Tilray Brands, Inc. (TLRY) Q3 2022 Earnings Call Transcript

Good morning, everyone. Thank you for joining us to discuss Tilray Brands, Inc.’s Financial Results for the 2022 Fiscal Third Quarter Ended February 28, 2022. Joining me on today’s call are Irwin Simon, Chairman and Chief Executive Officer; Carl Merton, Chief Financial Officer; Denise Faltischek, Chief Strategy Officer and Head of International; Blair MacNeil, President of Tilray Canada; 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, and 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, please note that 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 measure prepared in accordance with GAAP. In addition, we will be making numerous forward-looking statements during our remarks and in answering your questions. 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 Brands’ Chairman and CEO, Irwin Simon.

Thank you very much, Berrin, and hello, everyone. We thank you for joining us this morning. We’re pleased to again have several members of our senior leadership team on the call, including Denise Faltischek, Chief Strategy Officer and Head of our International business, who will update us on the strength of our global operations at the heel of international growth and legalization across Europe. Blair MacNeil, President of our Canadian business, will update us on our Canadian market and our plan. I will then walk you through our U.S. CPG business and the progress we are making against our cost optimization plans. And finally, last but not least, Carl Merton, will provide us with an update on our financials. Turning now to Tilray Brands’ recent performance and the quarter highlights. We’re pleased to have delivered a profitable quarter with year-over-year revenue growth and achieved our 12th consecutive quarter of positive adjusted EBITDA. While Denise, Blair, and Carl will discuss these results in detail, I want to outline how we aim to achieve our ambitious goal of $4 billion in revenue by the end of fiscal 2024. The first is the potential we articulated in December of 2020 when we first announced the Tilray-Aphria merger. We are a global CPG cannabis growth story backed by organic growth and acquisition opportunities in adult-use, medical, and other cannabis and CBG adjacencies, as well as synergistic opportunities that we continue to realize from merger and operational excellence delivered by our world-class team. We have the infrastructure, people, brands, and strategy in place across three main markets. In Canada, the adult-use industry is only now entering its fourth year. This means that the first mover has the infrastructure and resources, coupled with a consumer-first approach to brand building and innovation that will win. We have the leading brands in Canada. We are investing in new strategies and brands to build upon our leadership position and aggressively regain market share, as Blair will expand on momentarily. Recently in Canada, we announced a proposed acquisition of convertible notes in a partnership with HEXO that advances multiple objectives. The proposed transaction will be immediately accretive, creates a pathway to a meaningful equity position in HEXO, generates substantial shared operational efficiencies of approximately $80 million, and allows us to partner for product innovation that we would benefit from in Canada across the globe as legalization continues to gain traction. With Europe, we continue to believe the European market is on the cusp of broad-scale adult-use legalization. Companies with EU GMP certified operations like Tilray Brands possess a significant advantage as legalization spreads. We have a robust foundation and unmatched infrastructure in those markets, as Denise will explain soon. On the medical front, we recently unified the global medical divisions of Tilray and Aphria under a cohesive strategy and mission. Now, Tilray Medical is the premier global supplier of a portfolio of high-quality, effective medical cannabis brands and products for patients in need around the world and across 20 countries and 5 continents. As I said before, we believe the EU alone presents a potential $1 billion opportunity in our $4 billion strategy. Denise will also address international developments beyond Europe that are compelling and moving very quickly. In the U.S., legalization would be a milestone for Tilray Brands and the industry. Given uncertainty regarding actual legislative reform, we are pursuing the next best thing, optionality. Our investment in MedMen is the best example of this approach. With our strong balance sheet, leadership experience, profitable operating CPG businesses, and growing brands that consumers love, we see a clear path to additional acquisition opportunities across the U.S. and remain optimistic that the recent passage of the MORE Act in the House will provide additional momentum for legalization. Another key factor on our path to $4 billion is our best-in-class, high-quality cannabis CPG brand platform. In turn, this means that we are ideally positioned to disrupt the global medical health and wellness consumer products market, an opportunity that McKinsey has estimated to be more than $1.5 trillion globally, with annual growth of 5% to 10%. While I will discuss our CPG segment performance in more detail later on this call, I want to reiterate highlights of this business, which include key U.S. and global assets of SweetWater, Breckenridge Distillery, and Manitoba Harvest. Together, our current U.S. CPG platform represents a portfolio of highly sought-after brands that bring people together in a memorable and positive way, a strong and robust infrastructure, a broad global distribution footprint, and hands-on CPG expertise. Utilizing our current footprint in the U.S. today, we’re able to leverage these strong brands and their distribution system to expand into CBD beverages, CBD personal care products, and related adjacencies, which may later be translated into THC products upon federal legalization in the U.S. as well. I am confident that the unique experience of our executives will help Tilray Brands build on the lessons of better-for-you CPG and beverage alcohol to accelerate our market growth. Now, to hear about that in detail, I will turn the call over to Denise Faltischek, our Chief Strategy Officer and Head of International Business. Denise?

