Aleafia Health Inc.

Geoffrey Benic - Chief Executive Officer Benjamin Ferdinand - Chief Financial Officer Nicholas Bergamini - Head of Investor Relations

Thank you, and thank you for joining us for Aleafia Health’s 2019 third quarter results call. Joining me is CEO, Geoffrey Benic; and CFO, Benjamin Ferdinand.

This morning Aleafia Health filed its third quarter 2019 financial statements and associated management discussion and analysis on SEDAR. Please note that this call contains forward-looking statements and reflects the company’s current expectations.

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. Geoffrey and Benjamin will now deliver remarks.

Geoffrey, over to you.

Thank you, Nick and thank you to our stakeholders for being with us today. Aleafia Health’s third quarter by a wide margin turned out to be the best quarter in the history of a young company.

As we demonstrated substantial improvements in every single key operated metric, this marks the second consecutive quarter featuring both major increases in revenue and major decreases in expense. I believe we're unique amongst her peers in that regard.

My most important mandate as a CEO when I joined this very new company in the summer of 2018, was to make the right hires at the senior management level and give them the authority to execute their individual responsibilities. The executional focus of this team is clearly impaired.

At this time last year, the sum of our business was a 7,000 square foot indoor growing operation in our Cannabis Medical Clinics. We’ve come a long way since then.

But the objective as articulated by our Board Chair, Julian Fantino has been very clear from day one, to be the global leader in cannabis health and wellness. We believe that responsible, sustainable growth today means avoiding the mistakes we've seen across the industry as operational facilities are closed and incomplete facilities are mothballed and both frontline staff and senior management officials are gone.

To continue scaling our cannabis ecosystem globally, we continue to lean on our second mover advantage. Case in point, our outdoor cannabis facility in right sized greenhouse which features the most modern growing technology.

Last year cannabis companies’ valuations were tied to the square footage of their cultivation facilities. This created a perverse intent to build or buy the largest cultivation facility possible.

The consequences of these actions are just beginning to be felt in the industry. We decided to pursue a different route, focusing on ultra-low cost cultivation and high margin production.

Last year we made a bet on outdoor cultivation. Despite major roadblocks and uncertainties surrounding licensing time, we completed our successful inaugural 2019 outdoor grow harvest, yielding 10,300 kilograms of dried flower at an all-in cost of $0.10 per gram to harvest.

Our current plan is to extract the entire harvest and use it for our high margin oil-based products. Our present cannabinoid content, which represents the true underlying value of the harvest was only slightly below the cannabinoid content of cannabis grown in our small batch indoor growing facilities.

We can now say that Aleafia Health is among the lowest producers in the Canadian cannabis industry. Next year we will benefit from a much earlier growing season and increased automation and economies of scale, as we expand our outdoor cultivation facility to 3.7 million square feet or 86 acres from the president 26 acres today.

We continue to remain extremely focused on our core business: growing, producing, selling and exporting high margin cannabis health and wellness products, rather [ph] to our other health fees, we are able to sell a higher proportion of our oil-based products versus dried flowers relative to our total sales. As a result, we realized an average revenue per gram to medical sales of $15.11 per gram equivalent sold.

This represents among the highest in Canada and again, this is coupled with our low cost production. Aleafia Health’s primary focus has been and will continue to be repeating successes on a larger scale.

As such, we're building out our sales team in key markets for recreational in both Canadian and international medical sales. From a production standpoint we made a substantial progress over recent months.

We're adding additional extraction machinery at our operational Paris facility, in order to ensure adequate extraction capacity, to process the 2019 outdoor harvest. Our Paris facility handles all extraction, packaging, order fulfillment for medical, adult use and international sales.

Likewise, with these two expansions, interior and exterior Paris facility is 100% complete and is entirely dedicated to the extraction, production, packaging, distribution of finished cannabis products. The new Paris facility will be able to extract 115,000 kilograms of dried flower equivalent annually.

The cannabis health and wellness ecosystem we built continues to separate from our peers. Today prospective patients can visit a physician and our medical cannabis clinics take propriety education courses through our FoliEdge Academy and purchase Emblem medical cannabis products through an integrated experience.

