Aleafia Health Inc. (ALEAF) CEO Geoffrey Benic on Q4 2019 Results – Earnings Call Transcript

Aleafia Health Inc. (OTCQX:ALEAF) Q4 2019 Results Conference Call March 18, 2020 8:30 AM ET

Company Participants

Nicholas Bergamini – Head, IR

Geoffrey Benic – CEO

Benjamin Ferdinand – CFO

Dr. Michael Verbora – Chief Medical Officer

Conference Call Participants

Graeme Kreindler – Eight Capital

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Aleafia Health Fourth Quarter and 2019 Year-End Earnings Call. At this time all participants are in a listen-only mode. After the speakers’ presentation, there will be a analyst question-and-answer session. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Nicholas Bergamini, Head of Investor Relations. Please go ahead.

Nicholas Bergamini

Thank you. Joining me on the call today are Aleafia Health’s CEO, Geoffrey Benic; CFO, Benjamin Ferdinand; and Chief Medical Officer, Dr. Michael Verbora.

This morning Aleafia Health filed on SEDAR its audited consolidated financial statements and notes thereto for the year ended December 31, 2019, which have been prepared in accordance with International Financial Reporting Standards. The associated management discussion and analysis as well as the Company’s annual information form for its December 31, 2019 fiscal year end. All comments we made on this call today should be taken with reference to and are qualified in their entirety by those documents.

Please note that this call contains forward-looking statements or information and reflects the Company’s current expectations, estimates, projections, assumptions and beliefs about future events and financial trends that they believe may affect the Company’s financial condition, results of operation, business strategy and financial needs. By their nature, forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements or other future events to be materially different from any future events performance or achievements expressed or implied by such forward-looking statements.

Given these risks and uncertainties, shareholders and prospective purchasers of the Company’s securities should not place undue reliance on these forward-looking statements. Further, any forward-looking statements speak only as of the date on which such statement is made. And except as required by applicable law, the Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances after the date on which such statement is made. This call also contains non-IFRS financial performance measures, which the Company believes provides users with relevant information regarding operational performance. These measures are not recognized or defined under IFRS and as a result, they may not be comparable to the data presented by competitors.

I’ll now hand the call over to CEO, Geoffrey Benic. Geoff, over to you.

Geoffrey Benic

Thank you, Nick, and thank you to our stakeholders for being with us today.

In the period of economic uncertainty for the cannabis industry and globally, Aleafia Health continues to progress through disciplined sustainable growth. This has been a transformative year for Aleafia Health. Before I identify some of these highlights, I’d like to first address the ongoing COVID-19 pandemic.

Risk factors related to the impact of COVID-19 on our business and operations have been addressed in our annual information form filed on SEDAR. We’ve taken decisive action to ensure the safety and security of our patients. Since yesterday, all appointments in our national network of cannibal and GrowWise Health clinics have been moved to telemedicine.

As we announced in October, 2018, we have made significant investments to build the capabilities to scale our business through telemedicine. Today, those investments are more important than ever. As a result, we believe that we are in a position to not miss a single appointment. In addition, the safety and security of our patients means also ensuring our patients receive access to uninterrupted medical care.

Our Chief Medical Officer, Dr. Michael Verbora, joins us today, as a physician, who also practices in our clinic and Assistant Professor at McMaster University School of Medicine. He will position to provide some insight on.

Dr. Michael Verbora

Thank you, Geoff.

As Geoff alluded to, we began implementing country-wide telemedicine capabilities in 2018. At the time we moved to telemedicine with the business decision to allow our patients and physicians greater choice in how they access or practice medicine, while simultaneously reducing barriers to care for patients.

Today, we can appreciate from a health and safety perspective, these investments are of even greater importance. Earlier this week, we implemented a nationwide plan across our clinic network. We are proactively contacting every patient in advance of their appointments and providing them with instructions on how to complete their medical visits remotely. Despite the turbulent health environment, we are ensuring all of our patients are seen and their care remains uninterrupted. It is important to appreciate that as a health and wellness company, the responsibility we take as an organization is twofold: One, we must ensure the safety of our patients and staff; and two, we must always ensure that access to medicine continues uninterrupted for our patients.

Furthermore, given the global concern regarding COVID, we have begun offering medical expertise via our telemedicine network to connect any patients across Canada to medical professional to discuss concerns regarding the virus and appropriate screening measures. Many fields [ph] recognize that the patient population of medical cannabis users consists of complex patients such as children with epilepsy or autism, where the risk to their health without access to cannabinoid therapy can have grave consequences. It’s clearly throughout our organization and instilled in our culture that the health of our patients is and will always be a top priority.