Thank you, Irwin, and good morning, everyone. As noted earlier, we recently launched Tilray Medical, a global medical platform that unifies four medical cannabis brands under one strategy mission and vision. By unifying the global medical divisions of Tilray and Aphria under a cohesive strategy and mission, Tilray Medical emerges as the premier and leading global supplier of a portfolio of high-quality, consistent, and effective medical cannabis brands and products for patients in need around the world. Internationally, our strategic presence and position continue to accelerate powerful growth. In the third quarter, we saw strong performance from our EMEA business with sequential quarter-over-quarter growth of 37%. This growth was primarily driven by increased medical whole flower sales in Germany and Israel. The potential of the EMEA business was a factor of the Tilray and Aphria transaction, and we’ve seen over 4,000% growth compared to the prior year quarter. We have invested in our infrastructure in Europe, and as a result, Tilray is uniquely positioned as the only company on the continent with two EU GMP facilities located in Portugal and Germany. Our German facility also remains the only facility producing medical cannabis in Germany today. In addition to our well-received whole flower offerings, we have a comprehensive portfolio of medical cannabinoid extracts to meet our patients’ needs and are excited about the launch of our high-THC balanced extract product, which we expect will launch in May and which we developed based on our insights. Today, Germany remains the largest medical cannabis market in Europe and is expected to be one of the largest adult-use markets upon legalization. We are already the leader in medical cannabis within Germany with a market share of approximately 20% with our whole flower extracts and Dronabinol products. This, together with our investments in infrastructure, brands, and people positions us exceptionally well for the eventuality of adult-use legalization. We also see growing potential in our German distribution business, CC Pharma. With access to over 13,000 pharmacy distribution points across Germany, we expect this business to grow as medical cannabis continues to gain traction across the country and CC Pharma adds additional Tilray Medical products to its distribution points. Please note that any revenue generated by CC Pharma for cannabis is accounted for within our international medical sales. Outside of Germany, we believe there are great opportunities across other European countries as well. Other countries have expressed a clear political ambition to broadly legalize adult-use cannabis, such as Portugal, Luxembourg, and Malta. Some are engaging in an experiment for adult-use, including the Netherlands and Switzerland, while others are debating regulations for cannabinoid-based medicines such as France, Spain, Italy, and the United Kingdom. In fact, we think all of Europe could legalize medical cannabis within the next few years or sooner, with certain countries legalizing adult-use thereafter. Let’s now discuss our international business across various countries. In Portugal, we are the only approved medical cannabis product in the market with our high-quality medical whole flower, which is distributed through our distribution partners to medical stakeholders. In Luxembourg, we were selected by the Luxembourg Ministry of Health as the exclusive supplier for the country’s medical cannabis program for medical whole 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 will inform a regulatory framework for medical cannabis, and we estimate that the French medical market is roughly the magnitude of Germany’s medical market. In Italy, we are one of five distributors licensed to import medical cannabis into the Italian medical market. In the UK, we completed our first shipment of a broad range of medical whole flower products last quarter with high, medium, and balanced potencies, and our shipments this quarter have increased and are growing nicely. We also launched Pollen, a CBD wellness brand with three broad-spectrum CBD products, including gummies, drink drops, and oil across the UK within Amazon. In Ireland, we are one of only two suppliers within the Irish market whose cannabinoid-based medical products are eligible for reimbursement. Continuing with this theme of opportunities in Europe, in February, we completed our first sale of medical cannabis whole flower in Malta. In March, we expanded the offering and launched the first EU GMP medical cannabis oil products in Malta. Turning now to the Oceania region. In January, we announced the expansion of our medical cannabis product offerings in Australia and a new medical cannabis e-learning platform for healthcare providers. After listening to patient feedback and leveraging learnings from our operations in Germany, we are excited to launch new products in Australia to meet consumer needs and now have a broad and complete range of EU GMP certified medical cannabis whole flower offering. Finally, we also see additional opportunities in other parts of the world, and therefore, look forward to further updates on our progress. These include Colombia, where we are seeking product registrations, Argentina, where we benefit from our distribution business, ABP, Brazil, and even China and India. With that, I’ll now turn the call over to Blair MacNeil, President of our Canadian business. Blair?