This ecosystem creates loyalty amongst patients and ultimately adds lights to major increase of medical cannabis sales, while most of our pears see their corresponding revenue stagnant or declined. Our clinic expertise and education platform, along with products, continue to be a major value add for our international partners.

For instance, our educational platform, FoliEdge Academy, is now available and being used by prescribing positions in Australia, where medical cannabis products are already in market. Over the last six months investors have clearly demonstrated a lack of confidence in the cannabis industry.

Some of these sector wide hurdles can be attributed to slow rollout of retail stores and other regulatory challenges. But clearly, investors are readily demanding a clear path to profitability, executional excellence and a focus on disciplined sustained growth.

With continued revenue growth and prudent allocation of capital, we're on the right track. I'm now pass it over to our CFO, Benjamin Ferdinand.

Thank you, Geoffrey, and good morning. Aleafia Health continues to demonstrate that our business model has very high barriers to entry and provide us with the lowest cost structure in the industry with one of the highest margins in the state.

We are focused on owning the medical health and wellness cannabis space Global. Disciplined, prudent allocation of capital remains the core focus of our management team across all divisions and that is now clearly represented today.

Examples of our model and action is our new outdoor cultivation with a cash cost growing $0.08 per gram, while being able to have high margin medical products sold for an average of over $15 per gram. That is a recipe for our very high margin business.

I'd like to highlight some of the key metrics Geoffrey spoke to at a high level. As we said in previous earnings calls, earlier this year we experienced a large number of expenses directly related to the Emblem acquisitions which have now been fully worked through in previous quarters.

Total expenses declined quarter-over-quarter by 30%. If we compare the third quarter 2019 to first quarter 2019, total expenses have declined 59%.

This expense discipline has occurred at the same time, because we have vastly expanded our production facilities and scaled our business. From an industry sales perspective, we agree with recent analysts’ commentary, that companies relying on LP to LP wholesale sales are particularly vulnerable to declining prices and demand, whereas our focus is very different.

We sell high margin cannabis health and wellness products directly to patients. This quarter packaged consumer products sold in the medical and recreational markets represented 94% of our net cannabis revenue.

This distinguishes our self from our peers. To continue this trend, we believe firmly in owning the patient experience.

From a medical market perspective LPs generally offer similar products in comparable prices. We on the other hand offer not only high quality medical grade products, but also access to physicians, specialists and our medical clinics and a FoliEdge Academy education platform.

Our active, registered Emblem medical patients increased 48% quarter-over-quarter to over 10,000 patients. A core focus of our business will be to continue this trend.

Our cannabis medical clinics and GrowWise Health Centers see approximately 3,400 need patience per month positioning us for further growth. The unit economics of our products remain very strong.

This will keep margins very high compared to other LPs who are now experiencing significant price and margin compression. Quarter-over-quarter gross profit before fair value adjustment increased 265%.

However, we believe from a production standpoint we have significantly more upside. First and foremost, in the input material from our Outdoor Grow which is cash cost of only $0.08 per gram to harvest from Outdoor will greatly reduce our cost per gram and cost of goods sold in the future, and create a great environment for high margins.

This cost of production is a fraction of some of our peers. In addition, we continue to benefit from economies of scale as we increase our sales footprint just as we saw in this quarter.

Next I’ll turn to our balance sheet. Our balance sheet is very, very strong and we are in a great position today.

As of September 30, 2019 we had over $51 million in cash along with an additional $6 million in marketable securities for a total of $57 million in cash and marketable securities. We also had $83 million in working capital.

We're in a very, very strong liquidity position and allow us for room to invest. As we have said, our operating costs have declined by two-thirds over the course of 2019.

During that time we’ve undertaken major capital projects; the Niagara Greenhouse, the Phase 2 expansion of the Paris facility and the Outdoor Grow facility, all of which are now substantially complete. We believe this puts us in an excellent position as we progress towards becoming cash flow positive.

Geoff, over to you.

Thank you, Benjamin. In closing, obviously we're pleased to have made a major step forward in all core areas of our business; however, we believe there remains a lot of room to grow and our manufacturing management teams’ remains as motivated as ever to continue on this trajectory.

Never ever have I ever felt so confident in our business and let's not forget that the best is yet to come. Operator, over to you.

