Tilray Brands, Inc. (TLRY) Q2 2022 Earnings Call Transcript

Good morning, everyone. Thank you for joining us to discuss Tilray, Inc.'s Financial Results for the 2022 fiscal Second Quarter ended November 30, 2021. Joining me on today's call are Irwin Simon, Chairman and Chief Executive Officer; Carl Merton, Chief Financial Officer; Blair MacNeil, President of Tilray Canada; Denise Faltischek, Chief Strategy Officer and Head of International; and Berrin Noorata, Chief Corporate Affairs Officer. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session for analysts and investment firms, conducted via audio and participating retail shareholders conducted through the Say technologies platform. Questions submission and uploading through the Say technologies platform has already been concluded and the company will read aloud and answer the top questions. Ms. Noorata, you may now begin the conference.

Thank you. Good morning. By now, everyone should have access to the earnings release, which is available on the Investors section of Tilray's website at Tilray.com and has been filed with the SEC and SEDAR. On today's call, we will be referring to various non-GAAP financial measures which can provide useful information for investors. However, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Today's earnings press release contains a reconciliation of each non-GAAP financial measure to the most comparable measures prepared in accordance with GAAP. Also, please note that we will be making numerous forward-looking statements. These statements are based on our current expectations and beliefs and involve known and unknown risks and uncertainties which may prove to be incorrect. Actual results could differ materially from those described in these forward-looking statements. The text in our earnings press release issued today includes many of the risks and uncertainties associated with such forward-looking statements. And now, I'd like to turn the call over to Tilray's Chairman and CEO, Irwin Simon.

Thank you, Berrin, and hello, everyone. We thank you for joining us for our call this morning. As the operator just noted, I want to recognize the new additions to our call today, including Blair MacNeil, President of our Canadian business, who will speak on the evolution of our Canadian business and the Canadian market, and Denise Faltischek, President of our International Business and Chief Strategy Officer, who will speak on our global operations and its strength at the heel of international growth and legalization across Europe. For all of the reasons we will discuss this morning, we're excited to be announcing a new parent name for our company, Tilray Brands, Inc. Our new name reflects our evolution from a Canadian LP to a global consumer packaged goods company and branded powerhouse with a market-leading portfolio of cannabis and lifestyle CPG brands that are empowering the worldwide community to live their very best life. Through the completion of our business combination last year, we positioned Tilray as a disruptive cannabis industry leader with a portfolio of highly sought-after brands that bring people together in a memorable and positive way, contribute significant operational scale, benefit from a broad global distribution footprint, and last but not least, flourish from hands-on CBG expertise and operational excellence across the board. The economic engine driving shareholder value is our model that seeks to generate current cash flow, positive EBITDA while adding the infrastructure, production facilities, and distribution networks to capitalize on long-term growth opportunities that come with increasing acceptance of medical and recreational use of cannabis globally and ongoing cannabis legalization. This is the heart of Tilray's value proposition, and it's unique among our peer set. Most importantly, this model constitutes the road map to $4 billion in revenue by the end of fiscal 2024. As our results today underscore, we are making tangible and notable progress towards executing against this opportunity despite challenging conditions in certain key markets and geographies. Despite the continuing challenging backdrop driven by COVID and other competitive considerations, we delivered growth in the second quarter compared to a year ago. We're also deeply gratified with second quarter results, including our eleventh consecutive quarter of positive adjusted EBITDA, a strong affirmation of our ability to achieve top-line growth and have paired it with smart, disciplined operational acumen. While there are multiple factors that contribute to this relatively strong outcome, none is more notable than the grit, hard work, and resilience of Tilray's global team. They are performing admirably under some trying conditions, and I'm immensely proud of their ability to execute. Second, we have been proficient and flexible in terms of simplifying our supply chain, particularly in light of today's headwinds facing our businesses. This combined with our production and cultivation efficiencies we have gained through the integration have allowed us to partially offset the negative impacts of COVID and current cost pressures impacting every segment of the global economy. Importantly, we believe there are temporary headwinds which, when they abate and conditions normalize, will put us in an even stronger position for growth as we capitalize on our leading brands, our distribution network, our proven execution skills, and our strong financial profile and scale in Canada, Europe, the US, and the opportunities around the rest of the world. With that, I will now turn the call over to Blair MacNeil for discussions on our Canadian business.