Thank you, Denise, and hello, everyone. As Irwin noted, we are now entering the fourth year of cannabis legalization in the Canadian market. The total cannabis opportunity in Canada is approximately a $10 billion market, of which only 54% is currently being serviced by the legal market. This presents a significant revenue opportunity ahead. However, the Canadian cannabis market remains crowded and oversaturated, with 800 licensed producers and 3,200 retail stores. This has led to an oversupply of product and price compression. Over the last 12 months, the market has seen reductions in retail pricing of 24.5%. In the last three months, the market has seen a reduction of 6.5% in pricing. Despite these price reductions, we’ve been able to maintain our margins in the 40% range. In Q3, our retail market share declined to 10.2% from 12.8% in the sequential period due to this heightened price compression. Still, we maintained our number one market share in Canada and leading positions across several adult-use categories, including pre-rolls and vapes, based on recent Hifyre sales data from December through February. The market share decline was attributed to a shift in our flower strategy and availability, as well as vaccine passports in Quebec and the dissolution of our partnership with the Marley Natural brand. Notably, the rate of decline in February was the lowest we have experienced in over a year, which is an encouraging sign that our pricing and marketing adjustments are yielding dividends. We remain focused on brand and product education, and we have boots on the ground working with retail partners and budtenders across Canada. In Q3, we executed 1,076 budtender product knowledge sessions alone. According to a Brightfield Research report published in December, budtenders influence 33% of in-store purchases. Executing these sessions maximizes the opportunity for our brands at retail. These investments are paying off, as a national budtender survey released in Q3 identified our Broken Coast brand as the leading favorite consumer brand among Canadian budtenders, the most recommended and perceived as the most premium brand. Additionally, we continue to rationalize SKUs. We currently have 12 brands in Canada, and we will be rationalizing them to focus our innovation, investments, and distributor resources on the brands with the scale and unique value proposition that serve consumer needs and help improve margins. This work is already underway. As part of our innovation strategy, we have made strategic adjustments and investments in vapes and pre-rolls, which are the two largest categories after flower. In the vape product category, we grew market share in Q3 from 11.4% to 11.7% by launching a series of new products, including new Solei Vape Mix dual packs by our best-selling and leading wellness brand Solei. New Vape Mix dual packs include two great flavors in a single pack at great value. We also expanded the Solei brand’s functional benefits of cannabis with the launch of Solei, Renew Moonlight, CBN vape pen, formulated for nighttime use. Yesterday, we announced our collaboration with the SQDC in launching the first THC edible available in Quebec, Solei Bites by our own Solei brand. In Q3, we also became the number one leader in pre-rolls with 14.9% market share from December through February, with significant growth in Good Supply, one of our leading Canadian cannabis brands and the favorite among consumers and budtenders. Good Supply launched Hash Bats, our unique take on infused pre-rolls that deliver on consumer demand for a consistently high-potency experience without compromising on quality or breaking the bank. Hash Bats quickly achieved a 1.6% share in its first month of distribution and has already become one of our fastest-growing products for Good Supply. Moving into our medical business in Canada, Q3 represented the continued evolution of our global medical platform, Tilray Medical. We continue to increase our product assortment within Tilray Medical, leveraging the needs of patients from all our platforms, including Aphria and Symbios. Additionally, we are engaging in partnership conversations with national retailers to grow our patient base, reduce costs, and expand the route to market in the medical channel. Looking ahead to Q4, we remain focused on regaining market share and have exciting innovation across all product categories. This includes our industry-leading BHO capabilities at scale. Butane extraction allows us to further utilize naturally curing low-potency flower combined with BHO distillate to provide consumers with a better product than the industry standard CO2 extraction. Our in-house BHO capability combined with our extensive growth allows us to launch high-quality live products in the market, which we did for the first time in Q3 with the launch of Broken Coast, Amnesia Haze Live Resin Budder. We believe we are the only licensed producer able to do this at the scale and cost required to compete in the Canadian market. From an operational standpoint, we continue to identify significant cost savings beyond our highly successful synergy initiatives. In Q4, we plan to invest significantly in CapEx to drive massive labor savings in our pre-roll capability. This is in addition to our vape automation and significant improvements in supply chain, procurement, and packaging savings. These initiatives illustrate our commitment to gross margin despite a constantly changing retail environment. In summary, we have a five-point plan to win in Canada. First, we are investing significant resources in our genetics program to capitalize on the consumer need for experimentation. Second, our investment in consumer-first innovation across all categories, especially pre-rolls, which we believe will be the largest category in adult-use in three years. Third, leveraging the scale of our distributor partnerships with Great North Distributors and Rose Life Sciences, as we have the most feet on the street and will be relentless in our execution. Fourth, budtenders influence one in three purchases in-store. We will leverage our brand investments and category knowledge to ensure they know our brands and innovation. Lastly, we will do this all with a cost efficiency mindset to ensure we preserve our margins in this competitive marketplace. I will now turn the call back over to Irwin for a discussion of our U.S. operations before Carl closes the prepared portion of our remarks with a detailed financial overview. Irwin?

