ever been in. The capital structure – groaning under 360MM shares fully diluted – isn’t the best set of legs in the room, but relatively speaking, not many are. So a departure of 2 founders seems anomalous.

The inventory is significant, yet the CEO was adamant on the conference call that they would never take product in they wouldn’t be able to sell. They’re fully planting indoor and outdoor this year, and it appears full steam ahead.

Look for sales to grow at a ridiculously fast clip next couple of statements then, because according to management, that’s what’s gonna happen. It’s what’s going to need to happen as well – that $41MM is not going to last long with their buildout of Paris (extraction/processing) and planned operations. If sales don’t take off, they’re gonna be swimming in dope come November.

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 $ALEF