Hi guys, congratulations on the quarter. Just a couple of questions.

I think you indicated that you'd be extracting all of the Outdoor Grow and using it for your own product, does that mean that you – I mean if you had excess oil would you actually want to sell that to another licensed producer if they couldn't do it themselves or is this all – do you think that all of the product that you're going to be extracting be necessary for your product development next year?

Yeah, thanks Greg, its Benjamin. So our focus is on selling to the end consumer and so, when you think about our distribution and our priority, its focused on selling to our medical patients first and foremost and we also have the recreational and over the counter channel.

But as you know, we also have an international platform to be able to distribute our products to end users as well. And so our goal is really to take you know the Outdoor harvest, extract them to high quality medical grade products and distribute to end consumers in Canada and globally.

Greg, I'd like to add to that as well that cannabis oil produced in Canada with our ecosystem is in very, very high demand globally and we're exporting our entire ecosystem in our platform in many jurisdictions internationally and it's in very, very high demand.

Great! And just moving over to the cultivation assets, you do – you’re still awaiting the licensing of the Niagara Greenhouse, but you're also – you do have a huge expansion going on next year with your Outdoor Grow.

Does this mean that your CapEx is effectively complete and that we should see far lower CapEx going forward?

Yes, it's Benjamin. Yes, so all of our facilities are substantially complete and we have very little CapEx remaining.

Great! And just could you maybe just discus a bit about your strategy for retail products for Cannabis 2.0, more aimed at the recreational market and not the medical market and sort of how you are progressing there?

Yes, this is Benjamin. So one of the reasons why we had our Outdoor low cost cultivation was to prepare us for Cannabis 2.0 and the way that we think about our model is focused on cash flow and being really diligent on our capital allocation, so we're not trying to build everything ourselves, we're working with partners to be able to get the best in class expertise and technology.

So we have a number of partnerships that we’ll be announcing in the near term.

Yes, so I'd like to add to that, specifically to cannabis 2.0 products. Greg, we’ll be producing them from when we receive an amended license for Paris Phase II Expansion.

There is a lot we're doing behind the scenes to ensure we are ready. We have licensed as Ben mentioned, a lot of large international brands, mostly coming out of California, including the formations, productions, know how, across a wide range of formats and we're going to be a big part of cannabis 2.0 space, not to mention that with our retail partnership with the Serruya private equity in One Plant, you’re going to start seeing a few more of those stores and a flagship one in the GTA, where we are going to have on the shelves, in those flagship stores in these key markets in Ontario and it’s a big part of our strategy going forward.

Great! And just one final question from me.

Your G&A spend and sales and marketing and everything through the quarter was down a lot. I mean is this a good run rate going forward.

I mean you guys, I mean this is a great trend going forward, but is this sort of sustainable or is there going to be some increase in spending going forward?

Yeah, it’s Benjamin. So our focus is not you know wasting money and streamlining our operations.

You know so it is a good level as it stands right now. But as you can imagine, as we ramp up, sales growth we’ll have to invest, but as you know us and you’ve seen us, we’ll be investing you know very prudently and only a few.

So Greg, the team is intact, very excited and everyone loves coming to work every day, and everyone's excited about executing and continue to becoming the lowest cost producer with the best products and the best outreach in our medically, vertically, integrated ecosystem here, and I could tell you the excitement in the office every day is just, is unbelievable.

And just one sort of a – just sort of a hypothetical question. You're going to be doing 86 acres of Outdoor next year.

Are you having LP's come to you that are having trouble growing indoor, asking you to potentially grow outdoor for them to get biomass?

It’s Benjamin. I won’t speak to specifics, but as Geoff’s highlighted, you know us being a leader in the outdoor space and low cost growth is really changing the industry and you are seeing a lot of these players in this space with you know overbuilt infrastructure you know and massive investments in indoor and what not, you know realizing the error of their ways and we are getting a number of calls.

But you know we're focused on as we said, you know delivering our products to the end consumer and making sure that experience makes sense and we’ll look at opportunities as they come up.

Great! I’ll get back in the queue.

Thanks guys.

Thanks Greg.