Thank you, Irwin. I'm very pleased to be here speaking with all of you today and providing an update on our Canadian business. I'm excited to have joined the Tilray team from Bacardi, where I successfully ran their Canadian business for the last five years. I see tremendous growth for Tilray in the Canadian market, bringing new consumers into the market and taking consumers away from the illicit market. At the highest level, this market remains defined by an oversaturation of licensed producers and retail stores, leading to unsustainable price compression and lack of profitability. I want to be clear, we do not believe this is a sustainable environment. The strong will survive, so we view this as a temporary pain point and an opportunity. Namely, we are being more aggressive to win share, capitalizing on our iconic and leading brands, our innovation pipeline, industry-leading cultivation capabilities, boots on the ground provided to us through our expanded distribution partnership with Great North Distributors, and the strength of our balance sheet. Importantly, even in this intensive price competitive market, we have maintained our number one leading market share position in Canada and leading positions across our portfolio of brands with top rankings across adult use product categories such as concentrates, edibles, flower, oils, pre-rolls, topical, vapes, and beverages based on recent HiFyre sales data in Canada for the months of September through November. Still, in the second full quarter since the completion of the business combination, our retail market share declined to 12.8% from 16% in the sequential period because of the heightened price deflation. As I alluded to, our pricing strategy is to defend share to a point, but we will not severely compromise margins. And to protect our gross margin, we are implementing several initiatives to ensure we have the right cost index to compete profitably. To be clear, our Canadian market share strategy is to execute relentlessly and with precision across two main fronts that complement and reinforce each other: first, the strategic price reductions will drive near- and long-term growth in our fastest-growing categories – vapes and prerolls – and position us for strong upside when the market consolidates further; and second, we are ramping up initiatives to educate and bring in new consumers through many different fronts, including partnering with retail and budtenders and delivering a more aggressive marketing strategy and product innovation pipeline through business intelligence and insights. On the medical front, we are also rolling out a new Tilray medical website and patient platform that gives patients access to all four medical brands and enhances their experience. This includes Tilray Medical, Aphria Medical, Broken Coast Medical, and Symbios. In short, we have the scale and resources in Canada to allow us to double down on brand and strategically win.

