Tilray Brands, Inc. (TLRY) Q2 2023 Earnings Call Transcript

Greetings. Welcome to Tilray's Second Quarter 2023 Earnings Call. At this time, all participants will be in a listen-only mode. Question-and-answer session will follow the formal presentation. Please note this conference is being recorded. At this time, I'll turn the conference over to Berrin Noorata, Chief Corporate Affairs Officer. Berrin, you may now begin.

Thank you, and good morning. By now, everyone should have access to the earnings press release, which is available on the Investors section of the Tilray brands website 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. The 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 response to 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 press release issued today includes many of the risks and uncertainties associated with such forward-looking statements. Today, you will hear from key members of our senior leadership team. Irwin Simon, Chairman and Chief Executive Officer, Tilray Brands Inc.; and Carl Merton, Chief Financial Officer, who will provide a quarterly financial review as well as reaffirm our full year free cash flow and adjusted EBITDA guidance. Also joining for the question segment of this call are Denise Faltischek, Chief Strategy Officer and Head of International; Blair McNeill, President, Tilray Canada; and Ty Gilmore, who recently joined the team as President of our U.S. Beer Business. And now, I'd like to turn the call over to Tilray Brands Chairman and CEO, Irwin Simon.

Thank you, Berrin, and hello, everyone. We appreciate you joining this morning and hope everyone had a nice holiday season and a great start to 2023. We head into this New Year with momentum and a realigned platform centered around three priorities to create the world's leading and most diversified cannabis lifestyle and consumer packaged goods company in the world across adult-use, medical cannabis, beverage alcohol, and wellness consumer products. These priorities include pursuing our most profitable core business to drive growth now and over the long term, which we're well on our way to realizing. Maintaining our number one leadership position and growing market share in recreational cannabis in Canada, the largest legal market in the world. Maintaining our leadership position and growing market share in medical cannabis across Europe and a strong position to capture the adult-use market when legalization occurs. Winning in the U.S. despite delayed federal cannabis legalization, which we do not expect to happen at any time in the near future. We've invested in leading and profitable cannabis-adjacent CPG lifestyle brands across craft beverage alcohol and wellness consumer products that resonate powerfully with consumers and are ideally positioned in key markets. When federal cannabis legalization does occur, we will leverage our U.S. brands and business, their distribution, and marketing networks to enter and capture opportunities by creating a broad set of cannabis-infused CPG brands. We are also diligently focused on optimizing our global operations while maintaining our status as a low-cost producer. Last but not least, we are strengthening our industry-leading balance sheet and driving our cash position because it affords us opportunities for growth and expansion, including through cannabis adjacencies within an economically uncertain environment. I want to emphasize the value potential of Tilray brands built on growth opportunities and our foresight to diversify both organically and acquisitively. I am confident in the fundamental potential of Tilray brands as the most diversified cannabis lifestyle company and consumer packaged goods leader. We have already made notable progress in quarter two and exceeded against these priorities, as is evident by significant improvements in operating cash flow despite a challenging top-line performance. We have a long view generating free cash flow as an integral part of our business model, which enables us to deliver on our highest priority: delivering sustained durable shareholder value. Close observers of Tilray brands and our team know one thing: we move quickly and decisively to adapt to market changes. I am proud to highlight that even with the breadth of the platform and our sheer scale, we remain agile, pivot quickly, and make smart strategic decisions while executing against our free cash flow objective. For example, during the quarter, we opted to build cash by temporarily slowing down production in our cannabis facilities because of the longer-than-anticipated march toward legalization in key markets. This included cutting headcount and reducing other operational costs. I want to highlight at the outset our bottom line initiatives first and our top-line initiatives second, this is appropriate given the market and the incredible progress we have made to drive efficiencies and build a 'built-to-last' platform. I would like to start this discussion with our cost optimization plan. We have already removed over $100 million of cash costs when compared to a year ago. These cost reductions, which I'll detail shortly, have guided us to achieving over $29 million of positive operating