Geoffrey Benic

Thank you, Dr. Verbora. We really appreciate you joining us today. Our entire team is focused on ensuring our patient care continues, and I’m very proud of how we’ve handled this responsibility.

Now, we are a relatively a cannabis company. In fiscal 2018, our cannabis sales were $600,000. But even from those humble beginnings, we did have the vision, which is a very clear from day one, to be the leader in cannabis health and wellness. That vision remains true today. Our Q4 2019 was again a significant step forward on the path to profitability. We have now reported our first quarterly positive adjusted EBITDA. While most of our peers reported a sequential decline, our cannabis net revenue has increased 27% quarter-over-quarter, led by medical cannabis sales and wholesale. Year-over-year, cannabis revenue has increased 1,748%, and perhaps most importantly, we can report 80% gross margins on cannabis net revenue. 80% gross margin is to our knowledge among the best in this cannabis industry.

We are a growth company in what has been a growth industry. However, it’s very clear for us to see that times have changed. The most capital increases — the cost of capital, sorry, increases every day and balance sheet’s risk hangs like a cloud over the sector. Like many analysts, we knew this wakeup call could arrive for this industry. But, we did not wait for it. Rather, we took decisive action over a year ago to ensure we could weather the storm when it arrives.

It was almost exactly a year ago today that we closed the acquisition of Emblem. Since that time, we’ve instituted a culture of disciplined growth, reducing overheads and focusing on core revenue generating operations. In Q4 2019, our SG&A expenses were $4.3 million, a decline of 11% over the previous quarter. I’m excited with how far we’ve come, but we aren’t resting on our hands. We have a long way to go. And to do that we will continue to lean on Aleafia Health second mover advantage. This means avoiding mistakes made by some of our peers.

In 2018, cannabis companies’ valuations were tied to the square footage of the cultivation facility. This created a perverse incentive to build or buy the largest cultivation facilities possible. The consequences of these actions are just being felt in the industry today. Since the outset, facility licensing has been a significant problem for the business. Obviously, we have some important news arrived over the weekend, receiving the cultivation license for our Niagara facility. To say, it’s long time coming, we see an understatement, but we have been prepared for this day for months.

Despite the size and scale of our outdoor cultivation, the Niagara facility remains incredibly important for us for three reasons. First, it will serve as a base of our operations for our outdoor cultivation, with clones grown in Niagara and then transported to the outdoor site. This significantly reduces risks and lead time relative to planting seeds. Niagara will also play a role following the outdoor harvest in the fall.

Second, because it’s much needed source of input material for dried flower products, we do not have enough capacity at our indoor facilities to replace the loss of expected supplies from third parties, specifically for the adult-use market. We have not been able to attain product from third parties that meet our needs.

Lastly, we have heard a lot about facilities being right sized, in other words closed down, but the Niagara facility was built right sized from the get-go and modest — at a modest 150,000 square feet, this was appropriate for our uses today.

So now, we finally have the licensing bottleneck opening and only two outstanding amendments for our expanded Paris production facilities and our expanded Port Perry outdoor grow facility. While there can be no certainty on when the license amendments will be secured, we feel confident that both will arrive during the next quarter.

During the reporting period, we completed our inaugural outdoor cultivation harvest. Our very conservative estimates at this time indicated that we yielded approximately 10,300 kilograms. Since then, we’ve completed drying and curing process and its essential tally is 12,747,000 kilos of dried flower. We sold 1,122 kilograms of outdoor flower in Q4 2019. In this Q1 2020 to-date, we have sold an additional approximate 4,000 kilos and will — and continue to consider additional transaction.

Looking forward, the cultivation infrastructure for Port Perry Phase 2 outdoor cultivation expansion to 86 acres is complete. The application submitted and we’re looking forward to plant in the spring.

The fourth quarter was significant also for our Paris to say. This is by far the crown jewel of our production ecosystem, and our most important facility. It’s where all of our finished products are produced, packaged and shipped. We have now completed the Phase 2 expansion of Paris, which will exponentially increase our ability to produce, sell value-added cannabis products. The facility has been purpose built to meet EU-GMP certification requirement. Senior members of our team have spent their entire careers in EU-GMP production, and their expertise will be essential as we look to gain market access to the EU.

Looking forward, we have recently hired medical cannabis sales veterans to help grow our core business. We continue to believe the medical cannabis, both in Canada and abroad remain incredibly attractive market, which many have ignored. Our medical sales have increased significantly in the last month as we see some of these changes paying dividends.