Thank you, Blair. Thank you all for joining us today. Internationally, our presence continues to grow. We now offer branded medical cannabis in 20 countries around the world, reflecting the trust that governments, healthcare professionals, and patients place in us every day. Importantly, over the past five years, while everyone else was focused on other markets, we were focused on Europe. We strategically invested, acquired, and built a strong infrastructure team and business across the EU, which has twice the population of the US and 20 times the size of Canada. Just within the last couple of months, policy discussions on the legalization of cannabis for adult use have intensified throughout Europe, with Germany and Portugal being the most prominent candidates. The dominoes are beginning to fall, and Tilray is uniquely and optimally positioned when they do. Our two state-of-the-art cultivation facilities in Portugal and Germany provide EU GMP certified pharmaceutical-grade medical cannabis, and we have sales and distribution arrangements to supply cannabinoid-based medicine through major pharmaceutical distribution channels. This includes, among others, our wholly-owned subsidiary, CC Pharma in Germany, which has preferred access to approximately 13,000 pharmacies and Grow Pharma in the UK. Notably, Tilray is the only company currently supplying the German government with medical cannabis cultivated in-country, and we are the market leader across Germany in medical cannabis extracts and dried flower combined, which helps ensure that patient needs in Germany are met with products of the highest quality and safety while at the same time ensuring consistent supply and reducing dependence on importation. In Germany, our revenue related to medical cannabis extract products grew 16% versus last quarter, and we now have a market share of 64% in the extract market. Our revenue related to dried flower products grew 10% versus last quarter, and we now have a market share of approximately 16% in the dried flower market. As of November, Tilray is now the market leader in Germany with an overall market share of approximately 20%. Our strong reputation and product quality and safety and science-based cannabis research also puts us in an excellent position to capture the enormous opportunity for both medical and adult use legalization in the EU. That time may be nearer on the horizon because Germany's incoming government coalition has reached an agreement to legalize adult use cannabis nationwide within the framework of a regulated market. In terms of population, Germany would then become the largest country in the world to permit the sale of adult use cannabis on a federal basis. When that milestone does occur, we believe we have a head start on the competition based on our EU GMP certified cultivation facility currently operating in Neumünster, Germany, which has additional capacity to immediately support the recreational market. We have a track record backed by science, technology, and quality control standards to offer high-quality adult use cannabis brands and products on a consistent basis that we are confident would be well received in the market. We are also a market leader within other countries in Europe, where we have achieved the following: in Portugal, we are the only approved medical cannabis product in the market with our T18 dried flower, which is distributed through our distribution partners to medical stakeholders throughout Portugal; in Luxembourg, we were selected by the Luxembourg Ministry of Health as the exclusive supplier for the country's medical cannabis program for dried flower and oils; in Switzerland, we distribute our cannabinoid-based medical extract products to Swiss patients through our local partner; in France, we were selected as one of four suppliers in a two-year pilot experiment to supply approximately 3,000 patients with medical cannabis; this experiment was to inform a regulatory framework for medical cannabis going forward, and we expect the French medical market to be in the order of magnitude of Germany; in Italy, we are one of five distributors licensed to import medical cannabis into the Italian medical market; in the UK, in the quarter, we completed our first shipment of a broad range of dried flower products with high, medium, and balanced potencies into the UK market; in addition, we are one of only three suppliers within the Irish market whose cannabinoid-based medical products are eligible for reimbursement. As we look ahead, regarding legalization more broadly, we expect all of Europe to legalize medical use cannabis within the next 12 to 24 months, and certain countries legalizing adult use thereafter. Right now, there are compelling signs that Portugal and Israel are also gearing up for adult use markets. Outside of the EU, our businesses in Australia and New Zealand are performing very well, with Tilray-branded extracts and flowers leading the market. To give some highlights, Tilray was the first company to have both purified CBD and balanced THC extracts registered in New Zealand by meeting their high-quality standards. This took effect October 1, and the rollout of our products is going very well. Patients now have accessibility to all four Tilray products offered in the market, and we are well positioned to drive ongoing growth. In Australia, the reputation and trust in our brands continue to grow. To give an example, through a contract with the Department of Health in Victoria, 90 children are now participating in a government-funded seizure program using our products, which will continue until the end of 2024. Consistent with this growing trust in our brands, more national pharmacies in Australia have requested Tilray product by name, driving a 29% increase in revenue quarter-over-quarter. In fact, our performance would have been stronger had our sales team not been prevented by COVID lockdowns from promoting our products face to face. Turning to the rest of the world, we see additional opportunities in Argentina, where we benefit from our distributor relationship with ADP, in Brazil, and even China and India. So, in short, our international opportunities are tremendous, and I look forward to keeping you updated on our progress. I'll now turn the call over to Irwin for a discussion of our US operations before Carl closes the prepared portion of our remarks with a detailed financial overview.