Thank you, Denise and Blair. I’d like to now discuss our growing CPG business in detail. Our beverage alcohol brands now include SweetWater, the nation’s tenth largest craft brewer, and our recent acquisition of Breckenridge Distillery, along with two iconic West Coast craft beer brands outlined in Green Flash. Our wellness business consists of Manitoba Harvest, a pioneer and leader in branded hemp-based foods. In aggregate, these businesses generate approximately $130 million in annualized revenue and are high-margin EBITDA positive, presenting exciting potential for future growth. Of course, they also represent good adjacencies to the cannabis industry upon legalization, fitting well within Tilray Brands. Earlier this year, SweetWater Brewing Company was announced by the Brewers Association as the tenth largest craft brewer in the U.S. It began operating a new 32,000-square-foot production facility in Fort Collins, Colorado, which provides a launch pad for further distribution to the West Coast, as well as opening a new taproom at the Denver International Airport. The brand also launched an extensive new line of innovative products, including seltzers, a new beer offering developed in collaboration with our Canadian cannabis Broken Coast brand, and a new vodka soda offering developed in collaboration with our Canadian cannabis brand, RIFF. We view our ability to leverage our growing portfolio of brands as a means to launch THC-based product adjacencies upon federal legalization in the U.S. SweetWater has also launched a partnership with the largest beer distributor in the U.S., Reyes Beer Division, to bring its portfolio of brews to California. Through this expansion, SweetWater will now be available through the western states at local restaurants, bars, grocery chains, liquor stores, and other retail establishments, either on draft or in cans. We continue westward expansion into both Washington and Oregon through our distribution partner, Columbia Distributing. This expansion marks the 39th and 40th states, respectively, where SweetWater products are available for purchase. During Q3, we acquired Breckenridge Distillery, known for its award-winning bourbon whiskey collection and innovative craft spirits portfolio, including bourbon whiskey, gin, and vodka. Distribution already spans across 50 states, but now the brand is poised to benefit further from distribution synergies paired with SweetWater, which we are confident will drive growth both now and in the future. Then, let’s discuss Manitoba Harvest, the world’s leading hemp food brand, with products and distribution across 17,000 stores in North America. This brand was acquired as part of the business combination, and we have since given this business great focus. As a result, we have generated measured channel growth and improved consumption and share gains. In Q3, Manitoba Harvest's hemp seed products grew nearly 5% in multi-outlet and convenience retail accounts, securing a leading 49% market share among hemp competitors. The brand invested in marketing and communications in Q3, featuring campaigns that promoted hemp as a superfood and healthy food option for New Year’s wellness products, such as smoothies and salads. The Manitoba Harvest team has also carefully managed its costs while implementing pricing actions amidst rising cost inputs. During Q3, Manitoba Harvest grew revenue and improved its gross profit contribution. We intend to accelerate the business through the remainder of calendar 2022 as we introduce a great deal of new product innovation that capitalizes on consumer’s interests in hemp products and aligns with plant-based, low-carb, and keto diets. Looking forward, at the Natural Products Expo West in Anaheim last month, we introduced a new line of hemp protein items blended with powerful plants like Matcha and Supergreens. We also unveiled new formulas such as Ground Hemp Seeds, which offer great convenience to consumers looking to incorporate hemp into baked goods, snacks, and smoothies. These items will launch exclusively with Whole Foods across North America this month and will be available at other locations in the near future. Let me now update you on our progress regarding cost synergies. Recall that we initially identified at least $80 million in benefits as part of the Tilray-Aphria business combination and have since added another $20 million to our target. As of the end of February, we achieved $76 million in cost savings on a run-rate basis and $42 million in actual cash savings. Carl will now discuss our financials in greater detail. Carl?

