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HIGHLIGHTS
  1. Aleafia has cancelled a five-year, 175,000 kilogram supply deal, “after a consistent failure by Aphria to meet its obligations,” according to Aleafia.
  2. Aphria has struggled to meet production promises, due to delays in getting facilities licensed and operational.
  3. Collapse of deal highlights the risk of relying on a single source of third-party production.

Aleafia Health Inc. has cancelled a 175,000 kilogram supply agreement with Aphria Inc. – the largest publicly disclosed LP-to-LP supply deal to date – “after a consistent failure by Aphria to meet its obligations,” according to Aleafia spokesman Nicholas Bergamini.

The agreement had been negotiated between Aphria and Emblem Corp., which was acquired by Aleafia in March. Shipments from Aphria to Emblem were set to begin in May of this year, starting with 25,000 kg in the first year, and building toward 45,000 kg a year by 2023.

Mr. Bergamini did not say whether the cancellation was due to Aphria’s inability to supply enough cannabis or due to the quality of cannabis being supplied. He did point to an Emblem news release from September 2018, which said that Aphria would supply “high quality dried cannabis flower and crude cannabis oil at preferred wholesale pricing.”

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In a statement released by Aphria, the company said it “had every intention of fulfilling its obligations under the agreement,” and had “made good faith efforts to ensure continuation of the agreement.”

Aphria did not respond to multiple requests for further comment.

Aphria’s agreement with Emblem in September, 2018, was premised on the company having a full production footprint, including its 1.4-million-square-foot Aphria Diamond greenhouse, fully licensed and operational by early 2019.

Aphria Diamond, however, has yet to be licensed by Health Canada. On its most recent earnings call, Aprhia’s management declined to provide guidance on when it expects the facility to be licensed. Aphria will report its next quarterly results on Oct. 15.

It also took longer than anticipated to get Aphria’s main greenhouse facility, Aphria One, fully licensed. A full 800,000 square feet of production space in Aphria One (known as Part IV and Part V of the facility) was not licensed until March. Likewise, leading up to Part IV and Part V being licensed by Health Canada, Aprhia had to allocate a significant part of its already licensed growing space to mother plants, in order to prepare for Part IV and Part V.

At the time of the deal, Aphria said it would be producing 255,000 kilograms on an annualized basis by early 2019, which it said would give it enough supply, “to meet all of our supply commitments across Canada and anticipated international demand, but also have the capacity to support the projected demand through our partners.” So far, however, Aphria has fallen far short of those production targets, which are based on having all 2.4 million square feet of greenhouse space operational.

The collapse of the agreement with Aleafia is a reminder of the risks of relying on a single third-party for production, at least in the early phase of the market, when LPs are struggling to scale up and grow high-quality product.

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This risk was addressed succinctly by Tilray Inc. CEO Brendan Kennedy on an earnings call in May.

“A lot of the Canadian LPs were being valued on a really strange metric. They were being valued on a multiple of funded capacity, which led all of the CEOs of the public LPs to grossly overestimate the capacities that they would have in place today,” said Mr. Kennedy.

When it entered into a supply agreement with Aphria, Emblem abandoned plans to acquire Leamington, Ont.-based greenhouse grower Natura Naturals Inc.

“I hated that [Aphria] deal and I opposed that deal when Emblem signed it, but I was already the odd man out,” said Maxim Zavet, co-founder of Emblem, who was an Emblem board member at the time of the deal, but left the company before the acquisition by Aleafia.

It was risky for Emblem to rely heavily on outside production, said Mr. Zavet, now CEO of Robes Cannabis, in an interview with Cannabis Professional.

“I knew Aphria was a low-cost, low-quality producer, and I’m still a firm believer... you can’t re-brand bad product,” he said. “I wanted us to be in control of our own destiny, and I knew the market at the time rewarded more capacity than supply deals like that.”

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“If Emblem wasn’t acquired by Aleafia, it would have been a huge problem, because they sort of put their cards on that horse,” he added.

Aleafia is reserving the right to seek damages against Aphria for breach of contract, which could include seeking the return of roughly $23-million that Emblem and Aleafia paid to Aphria as a deposit.

Mr. Bergamini said that the termination of the Aphria supply agreement won’t adversely affect Aleafia’s business.

“Aleafia Health maintains a wholly-owned, robust cannabis production ecosystem with high-margin products and a newly expanded, 86-acre low-cost outdoor cultivation facility,” he said.

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