Thank you, Denise and Blair. In the US, I want to start with our CPG businesses SweetWater Brewing, Manitoba Harvest, and our new addition Breckenridge Distillery, which together generate approximately $150 million in annualized revenue and profitable EBITDA and have exciting potential for future growth. To offer some insight, utilizing our current footprint in the US today, we're able to invest in these strong brands, meaningfully expand their presence, and leverage their distribution systems to parlay into CBD beverages, CBD personal care, and related adjacencies. The free option at play is that these attributes will later be translated into THC businesses, in addition to our beverage alcohol businesses. Upon federal legalization in the US, much like our MedMen investment, we'll continue to explore THC options in the US market once additional clarity is available. SweetWater is known for its 420 beers, among others, but since our acquisition of the business a year ago, we've expanded the product line to include spirits, ready-to-drink vodka sodas in a can in collaboration with our Canadian cannabis brand, RIFF, as well as hard teas and lemonades, and new craft beers including a new imperial IPA and a BC lager in collaboration with our award-winning Canadian craft cannabis brand, Broken Coast. It is our intention to make US beer consumers more aware of our Canadian cannabis brands prior to federal legalization because we have data that shows that beer drinking consumers are often cannabis users too. We have even more opportunities with SweetWater down the road, such as developing CBD products or infusing non-alcoholic spirits with THC. In addition to the new SweetWater taproom located at Denver International Airport, and please visit it on your trips, we also recently acquired a second SweetWater Brewery and taproom in Fort Collins, Colorado, both of which enable SweetWater to pursue their expansion to the rest of the US and in the western states. Just a few weeks ago, we announced the acquisition of Breckenridge Distillery, widely known for its award-winning bourbon whiskey collection and innovative craft spirits portfolio, including bourbon whiskey, gin, and vodka. Breckenridge is an exceptional leading brand that has current distribution across 50 states. Working with its founder, Brian Nolte, and his team, all of whom will remain in place, we plan to bring our CPG brand building expertise to bear and make targeted investments in marketing, brand awareness, and increased distribution. Even now, Breckenridge will benefit from synergies on the distribution side when paired with SweetWater. We are confident that these steps will drive growth both now and in the future. I should note that both SweetWater and Breckenridge distilleries are businesses that are cash flow positive, EBITDA positive, and can be leveraged for cannabis when federally permissible. SweetWater's distribution currently reaches over 47,000 on and off-premise points of sale, and we are continuing to build the business. Right before year-end, SweetWater announced the acquisition of Alpine Beer and Green Flash, iconic West Coast craft beer brands to be brewed in our new Fort Collins facility for West Coast distribution, all of which complements SweetWater's existing product offerings and gives us a strong foothold in California and the western part of the United States, the largest state economy in the US and the largest legal cannabis market in the world. I spent my career building CPG brands with teams that I work with today. We've brought this expertise to Tilray with an ability to identify and significantly expand leading CPG lifestyle brands that resonate powerfully with consumers even without legalization. We can therefore grow these brands while building all the sets and pieces for the immensely positive impact that legalization will bring one day. With this in mind, I'm excited about the very fast growth of the spirits category in the US. We're exploring additional opportunities to build out our beverage alcohol business through more categories and, of course, brands. The CPG deals in turn ensure access to even more potential and deal flow and accretive EBITDA for us. Turning now to Manitoba Harvest, we have stabilized the business since assuming ownership by rebuilding its core hemp food portfolio. In the latest 12 weeks, our US consumption in measured channels is up 2%. On Manitoba Harvest, a significant turnaround from the double-digit decline that brand was experiencing at the time of our business combination. We intend to accelerate the business through 2022 as we're introducing a great deal of product innovation that will enable us to capitalize on consumers' interest in hemp products aligned with plant-based, low carb, or keto diets. As a certified B Corp, Manitoba Harvest is committed to educating consumers about both the nutritional benefits and the sustainability of hemp as we grow consumer trial and awareness of hemp foods. Additionally, we are leveraging our ingredients division to collaborate with CBG partners who are incorporating hemp seed, hemp protein, and hemp oil into their brands. Our Tilray Wellness business is also developing multiple CBD beverage products for launch in 2022. We'll take full advantage of our beverage manufacturing capabilities to deliver these innovative products to market. Manitoba Harvest products are currently available in 17,000 stores in the US. As with SweetWater, there is room to run. Beyond that, as we grow each of these brands, we will be able to use these distribution systems to parlay into CBD beverages, personal care products, and related adjacencies. These may later be translated into THC-based products upon federal legalization. In both cases, we do not need to expend significant capital, build production facilities, or distribution networks. They already exist and can be leveraged. We are setting the standard. Manitoba Harvest has the opportunity to become a multiple 100 million dollar company. This is a clear reflection of the fact that even now, before federal legalization, we're building out our US infrastructure through cannabis adjacent products, putting the pieces in place to drive revenue growth today and to allow us to hit the ground running once legalization occurs and these assets can be more fully leveraged. That being said, we view our ability to go on day one as important in that process, which is why we invested in convertible notes of MedMen. We have multiple benefit options regarding MedMen. More broadly, we continue to build our strategic position through multiple alternatives so that we can fully benefit from legalization when the time comes. Of course, we could take additional options on multiple MSOs now, but this approach only provides options since we could not recognize revenue or EBITDA from the underlying businesses and are dependent upon regulation to realize the full benefits of these options. Moving on, I will touch on our progress in delivering the $80 million in cost synergies we've identified as part of the Tilray Aphria business combination. In short, we are ahead of our original pace, having reached $70 million on a run rate basis to date, with actual cash savings close to $36 million. Carl will speak in more detail on our progress against the synergy goals in a minute. In conclusion, to sum up, before I turn the call over to Carl, Tilray's business model, which is based on current value we are generating from our business in Canada, international, and US, plus the upside that comes with legalization, is the backbone of our strategic plan and we remain on track despite headwinds. Our strategy and team are in place and executing, and we are leading and differentiating our market position. We are looking at all ongoing opportunities to drive synergies, reduce production costs, and a strong pipeline of transaction and growth opportunities worldwide. At the same time, we are cognizant of the near-term challenges facing our business and the current pressure on our shares and that of our industry and the global economy in general. Omicron is likely to exacerbate these challenges. While unfortunate, neither does it deter us from executing on our mission to further build our position in the global cannabis industry. In fact, they enable us to make investments and adjustments now that will pay even bigger dividends when the market and the global economy normalize. We have the brands, we have the team, we have the plan in place, all to drive consumer demand, and we will reward our shareholders and allow us to win. With that, Carl will now discuss our financials in greater detail.