Thank you, Irwin. Despite ongoing obstacles, we continued strengthening our business, maintaining profitability, and distancing ourselves globally from our competition, all as previously outlined. As we look ahead, we believe that we are well-positioned to navigate through near-term market challenges and emerge stronger, more diversified, and more profitable. This is because we have already built the foundation of key competitive differentiators that can propel us toward long-term success. Before reviewing our financials, let me remind everyone that because of the arrangement between Aphria and Tilray, our results in the prior fiscal quarter are based on Aphria’s financial statements, which have since been adjusted to follow U.S. GAAP and are presented in U.S. dollars. Additionally, in July 2021, we published an appendix to our investor deck. This is located on our Investor Relations website and contains an unaudited analyst primer that breaks down Aphria’s U.S. GAAP financial statements for fiscal 2020 and 2021 by quarter. Moreover, 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. Beginning with the top line, our Q3 net revenue grew 23% to $151.9 million compared to the prior year quarter, although the comparison isn’t apples-to-apples because Q3 of fiscal 2021 does not include contributions from legacy Tilray, as well as significant fluctuations in forex rates. For example, if the average foreign exchange rate for the first nine months of this year matched that of the prior year for the same period, year-to-date, we would report an additional $20 million in net revenue and about $1.5 million in adjusted EBITDA. Q3 adjusted EBITDA was $10.1 million, extending our track record of positive adjusted EBITDA to 12 straight quarters. Our ability to generate positive adjusted EBITDA is the result of contributions from all our business segments, coupled with our strong focus on realizing operational and other synergies and efficiencies despite quarter-over-quarter margin pressures in our cannabis and distribution segments. These cost management efforts showcase the traction we are making with respect to integration. On a related note, adjusted gross profit increased to $39.8 million in Q3 from $30.5 million in the prior year quarter, while adjusted gross margin increased to 26% from 25%. Ongoing improvement in these metrics is expected as more operating synergies become embedded within the platform and as we complete the conversion of the legacy Tilray Brands to Aphria’s cost structure. Increased contributions from non-distribution revenues as a percentage of the top line will also serve to increase adjusted gross profit because they are higher-margin businesses. Net income for the quarter increased to $52.5 million from a loss of $258.6 million in the prior year quarter. This is our second consecutive quarter reporting net income. Moving to our business segments in further detail. Canadian medical cannabis revenue for the segment increased 19% in the prior year quarter, benefiting from legacy Tilray contributions and innovative product launches, including our new Symbios brand, which was created to address unmet medical needs and provide patients with more choices to manage their health. Patients eligible for reimbursed cannabis remain strong and represent the core of our medical cannabis business. We continue to face downward pressure due to COVID, with patients paying with discretionary cash flow being either unable or unwilling to see a doctor, alongside heightened competition from adult-use. Our thesis remains that demand for higher quality brands in Canadian adult-use cannabis will rise as the pandemic recedes and purchasing decisions can be positively influenced by budtenders in retail settings. To that point, Blair has previously provided detailed information on our increased involvement with budtenders. Following that, we will be best positioned to capitalize on the opportunity because cannabis consumers are very similar to alcohol consumers, often gravitating toward differentiated and high-quality, innovative products. However, as the cannabis industry is still in its early stages of development, the multitude of new entrants has led to increased competition, resulting in loss of market share and price discounting. Revenue for the segment decreased 10% versus the prior year quarter, facing these challenges alongside the residual impact of COVID on consumer behaviors and the inclination toward price-focused purchases. Almost $4 million of revenue decline is directly attributable to the price reductions we implemented in the prior year quarter on vapes and pre-rolls. Those price reductions paid immediate dividends, as we gained market share in both the vape and pre-roll categories during the quarter, as measured by Hifyre data. While we were able to grow share in vape and pre-rolls and maintain overall market leadership, we experienced a market share decline to 10.2% from 12.8% in the prior quarter, largely driven by low demand for our flower products. However, we believe this trend will reverse itself as our potency levels on new harvests increase and we introduce new product innovations. Notably, our overall market share decline reflected the smallest decrease in over a year, suggesting that we are closing in on stabilization as we are now near the bottom of what we foresee as a U-shaped recovery. Wholesale revenue more than doubled to $2.8 million in Q3 compared to prior year quarter, reflecting opportunistic sales, but will vary quarter-to-quarter moving forward. While we face challenges in Canada, our international story continues to set us apart from our competitors. During the quarter, our international revenue rose to $15.8 million from $0.3 million in the prior year quarter, attributed to the