I’ll now pass the call over to our CFO, Benjamin Ferdinand.

Benjamin Ferdinand

Thank you, Geoff.

Now, we will look to our financial results for 2019. As Geoff alluded to, it was a year of significant, consistent growth for Aleafia Health. This was our fourth consecutive quarter reporting record revenue. Q4 2019 was a great quarter for us as we achieved our first quarter of positive adjusted EBITDA, a significant milestone. This quarter really demonstrated our differentiated health and wellness strategy and action as our team executes very, very well.

Our strategy has high barriers to entry and provide with dependable, long-term competitive advantage relative to our peers. On top of that, we are laser-focused on having one of the highest margins in the business, the right cost controls, disciplined capital allocation and relentless execution. Year-over-year, net revenue increased by 391%, led increases in cannabis and clinic revenues.

Our cost management discipline has been demonstrated as we have seen expenses decline sharply throughout the year.

To put things into perspective, total expenses for the first two quarters of 2019 was $32 million compared to only $17 million in the second half of the year. We will continue to be vigilant from stamping out any unnecessary costs. From a liquidity perspective, our balance sheet remains very strong as we reported $41 million in cash. Our cash burn continues to decline significantly as we drive towards profitability, and that should only improve as we increase sales and with major capital projects already completed.

Now, we will look deeper into our product segments. Medical cannabis sales increased 19% over the previous quarter and medical cannabis gross margin was 68%, compared to 44% in the previous quarter. Patients have increasingly moved towards higher margin products, including capsules and sprays relative to dried flower. We’ve also made significant improvements to production processes of the Paris facility to increase operational efficiency. All of this contributes to our higher margin profile.

Having said that, we have continued to experience some supply challenges due to the loss of expected supply from third parties. Certain top selling medical products are stopped between November and early February due to a lack of raw input material. A successful outdoor harvest helped rectify this, and we now have built medical inventory. Now that we finally have sufficient inventory, we have reallocated resources towards expanding our medical sales team. There is substantial room for growth in medical sales through both attracting new registered patients and increasing revenue per patient.

Bulk wholesale net revenue was $2.8 million in Q4 2019 and was sold at 97% gross margins. This demonstrates the power of successfully executing our low cost, high quality outdoor cultivation. We were the first to plant on a large scale legal outdoor cannabis crop in Canadian history. Our operations team performed fantastic work in navigating all the challenges that were attempted and we are looking forward to doing this on a much larger scale this spring, utilizing 86 acres of cultivatable land on 3.7 million square feet.

Lastly, adult-use revenue for the quarter was down decreasing by 70%, largely due to lack of supply for recreational products. Fortunately, the challenges experienced were not permanent. Our Niagara facility license that we just received not only creates a support system for executing on our outdoor crops but also provides us with the ability to create high quality streams for both the recreational and medical market. Prudent allocation of capital remains our top priority. As sales increase, we do not expect to see a commensurate increase in overhead costs, as we take advantage of our operational leverage and business model strength.

We expect that our $41 million in cash is more than sufficient to fund our operations for the next year. However, should additional capital be required for new growth initiatives, we will prioritize non-dilutive financing methods. For example, we have three major facilities all of which are unencumbered and have no debt. We have the option to monetize them through different arrangements, including credit facilities and sale leaseback.

As you look to Q1 2020, our business model already has a large virtual presence, as Dr. Verbora mentioned the telemedicine and shipping to home. So, we’re already well-prepared to deal with the ongoing crisis. We will continue to serve as clients with the medical first focus in this challenging environment. We believe that now is time that investors and analysts will finally start to reward companies with high margins, low cost structures, high operational leverage and a clear path to cash flow and profitability. This will start to lead to a differentiation between competitors, and there will be clear winners and losers in this market.

Nick, over to you.

Nicholas Bergamini

Thank you, Ben. That concludes remarks. Operator, you may begin the question-and-answer session.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Graeme Kreindler with Eight Capital. Your line is now open.

Graeme Kreindler

I just wanted to follow up on the comments with respect to the gross margin, very strong gross margin in the medical and wholesale channel. I was wondering if you could provide some color in terms of the gross margin on the adult-use side, and how you expect that to trend in the coming quarters in addition to the scale-up of Niagara, whether that might see a bit of a headwind, as you go through that process? Thanks.

Geoffrey Benic

So, I’ll let Ben answer that question. Ben, go ahead.