Thank you, Irwin. Let's now discuss our relative strength during Q2, the synergies we are successfully building into our business model, as well as our cash and liquidity position. At the highest level, the quarter was unquestionably impacted by a variety of factors including, as Blair mentioned, marketplace saturation in Canada and the impact of COVID on our operations. Importantly, we are confident that the medium to long-term implications of these challenges play to our favor, particularly in terms of our ability to implement strategies that will ensure we win market share. We are therefore more confident than ever concerning our organizational objective to emerge from these short-term market challenges stronger, more diversified, and more profitable through our execution of our key competitive differentiators. As with prior quarters, I want to remind everyone that as a result of the arrangement between Aphria and Tilray, our results in the prior fiscal quarter are based on Aphria's financial statements but have since been adjusted to follow US GAAP and are presented in US dollars. Additionally, recall that in July 2021, we published an appendix to our investor deck located on our website that contains an unaudited analyst primer, which breaks down Aphria's US GAAP financial statements for fiscal 2020 and 2021 by quarter. Please also note that throughout our call today, we will reference both our financial results in accordance with GAAP as well as our non-GAAP adjusted financial results. Our earnings press release contains a reconciliation of our reported financial results under GAAP to the non-GAAP financial measures identified during our remarks. Starting with the top line, despite a challenging environment, our Q2 net revenue grew 20% compared to Q2 last year although the comparison itself is not apples to apples because the year-ago quarter does not include any contributions from legacy Tilray. We achieved our 11th straight quarter of positive adjusted EBITDA, particularly in a market where revenue was a challenge speaks volumes to our relentless focus on operational and cost efficiencies, our overall planning capabilities, and the success in integration and executing on the synergies we identified in the Tilray Aphria combination. Over the past year, we have continually challenged market expectations on profitability and delivered superior results each time. From a medical standpoint, there was similar downward pressure caused by COVID from patients unable or unwilling to see a doctor as well as increased competition from adult rec and related price compression. Ultimately, we believe that consumer demand for higher quality brands will rise once the pandemic wanes and budtenders are able to more positively influence purchasing decisions, and then we will be best positioned to capitalize on that opportunity, similar to how consumers behave with regards to other products, such as alcohol. Turning to our beverage business, SweetWater on-premise demand remains impacted by COVID. Off-premise channels look to be stronger in the future with our new innovation pipeline and increased distribution points. New leadership, product innovation, and operating improvements have stabilized Manitoba Harvest with its revenue contribution relatively flat from the sequential quarter and margins basically unchanged. After managing through the changes associated with moving from branded product at a big box retailer to a white label product, we are pleased with its revenue contribution in Q2. Finally, while CC Pharma experienced a decline in net revenue, a major part of the decline was tied to the strengthening of the US dollar and the inherent weakening of the euro versus the prior-year period. More specifically, if the euro/US dollar exchange rate had been the same in the current quarter as it was a year ago, CC Pharma would have reported an additional $5.3 million in revenue. Before we turn to profitability, it is important to note we performed a detailed review of our inventory as part of the quarter. As part of our review, we identified an adjustment of $8 million in the value we originally ascribed to inventory and $6 million in the value we originally ascribed to prepaids and other current assets as part of our reverse purchase of Tilray. During the current quarter, and prior to having finalized the purchase price accounting for the transaction, we reduced the inventory and prepaids and other current assets on the transaction date by $14 million and correspondingly adjusted deferred taxes and goodwill. These adjustments did not flow through the income statement. At the same time, as part of the inventory review, we identified inventory acquired in the transaction whose cost due to price compression in the market was now higher than our expected selling price for the inventory. Accordingly, we recorded an inventory impairment of $12 million in the quarter, with the vast majority of the write-down reflecting this higher-priced inherited inventory from the transaction. In a challenging revenue environment, operating excellence can play an outsized role, and that's certainly true as we turn to bottom line performance. Despite the headwinds we've all discussed here today, our team worked hard to optimize performance. As a result, we increased net income by almost $96 million to $6 million from the prior-year quarter as well as improved our adjusted gross margin to 29% from 27% in the quarter on a year-over-year basis. Further, we reported our 11th consecutive quarter of positive adjusted EBITDA, which increased to $13.8 million from $10.1 million a year ago. Importantly, we are confident our profitability will increase as more of our operating synergies become embedded within the platform, particularly by converting the legacy Tilray brands to Aphria's cost structure. On a pro forma basis, for example, if Aphria's cost structure had been applied to the legacy Tilray brands in Canada during Q2, we believe that our adjusted gross profit would have been $3.8 million higher. Recall that Aphria has been a low-cost producer with strong cultivation, processing, and manufacturing facilities, and we are now pulling additional costs out of that structure to gain further efficiencies while improving product potency and quality to meet market demand. Adjusted free cash flow improved to negative $16 million from negative $53 million last quarter. As we said last quarter, we believe that our first few quarters as a combined entity would likely see negative cash flows. However, as we achieved our synergies, we would be working