contribution of legacy Tilray’s larger international cannabis businesses and newly obtained business-to-business transactions. In Europe, despite COVID pressure, cannabis utilization for medicinal and adult-use continues to rise, and we are uniquely positioned to succeed with our infrastructure as the only company with EU GMP cultivation facilities in two European countries and the demonstrated commitment to the consistency, quality, and safety of our products. In Germany, which is by far our largest market internationally and where we are the market leader in medical, we generated 19% revenue growth in our medical cannabis products quarter-over-quarter. These growth metrics were achieved despite some patients being unable or unwilling to see a doctor due to COVID. In aggregate, net revenue for cannabis increased 32% to $55 million in Q3 from $41.7 million in the previous year quarter. Conversely, our distribution business, which primarily relates to CC Pharma, experienced an 11% decline in net revenue during Q3 to $62.5 million from $70.2 million in the prior year quarter. A significant part of the decline was tied to the strengthening of the U.S. dollar and the inherent weakening of the euro versus the prior year period. More specifically, if the euro-U.S. dollar exchange rate had remained consistent with the prior year quarter, CC Pharma would have reported an additional $6.7 million of revenue. Turning to our beverage alcohol business, we generated $19.6 million in net revenue in Q3, which is nearly $8 million more than the previous year quarter. This was primarily due to our acquisition of Breckenridge in December, while SweetWater also contributed an incremental $2 million via increased distribution points, primarily from products shipped from Fort Collins. Looking ahead, we believe significant upside potential exists for this segment as we fortify our strategic position in the U.S. through increased distribution points, recent, and potentially future acquisitions, coupled with an extensive innovation pipeline. Lastly, on Manitoba Harvest, revenue contribution grew sequentially by almost $1 million to $14.7 million in Q3, for which there were no comparables from the previous year quarter. We are pleased that our new leadership team has successfully stabilized this business, and we are presently introducing product innovation and executing operational improvements within this segment. In terms of profitability and margins, adjusted cannabis gross profit increased to $18 million in Q3 from $16.3 million in the prior year quarter, while adjusted gross margin fell to 33% from 39%. The decrease is primarily related to our wholesale cannabis sale. Without this sale, our adjusted cannabis gross margin would have been 40%. Margins were also impacted by our price reduction on vape and pre-rolled products, originally initiated in the previous quarter. Distribution gross profit decreased to $5 million in Q3 from $9.2 million in the prior year quarter, while distribution gross margin declined to 8% from 13%. This was due to increased costs, as our primary source of products could not ship during border closures and periods of peak demand. Beverage alcohol gross profit was $11.5 million in Q3, which more than doubled from $4.9 million in the prior year quarter. Beverage alcohol gross margin increased to 59% from 41% as we benefitted from contributions from the Breckenridge acquisition, which has a higher margin profile compared to SweetWater, and a resurgence of SweetWater driven by the Fort Collins location. Wellness gross profit was $5.4 million in Q3, and gross margin was 36%, better than the sequential period of $3.8 million and 28%, respectively, and for which there were no comparables last year. Total general and administrative expenses rose to $38.4 million in Q3 from $24.5 million in the prior year quarter, reflecting an increase in the number of directors, executive-level personnel, headcount, and stock-based compensation, alongside one-time costs associated with the upcoming closure of our Nanaimo facility. We had insurance recoveries totaling $4 million under our business interruption policy as part of CC Pharma’s property insurance related to the previously disclosed flooding in the first quarter. Net income was positively impacted by reductions in share price during the quarter, which affected the valuation of both the Aphria 24 convertible debentures and our outstanding warrants. Additionally, the net income in the quarter was influenced by a reduction in our assessment of the contingent consideration owed on the SweetWater transaction. Turning to cash flow and liquidity, adjusted free cash flow declined to negative $35.6 million in Q3 from positive $6.3 million in the prior year quarter. Recall that we are striving to maintain positive free cash flow generation, and achieving it on a consistent basis remains a priority for this business. To conclude, we have strong optimism for the future as the Canadian market rightsizes and pricing normalizes at a sustainable level. This process is ongoing, but will take time to unfold. We also eagerly await movements toward legalization across the globe, including in Germany, other EU countries, and eventually, the U.S. In the meantime, our investments in U.S. assets across our growing roster of beverage brands and Manitoba Harvest are cash flow positive, EBITDA positive, and earnings accretive, which will be leveraged for cannabis at the appropriate time. As we evaluate our opportunities across various markets and geographies, our focus remains on the highest-return priorities while executing our business integration efforts to better manage costs. Through these objectives, we can deliver long-term value for our shareholders. That concludes our prepared remarks.