Benjamin Ferdinand

Thanks, Graeme. So, our margin profile for adult-use is about 40%, and that compares to medical at proximately 68%, and our wholesale at around 97%. And to your point around Niagara, for us, what that’s going to do is do two things. One is, as Geoff alluded to, it will be a support system to prepare for outdoor growth and it will also allow us to create lower cost, high quality, flower and strains for medical and the recreational market, lower cost compared to the indoor. So, we view this as a very big positive for us, which will allow us to create a product at scale and feed into our outdoor network.

Geoffrey Benic

Hey, Graeme, I’ll just want to add.

Graeme Kreindler

Sorry. Go ahead.

Geoffrey Benic

I just want to add to that as well Graeme is that the — first of all, we don’t plant anything that we’re not forecasting that’s selling, and that includes our 4 million square feet that we’re anticipating on our outdoor and our 160,000 that we think we’ll get this year on our — that’s hybrid modern and greenhouse facility. We think that there’s a void in the marketplace for a high THC flower in both medical and adult-use, and we plan on using our greenhouse to meet that and exceed that void.

Graeme Kreindler

Okay, thanks. And to follow up on that is, you’re just trying to get an appreciation for the timeframe in which that greenhouse can get ramped up. Is there a target date set right now for when you’re expecting a first harvest?

Geoffrey Benic

So, I’ll answer that. So, I could tell you, flowers are — plants are going in as we speak. So, if I can connect the dot in our ecosystem, the first order of business for that greenhouse is to get our clones ready for outdoor harvest — sorry, outdoor planting season, which we anticipate will be about [indiscernible]. We are going to have — we are in a process of propagating and putting 100,000 plants in that facility and getting ready to be transplanted to outdoor space. Once that complete, then we’re going to continue going down the path of high-yielding, high THC, high-quality flower.

Graeme Kreindler

Okay, thanks. And then, another question, just to switch the topic here. Maybe if you could discuss, I guess maybe over the past 14 days or so, what the purchasing behavior — has it changed at all from any of your customers, whether that’s on the medical side, the wholesale side or from the provincial control boards? Seen a lot of headlines here about volumes picking up as customers are looking to stock up, in light of the current environment. So, any color you could provide on that and how you think that might trend over the next month or two would be helpful. Thanks.

Benjamin Ferdinand

Yes. Thanks, Graeme. Look, the great thing about our business model is that, it already has a large virtual presence in telemedicine going back to 2018. And so, we’re already built for this virtual environment, shipping to home and medical first. So, we stand out there ready and we have been, as Dr. Verbora has alluded to and Geoff alluded to, we have not missed any important appointment and have continued to service the surge in the environment. And we continue to put our patients first and stand up there ready to make sure that they get their medicine. So, we’re continuing to execute. And our business model was built for these types of volumes.

Graeme Kreindler

Okay, thanks. And then, my final question with respect to the adjusted EBITDA figure in the quarter. If I recall correctly, I think there was about a $1.6 million add-back of onetime transaction-related costs. So, I was just wondering if you could provide a bit more detail what that pertains to.

Benjamin Ferdinand

Yes. This pertains to a number of onetime transactions such as we’ve explored various potential transactions, which haven’t been announced but those are transaction costs that will subside, that are related to business acquisitions and transactions that we’re investing and that includes the banker, lawyer, consultancies.

Operator

Thank you. This concludes today’s question-and-answer session. I would now like to turn the call back over to our speakers for closing remarks.

Nicholas Bergamini

Thank you, everyone for — go ahead, Geoff.

Geoffrey Benic

No. I just really want to thank everyone that joined this call from our analysts, obviously to our shareholders and out there to some of our patients and some of our customers. This is an incredible time in our history as our history continues to evolve. One thing that we’re proud of about use of term in the industry right now is we use a term called cash barbecue. A lot of the LPs out there unfortunately have become cash barbecues. We pride ourselves to being very efficient, very effective and most of all, we focus on execution. And it’s something that I think as a shareholder and as a leader of this organization we pride ourselves on. And I — we will continue going down the path of representing our shareholders as best as we can. And I use the term as well that we throw nickels around like manhole covers in this business. And I truly, truly feel that way today is that we are looking out for our shareholders’ best interest.

So, we want to thank you for your questions. And on behalf of our Board of Directors, our management staff, we thank you for joining us today. Stay safe. Thank you. And I always say this and I want you to truly believe this that the best is yet to come. And that concludes our call today. And Nick, over to you.

Nicholas Bergamini

Thank you for joining us.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.

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