towards sustaining free cash flow generation, which we believe will generate sustainable shareholder value. Turning now to the business integration, we are making meaningful progress optimizing operations, and as we focus on reaching at least $80 million of synergies within the first 18 months post-transaction. To date, synergies achieved have reached $70 million on a run rate basis and $36 million of actual cash savings. Further, we are pleased to announce that we now anticipate reaching our $80 million synergy target within a little over 12 months of closing the transaction or by our current year end on May 31. Additionally, we are pleased to announce that we anticipate generating an additional $20 million in synergies from the transaction that will be achieved during our fiscal 2023 year. Now let's discuss Q2 in greater detail. Within cannabis, our medical business grew primarily due to contributions from legacy Tilray and innovative new products, including the June launch of our new brand Symbios, which addresses unmet medical needs and provides patients with more choices in managing their health conditions with medical products. Still, we experienced a lower number of existing patient renewals and lower numbers of new patients in both independent and clinic patients because they were unable or unwilling to see a doctor. Our adult-use business on a net basis declined year-over-year despite contributions from the business combination because of the move to price-based brands, more competition, and more aggressive price discounting during COVID. While we took the proactive measures to adjust our pricing and rationalize some SKUs during Q2, as discussed earlier, our cannabis gross margin fell as a result of the price protection provided to our customers as part of our pricing adjustments. As a result of our pricing changes, we anticipate a minor fall in our cannabis gross margins going forward, but we believe we will remain industry leading. Our adult-use business experienced a revenue decline. The strong performer of the quarter was our international cannabis business, where we reported a 227% increase in revenues from the prior year. Net cannabis revenue rose 7% to $58.7 million for the quarter. Net distribution revenue fell 7% to $68.9 million for the quarter. Net revenues at SweetWater were $13.7 million, slightly down from the prior quarter. Net revenues from our wellness business, Manitoba Harvest, were $13.8 million, which was relatively flat sequentially and for which there is no comparable to the previous year. We view this business as largely stabilized at this point under the leadership of Jared Simon. All of this led to net revenue increasing 20% to $155.2 million in Q2 over the prior year period, with the increase primarily driven by the contributions from legacy Tilray for which there was no comparable in the prior year and SweetWater for which the comparable was only five days in the same period. Adjusted cannabis gross profit remained flat at $25.5 million in Q2, while adjusted cannabis gross margin remained strong but fell to 43% from 46%. This reflects, in part, our proactive and decisive steps to adjust our cost structure and reduce production costs through the integration process, leading to some temporary inefficiencies during this transitional phase. But ultimately, this hard work now will yield greater efficiencies going forward. Distribution gross profit decreased to $7.6 million in Q2, while distribution gross margin declined to 11% as a result of the impacts of COVID on CC Pharma sales mix. Beverage alcohol gross profit was $7.8 million in Q2, and there was no meaningful comparable in the prior year as the acquisition was completed last November. Beverage alcohol gross margin was 57%, which was on par with the sequential quarter despite the drop in revenue, but below the 60% we achieved in the prior year. Wellness gross profit was $3.8 million, and gross margin was 28%, which was in line with our expectations and for which there were no comparables last year. In aggregate, adjusted gross margin increased slightly to 29% compared to the prior year, while adjusted gross profit rose 27% to $44.8 million. As we continue to achieve our synergy plan over the coming quarters and as our non-distribution revenues increase their share of our total revenues, we expect to see continued improvement in this metric. For the quarter, we reported net income of approximately $6 million compared to a net loss of $89 million in Q2 last year. Turning to cash flow and liquidity, adjusted free cash flow was negative $16 million during Q2 and reflected $17 million of net cash used for operations, $7 million in investment in capital and intangible assets, offset by $8.1 million of cash expended related to our acquisitions. Again, as I said earlier, we view achieving free cash flow on a consistent basis as a priority for this business. While we certainly fell short in Q2, the negative adjusted free cash flow was within expectations given the integration of the Tilray assets and represents a substantial improvement of over $37 million from the prior quarter. We also still maintain a strong cash position of $332 million as of November 30 to both support our existing working capital requirements and our business plan. As we look forward and get beyond the near-term challenges due to COVID and the Omicron variant, we see good reason for optimism. First, there will likely be a right-sizing of the Canadian market that candidly will be accelerated as the dramatic impact of Omicron variants impacts consumer behavior across the board. Further, continued pricing levels below cost levels for the vast majority of our competitors are not sustainable. Through the benefit of time, we believe those pressures will be removed. Second, the movement towards legalization is continuing. With the anticipated legalization of recreational cannabis in Germany, we believe other EU countries will follow suit. Moreover, we are continuing to invest in our US assets, including SweetWater and Manitoba Harvest, which are already cash flow and EBITDA positive, earnings accretive, and will be leveraged for cannabis along with other recent acquisitions, such as Breckenridge, Alpine Beer, and Green Flash Brewing that will be accretive to our portfolio. Across all markets and geographies, we are expending our energies and resources on executing on our highest return priorities, actualizing our business integration to better manage costs, and capturing and delivering value for our shareholders. This concludes our prepared remarks.