Thank you, Carl. We will 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 through the Say platform. Operator, what is the first question?

Hi. This is Gerald Pascarelli on for Vivien. Thank you for taking the questions. On the $4 billion revenue guide, it’s certainly encouraging to see that reiterated, and it was helpful to go through the drivers. So, taking it all together, how do you see the mix ultimately playing out once you reach $4 billion between cannabis, alcoholic beverages, and health and wellness? Just trying to get a sense of how to think about your segment mix overall. Thanks.

Hi. Good question. So, number one, a lot depends on legalization here. If I break it down, I’d like to target $1 billion in Canada, which would be organic growth. As the market grows in Canada to $10 billion, I’d like to pursue other acquisitions in Canada, along with their spirits and beverage businesses. We envision a future where you can walk into a bar in Canada and order a beer, bourbon, or tequila infused with THC. So, if we consider that, 90% of the business in Canada would be cannabis, with perhaps another 10% from consumer products. In the U.S., we’ve spoken about aiming for $0.5 billion in consumer products. Currently, we are approximately at $150 million, but most of that rest would come from MSOs upon legalization, and we’d love to eventually own MedMen and other great MSOs. Therefore, we'd target about $1 billion in the U.S. upon legalization. If we can’t achieve that, we’ll continue exploring consumer products. For Europe, our CC Pharma business constitutes about $300 million today, while the rest of the growth in Europe would come entirely from cannabis. Looking at the $4 billion combined, we expect $2.5 billion to $3 billion to stem from cannabis and around $1 billion from consumer products. Again, let me emphasize, a lot of this is contingent on legalization. Additionally, there are adjacency companies we would keep evaluating, and upon legalization, we would aim to leverage those products infused with cannabis. That’s the plan.

Got it. That’s helpful color. Thank you. Just one more on adult-use as it relates to Germany. If they go adult-use, that would be encouraging. One thing we all realize is that things often take longer than expected. From your perspective regarding Germany, what are the next steps you need to see to drive confidence in that regulatory change? When do you think commercialization could realistically occur if you had a timeframe? Thank you.

I’ll let Denise expand on that. We anticipated and hoped for a framework by May of this year. The war in Ukraine has definitely slowed some things down. However, we like what we see and hear from regulators and the government there. Denise?

Building on Irwin’s remarks, we had hoped to see a framework around the May-June timeline. We haven’t received any updates from government officials suggesting that this timeline will not be achievable, but as Irwin mentioned, the war in Ukraine is understandably taking precedence over policymakers’ attention, alongside ongoing COVID-19 discussions. We remain cautiously optimistic, and as for your question about commercialization, we're looking at potential commercialization as early as December 2023 or January 2024.

The good news is, you’re seeing progress in Italy and France, as well as continuous revenue increases—over 4,000% growth in Europe. Patients are returning after COVID. We anticipate that once progress is made in one country, others will follow closely behind, and we will be ready for it.

Setting aside the revenue target, which may be aspirational given various regulations and M&A, what do you believe the margin profile of the business could look like with your current assets? It compressed year-over-year, yet you also have incremental synergies. Any insights on your margin profile potential? Thanks.