cash flow and $25 million of positive free cash flow this quarter. The components of this effort include cost synergies realized from the Aphria-Tilray business combination, which closed nearly two years ago, representing the starting point for building an efficient and agile foundation. Recall that our revised post-closure target was increased to $100 million from $80 million in cost savings, which, as of Q2, has been completed. Beyond the Aphria-Tilray synergies, we launched an additional $30 million cost optimization plan, of which we have already achieved $19.6 million on an annualized run rate basis to further solidify our status as the industry-leading low-cost producer. Finally, our robust balance sheet consists of approximately $433 million of cash and marketable securities, with over 70% of our debt set with fixed interest rates. This solid financial foundation enables us to be opportunistic in capturing market share across global cannabis and CPG adjacencies as we watch what unfolds with respect to legalization in the U.S. and elsewhere. Having discussed cost structure initiatives and our commitment to maintaining a strong balance sheet, I would now like to focus your attention on our potential to seize top-line opportunities across both geographies and business lines specifically. In Canada, we maintained our number one market share position in recreational cannabis despite pressures caused by difficult operating conditions, ongoing price compression, and high excise tax, forcing both industry consolidation and a reduction in roughly 925 licensed producers that are operational today. Despite these challenges, Tilray remains in the number one cannabis market share position with an 8.3% market share in Q2. In Q1, Tilray led the next largest licensed producer by 54 basis points while in Q2 it expanded the lead to 176 basis points. Our share was up 28 basis points outside of Quebec. Recall that this data is sourced from Hifyre for all markets except Quebec, where we utilize Weedcrawler for a more accurate reflection of the marketplace. We continue to build a thoughtful approach to innovation, focusing on quality over quantity. In Q2, we launched products in regions, segments, and categories where we had gaps in our portfolio. We leverage our leading proprietary consumer research to ensure we clearly understand consumer values in those regions, segments, and products. As an example of this, we relaunched RIFF flower, focusing on a segment where we had gaps in our portfolio. Moving forward, our thoughtful innovation will also be easier on the environment. In 2023, Tilray will convert all flower, vape, and pre-roll packaging to hemp, diverting 158,000 kilos of plastic away from landfill sites. In Canada today, we have leading internal capabilities in low-cost flower production, infused and non-infused pre-roll automation, BHO, live resin, distillate, vape production, state-of-the-art beverage formulation, and production, and we further manage overhead more efficiently to help stabilize and sustain the Canadian cannabis industry. We have reached out to numerous industry partners to leverage our expertise in a low-cost environment and existing capacity in co-manufacturing partnerships. We understand the challenging nature of cannabis in Canada. Our investment in consumer insights, innovation, cost optimization, and market-leading sales coverage has allowed us to be stable during a time of instability. From our vantage point, we think we're best situated to thrive as these dynamics play out and we intend to stay the course for the long term. In Europe, we are seeing momentum across the continent that we expect will result in 27 countries working together to establish a collaborative effort on cannabis regulation. The EU has already embraced medical cannabis, with broad-scale adult-use legalization expected to follow over the next couple of years. When this happens, we're strongly positioned to further seize on the opportunity. Our European cannabis business offers unrivaled potential through our growth facilities in Portugal and Germany. The shift is supported by growing acceptance of medical cannabis for the treatment of numerous conditions and followed by growing support for cannabis legalization for adult use as well. We believe we're exceptionally positioned to benefit from the meaningful economic growth that will come to our industry as a result of these positive changes because of our end-to-end EU GMP supply, which enables us to leverage existing assets to meet demand for medical and adult-use cannabis when legalization does happen. However, in the near term, our industry, along with almost all others, is contending with a difficult economic environment in Europe due in part to soaring inflation caused by the ongoing war in Ukraine. This is affecting all key cost inputs, but particularly energy prices and negatively affecting consumer behavior. In Germany, our Tilray-branded medical business increased in the second quarter over the prior year quarter by 4% and 20% on an adjusted currency basis. In Poland, we completed our first two shipments of medical cannabis in Q2 and submitted additional doses for new products. In Italy, we