Thank you. We'll now begin the question segment of our call starting with questions from our covering analysts, which will be followed by a few questions from our retail shareholders from the Say platform.

You guys have been active from an M&A standpoint in the alcoholic beverage market, makes good sense, Irwin, as you articulated in terms of the long-term leveragability of those assets. But in the near term, it is a bit of a different network. So I'd be curious just to hear your thoughts on any kind of synergy opportunities you see across those assets, any incremental M&A to build more alcohol assets in the US?

Anyway, just in regards to that, listen, I think what we saw with SweetWater Brewery, number one, very quickly we rolled out our risk plan. We rolled out our Broken Coast brand. I think beverages are a major part of the whole cannabis industry. The second thing is this: I think one day when this does happen, the opportunity to replace alcohol with THC, and I've said this before, the brands that are out there today, whether it's SweetWater or Breckenridge, are brands that consumers know, and we will have the opportunity to get into the markets with THC products. I come back and I look at the whole bourbon category as such a fast-growing category, and one day to be able to come out with a bourbon that's infused with THC under the Breckenridge name, which we would have an alcohol business, we'd have a THC business. The third part is, listen, as you come back today to look to build brands out there, you saw we changed the name of the company to the Tilray Brand Company. You look at valuations and multiples; the spirit industry is similar to the cannabis industry in many ways, and there's many crossovers. Our study shows that consumers who consume alcohol are also cannabis users. So, a lot of synergies. Our partner in Canada, Southern Glazer, in regards to our distribution piece of the business, that's the opportunity here in the US. So, I see a tremendous amount of synergies, and these deals, A, are accretive. There’s good growth in these industries for us. One of the big things, Vivien, you can't do, which is wait for the US to legalize. What's important is us being in adjacency categories that got growth, that got accretion, and that give us opportunities in the marketplace.