I’ll let Carl weigh in, but if we look at our spirits and beverage margin, it's in the high 50s. If we exclude our distribution business in Europe, margins there are quite healthy. Our margins took a hit this quarter due to selling some products to distributors, which Carl will elaborate on. I believe we should see margins stabilizing in the high 40s to low 50s as we consolidate results from spirits and cannabis. That said, the pricing dynamics in Canada have posed challenges to our margins, but we’re working on improving efficiencies

In response to your inquiry, Andrew, our distribution business currently accounts for a disproportionate share of our revenue relative to where we expect it to be in the future, and it tends to have the lowest margin. As we minimize that business's proportion of our overall sales, our consolidated margin will increase. In the current quarter, we faced headwinds impacting margins from the distribution sector. However, if we exclude the wholesale sales made during the quarter, we anticipate adjusted margins normalizing in the low-40s.

Andrew, achieving the aspirational margins isn’t solely about just sales; it’s also about the profit mix. Today, we have products priced in three different currencies, and fluctuations in the euro have adversely affected us. We must remain focused on getting back to those margin levels in the high-40s.

I wanted to return to the international business since there are impressive trends and prospects for further growth. A couple of questions: can you comment on the competitive dynamics in Germany? It looks increasingly crowded and may get more so with planned recreational legalization. Are we seeing any pricing pressures arise? What could prices potentially drop to? I'm trying to assess risks here, especially considering the pricing pressures that we’ve observed in Canada.

Owen, we are indeed accustomed to markets becoming crowded; Canada is one example. There’s no doubting that the German market is becoming competitive, with more entrants. But I’ll let Denise expand on this. We have established growing facilities there and in Portugal and can aim to be that low-cost producer. We can also ship GMP-certified product from Canada. Denise?

You’re correct, Owen. There is pressure emerging in the German market, which was expected, given its breadth. The movement of competitive pressures comes as Germany is positioned to become a significant market. We’ve been investing in this market, and we have an advantage from being first movers. However, competition is growing, and although we are seeing price pressures, we have a strong foundation to build upon.

Moreover, we have the right infrastructure, people, and resources in place, able to draw on experience from our Canadian operations. We're prepared for competition, as we saw in Canada.

Following up, I’d like to understand how the domestic supply situation is evolving in Germany, both from medical and recreational perspectives. Do you foresee domestic suppliers having their allocations increased? How do you view the profitability of domestic lots in light of the government-mandated pricing constraints?

This is a great question. Today, the domestic lots are based on prior tenders, and we expect another tender to come once adult-use legalization is passed. Based on our expertise and established relationships with the German government, we are well-positioned to enter that tender process. Given our consistent product supply, we believe we can potentially secure increased domestic lots.

Two questions related to cash flow and the 2023 convertible notes. Firstly, regarding your 2023 convertible notes, can you share anything concerning plans addressing that maturity next year?

As you know, Rupesh, I’m not keen on debt. A good rebound on our stock could lead to effective conversions. It’s something we’re monitoring closely and plan to manage, but that’s all I can say for now.

Great. And for cash flow, I know your goal is to achieve positive free cash flow. Can you provide a sense of timing or any additional context regarding where you see that heading?

We are close to reaching that point; we did build inventory heading into seasonality. We’ve also vested considerably into bourbon, which is essentially a three-year investment. We are closer to cash flow positivity across the board, as I believe we will maintain positive cash flow next year.

Great answer. I fully support that.

I’d like to start with the Canadian cannabis business. You mentioned rationalizing your brands domestically. Can you provide some timeline and what percent of cannabis sales those brands currently represent?

Let me answer that. We are currently working through our portfolio strategy and consumer understanding. That work has been ongoing and we anticipate some rationalization of brands. Marley Natural and Bingo are examples of that, but rationalization will not significantly impact our sales figures.

The market requires this change. For brand rationalization in stores, there needs to be a reduction in the amount of LPs out there, as 800 is excessive. If you look at our 12 brands, we are conscious of how confusing a wide array of options can be for consumers. SKU and brand rationalization are necessary for educating consumers on what to purchase. Finally, I believe the market needs to undergo rationalization. If we don’t educate effectively, consumers will become confused, and that could hinder their purchasing decision. We must focus on fewer brands to enhance our reach to consumers. As we continue our M&A assessments, we look for strategic opportunities that will enable us to reach our goals without compromising our existing brand integrity. I appreciate the diverse perspectives of our teams as we evaluate potential assets while maintaining a focus on shareholder value. Thank you very much for your participation today. We anticipate promising developments ahead with Tilray and appreciate your continued support. Enjoy the rest of your day!

This concludes today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.