expect to commence the distribution of our T25 medical cannabis extracts in the third quarter. Consistent with our approach across all our businesses, we are relentlessly focused on both improving the quality and consistency of our medical cannabis products as well as our cost structure to be a low-cost producer in Europe. Therefore, we have developed a plan to take approximately $7 million of costs out of our European business. We strongly believe that our competitive differentiators in Europe include being the low-cost producer of high-quality, consistent cannabis. Our integration of CC Pharma and our medical cannabis teams will enhance and improve our sales function, bringing credibility to cannabis with CC Pharma's strong pharma relationships, both in Germany and throughout Europe. Our regulatory expertise to navigate the challenging regulatory landscape throughout Europe will continue to solidify our leadership position. In summary, while there are some near-term headwinds, we view this as an exciting time for us across Europe, anchored by our strategy, our people, assets, resources, and the tremendous opportunity we see ahead. Turning now to the U.S. and our CPG portfolio. In the U.S., participation in the adult-use cannabis market has always been very important to us and integral to our long-term strategy. However, as long as cannabis remains federally illegal in the U.S., we will not engage directly in business that touches the cannabis plant. To fully optimize the value and strength of our U.S. business, we appointed veteran beer and beverage industry executive, Ty Gilmore, as President of Tilray's U.S. beer business, a newly created position. Ty joined us from Glazer, beer and beverage, where he served as an Executive Vice President since 2020. Prior to that, he spent the majority of his career at Diageo. As you may already know, SweetWater is the tenth largest craft brewer in the U.S., now available in 42 states, including most recently, California. Over the past year, SweetWater and our two iconic Southern California brands, Green Flash and Alpine, have vastly expanded distribution through our partnership with Reyes, the largest beer distributor in the U.S. In November, we acquired Montauk Brewing Company, the fastest-growing craft brewery and number one craft brewer in Metro New York. Its success has been driven by its beloved product portfolio, premium price point, and over 4,700 points of distribution, including top national retailers such as Target, Whole Foods, Trader Joe's, Stop & Shop, King Colin, Walmart, 7-Eleven, Costco, BJ's, and Speedway convenience stores. The Montauk Brewing transaction was immediately accretive to EBITDA, and we expect it will deliver strong revenue and adjusted EBITDA growth as we move forward. Additionally, we are already leveraging SweetWater's existing national infrastructure to significantly expand Montauk Brewing distribution network beyond its concentrated presence in the Northeast, further driving Montauk's growth across key national markets, including California, Georgia, and Florida, while rounding out the presence of our craft beverage portfolio across the U.S. I'd like to briefly discuss our leading lifestyle Bourbon and spirit brand business, Breckenridge Distillery. Despite headwinds in the spirits industry, this brand is poised for accelerated growth through Republic National Distributing Company, with an expansive distribution network on and off-premise retailers and customers across 38 states and the District of Columbia. Now turning to our wellness segment, which is an important segment for us as we move forward. Our wellness segment continues to grow its branded hemp food business, Manitoba Harvest, in quarter two. Manitoba Harvest is the world's leader in hemp-based foods with product distribution across 17,000 North American stores and presence in 15 established international markets. The Manitoba Harvest brand expanded its U.S. market share leadership position in quarter two, continuing to deliver a better than 50% dollar share within branded hemp seed, and growing over 10% in multi-outlet retailers in the last 12 weeks reporting. Manitoba Harvest is now delivering dollar growth in each of its top 10 U.S. retailers, including Whole Foods, Sprouts, Walmart, and Kroger. Their market share in Canada remains near 80%. The drivers of growth include distribution expansion, a strong innovation pipeline, and pricing adjustments implemented in quarter two, coupled with our increasing consumer interest in hemp products given the key role they can play in plant-based, low-carb, and keto diets. Tilray wellness will be launching a new CBD wellness beverage, Happy Flower, via a direct-to-consumer e-commerce platform in early 2023, through our partnership with Southern Glazer, the leading distributor of beverage alcohol and CBD beverages in the U.S. We will look to expand the brand into key markets throughout 2023, focusing on states where CBD is permissible. In short, we continue to build out our wellness business with hemp foods and beverages with more to come. With that, I will now turn the call over to Carl Merton, our Chief Financial Officer, to discuss financials in greater detail.