I guess I want to step back and think through the Canadian adult use business. I think first off, kind of pressure on your market share, actually post integration of Tilray. Could you diagnose if it's all a function of pricing? And now that you're putting some price investments in place, do you think you'll be able to grow revenue at a level to where your actual Canadian profitability will grow from there?

I'm going to start it and then I'm going to turn it over to Blair MacNeil, who is the newly appointed President of Canada. But, yeah, I think – I come back for a second at this. Number one, the Canadian market is continuously going through its challenges. There are more stores opening up, more LPs out there, and also, there's pricing. I come back and I look at this: we have 12 brands, we're going through SKU rationalization, we're going through brand rationalization. If you come back to the liquor control boards, they're also going through SKU and brand rationalization. What's important is what Tilray has; we're going to have brands, we're going to have innovation, and we're going to have products that consumers want, because we're going to build our brands and that's why we changed the name to the Tilray branded company.

I would say, first of all, on the diagnosis side, it's very clear: the inventory levels at a lot of LPs are unsustainable. To get rid of those inventories, they're doing two things. One is they are compressing prices. If you look in the last year, we’ve come down in price 1.7%, while the market has come down 22.6%. We have definitely protected our margins on the way down, and I think as an LP, we have more room than a lot of our competitors to be able to take some smart pricing. So that's number one. I would say the other form of this oversupply of inventory has meant new brands; 157 new brands were launched in the last year. The market is getting very diluted. We are going to ramp up our innovation in a big way to fight that. We will take some strategic price, but we will do it with an industry-leading innovation portfolio behind our big brands. The most important thing, and final part of your question, is can we do it profitably? Yes, we think we can. We have big scale. We have some cost opportunities that we realized through the synergies, but we have further costs that we can take out of this business to ensure we can do this and grow our gross margins. It’s going to be a little bit bumpy over the next couple of quarters, but certainly, we’re in the best position to be able to weather it.

Andrew, I think the big thing is, listen, one of the things we're dealing with is a world called COVID. We're also dealing with supply chain issues with products and stuff like that. At the end, as we brought these two companies together and took out $70 million of cost and looked at more opportunities, that’s the important part here. There’s a big opportunity in the Canadian market. Right now, only 50% of the market is going through the legal market where there’s an additional illicit market. You heard Carl talk about the opportunities for us in the medical market. The industry is three years old in Canada. I think there's lots of opportunities. Yes, there could be additional M&A opportunities for us in the Canadian market.

Irwin, can I ask about the JV with Anheuser-Busch? If you can give some background about the termination of that JV and if I tried to put a positive twist on it, does that give you more flexibility in pursuing partnerships with other CPG companies or that was never an issue?

I think, listen, the opportunity with ABI – very early on, even before the transaction closed, we had discussions with ABI, and it made sense to terminate this deal. It was not a great deal for Tilray, number one. Number two, in the Canadian market, ABI just did not want to do THC products. Number three, it was a major money-losing relationship there. With our own infrastructure and our own distributor base, with distributors in the beer business, knowing that business, with no growth but big losses, it just made sense – it was mutually beneficial for both of us to terminate. We still have a relationship with them regarding a co-pack relationship in doing a CBD product for them. Ultimately, it was not any type of hostile issue. It just made economic sense for us. It can create opportunities; there are many other beverage companies out there.

In terms of your question regarding the run rate for Europe, we are looking at a 37% run rate for the rest of the year. Just as a note of caution, our numbers are often shipments into other countries. As you know, with the regulatory framework, the timing of that doesn't always work out the way we want with import and export permits. There was a shipment into Luxembourg and our first shipment into the UK, but just cautioning that with 37% there could be some changes in the outer quarters.

Excited about the European market today, and I said, how do we get to a billion dollars in Europe? It’s got to depend upon legalization in certain countries. You’ve heard Germany talk about it. We are working with the German government right now in ways that this is going to happen. It’s probably going to be announced soon, and it will probably take 12 to 18 months before it can happen. You will see potentially Portugal and other countries move ahead because of tax reasons. You even see Macron talking about it in France regarding his election in May. With our facility in Portugal, our facility in Germany, and CC Pharma, we're well positioned for that marketplace.