Hey guys, it Will here today online for Graham. Thanks for talking my question and congrats on a pretty solid quarter.

My first question and apologies, I cut out a bit earlier, so I might have missed this. But I was wondering if you could give an update on licensing timelines for the Paris and Niagara facilities.

So I’ll speak to that. So our Paris facility – so, we’ll start with the Niagara Greenhouse.

The Greenhouse construction is complete, and we can operate this facility within two weeks of securing our licensing. We have an ongoing dialogue with healthcare and we remain optimistic, that we are getting closer to the licensing of that facility.

Our Port Perry Phase II, we are expecting our outdoor by 60 acres for next year. The construction of the new site is almost entirely complete.

I will be submitting our licensing amendment application and package later this year. Our Paris Phase II and that's our Paris production facility two expansion is 100% complete, and we’ll have an update on submitting our sight evidence package very, very soon.

Okay great, thanks for that. So I noticed that the finished inventory was $5.6 million in the quarter.

So let's just say that equates to about 1,000 to 1,400 kilograms, plus the over 10,000 kilograms from outdoor. So just wondering how you guys are feeling about inventory levels between now and next year as you kind of wait for the next outdoor harvest and you know just, if there’s any delays with Niagara, like did you guys see wholesale as a potential alternative to kind of increase supply?

So with that – thank you for that question; it’s Benjamin. It’s clearly into two components.

On the – your second point we're not looking at wholesale as a supply. You know we’re focused on having our own product low cost and be able to control the margin ourselves, and on the first point, you know we feel very good about our inventory levels as we talked about you know the combination of our finished good inventory, our work in progress inventory that we're you know continuing to finish, as well as we've already started to process and extract through the outdoor as well.

We feel very good about our company though.

Okay, just kind of on that, on the outdoor extraction, you know with you guys seeing potency like just under normal levels, you know do you think you will extract all of that high risks or do you think you could sell a little bit into the market?

When you say into the market, you mean LP to LP.

Yeah, or even directly into like the distributors?

Got it. Yeah, so the question is would we sell some of it as flower extract and everything, correct?

Yes.

Yeah, I mean so for us you know when you look at our core patient base, it actually is over 80% you know non-flower. They are really focused on the extract, these are the baby bloomers you know and people who are focused on really health and wellness and taking you know how they treat their body very seriously.

So for us you know flower is a relatively small component and so for the most part you know all of it will be extracted from outdoor and passed through to our core patients.

I just want to make a note there as well. We have 3,400 patients coming through our clinic every month.

We're converting those patients onto the Emblem platform now that we have sustained input material and reliable input for material, our goal is to crystalize a sale with every single one of those patients and with the patients. That is our goal that is our sales initiative.

So with that said, not to mention the international experience, the opportunities that we've been speaking to were are also five per month, very high in demand. You know we think that we're going to be in a great position to sell through and not have to wait on wholesale.

Australia and Germany are two big opportunities for us, and Germany, we're in the process now of finalizing our agreement and licensing and getting our products in the market. We think that that is going to be a great opportunity for us as well.

Perfect! Thank you.

And just one last question for me – just kind of looking outside the rec market here, looking into wholesale and the medical market, you know I noticed you guys have some wholesale revenue, like LP to LP in the quarter and I’m just kind of wondering you know what your outlook is for that? Like are you guys seeing prices coming down significantly and you know how do you expect that to trend for you guys and kind of the same thing for the medical market.

You know, how do you guys see that growing because retail continues to expand in adult use.

Yeah, that’s a good question. Our focus as we said is focusing on selling into our medical and health and wellness ecosystem.

You know so for us, you know it has been published. Our average revenue per gram is $15 per gram equivalent in the medical space, so that’s the area that we’re really laser focused on and it's been that we’re seeing you know very strong prices.

We’ve got a captive audience as I mentioned. When you have 3,400 patients coming through your door monthly, because we do have the Canabo credit now where it presents a great opportunity for us to just continue selling in our brand.

So our brands are what's important to us and a big differentiator to us, in getting our patients and some are right, out-of-use consumers attached to our brands and the benefits of brands as we continue to grow the stickiness of our brands.

Perfect! Well, that's it from me guys.

Thanks a lot.