Thank you, Irwin. Our focus on operating efficiency, adjusted EBITDA, and free cash flow has always been critically important, but even more so in today's economic environment. As we balanced our business decisions between adjusted EBITDA and free cash flow in the past, we often chose adjusted EBITDA over free cash flow. In the current year, our focus has shifted, and we are prioritizing free cash flow even if it occasionally comes at the expense of adjusted EBITDA. These decisions are evidenced through our ability to generate positive operating cash flow of over $29 million and free cash flow of almost $25 million in the quarter, an almost $50 million improvement from the same period last year. Before I review our quarter, let me first remind everyone that our financials are presented in accordance with U.S. GAAP and are in U.S. dollars. Throughout this call, we will reference both GAAP and non-GAAP adjusted results. Our earnings press release also contains a reconciliation of our reported results under GAAP to the non-GAAP measures identified during our remarks. For the quarter, net revenue was $144.1 million, down 6% from the sequential quarter of $153.2 million and down 7% from the year-ago quarter of $155.2 million. These declines are due to lower net cannabis distribution and wellness revenue that were only slightly offset by higher beverage alcohol revenue. Similar to recent quarters, our revenue income and adjusted EBITDA are being impacted by the strength of the U.S. dollar, particularly given our largest revenue sources' currencies are the euro and the Canadian dollar. On a constant currency basis, our net revenue rose slightly to $157.6 million, with our distribution and beverage alcohol businesses also up in their base currencies compared to the year-ago quarter. Reported gross profit was $40.1 million, a 22% increase from $32.8 million in the year-ago quarter. Adjusted gross margin held at 29% despite the reduction in net revenue. This was made possible by our success in implementing numerous cost savings programs offsetting part of our allocated overhead from intentionally reducing production coupled with the revenue realized from our HEXO transaction. Net loss was $61.7 million compared to a net loss of $65.8 million in the prior quarter and net income of $5.8 million in the year-ago quarter. Our adjusted net loss improved to $35.3 million or $0.06 per share compared to $45 million in the prior quarter and $38.8 million in the year-ago quarter. Reported adjusted EBITDA was $11.7 million, down 15% from $13.8 million in Q2 last year. Still, we were able to extend our track record to 15 consecutive quarters of positive adjusted EBITDA. The decrease was due to the negative impact of our cannabis gross margin as well as an increase in bad debt expense. As we have stated over the past several quarters, we are keenly focused on being free cash flow positive, and this is evidenced by our significantly improved operating cash flow during Q2, even if it resulted in a reduction in adjusted EBITDA. Further, absent the one-time charges we took in the quarter for the return allowance and existing business relationships, adjusted EBITDA would have been $14.8 million, up $1.3 million from the prior quarter. Turning to our business segments, gross cannabis revenue is comprised of $6.4 million in Canadian medical cannabis revenue; $52.4 million in Canadian adult-use revenue, which marks 5.7% growth from the prior year quarter; $7.7 million in international cannabis revenue, all offset by $16.8 million of excise tax. This resulted in net cannabis revenue of $49.9 million, representing a 15% decline from the year-ago period, largely related to reductions in international cannabis revenue, including a charge of $3.1 million related to international cannabis returns, which we do not expect to reoccur. On a constant currency basis, the decline was only 11%. The decline in the Canadian dollar and the euro accounted for $2.3 million of the revenue decrease compared to the prior year quarter. Cannabis gross profit increased 37% to $18.6 million from $13.5 million in the prior year quarter, while the gross margin percentage increased to 37% from 23%. In Q2, we also recognized a one-time sales return adjustment, which reduced our top line as well as an inventory disposal incurred as exit costs from both Israel and Uruguay. Together, these had a combined impact of reducing gross profit by $4.2 million or gross margin by 7.5%. Also impacting the decrease in the adjusted gross cannabis margin is a shift in strategic priorities to focus on pursuing cash flow-generating activities previously discussed. We consciously desired to lower production in our cannabis facilities as a result of slower-than-anticipated legalization globally by reducing operations, headcount, and other operational costs and continue to assess other cost-saving initiatives. We view these activities as temporary as supply requirements stabilize in the Canadian cannabis market and as European cannabis markets proceed with legalization. Distribution revenue, which is derived predominantly through CC Pharma, declined 13% to $60.2 million from $68.9 million in the prior year quarter. This was primarily impacted by the strengthening of the U.S. dollar relative to the euro. On a constant currency basis, revenue would have actually increased 3% to $71 million for an additional $10.8 million of revenue. Adjusted distribution gross profit increased to $7.7 million from $7.6 million in the prior year quarter, while distribution gross margin increased to 13% from 11%. This was the result of a positive change in product mix and our focus on higher-margin sales, including the decision to exit the medical device reprocessing business line. Looking ahead, we think we can continue to drive larger business profit margins despite not increasing revenue as we approach full utilization of our facility. Turning to our beverage alcohol segment, we generated $21.4 million in net revenue, which was 56% higher than the prior year quarter of $13.7 million. This was primarily due to our acquisition of Breckenridge and the Green Flash and Alpine beer brands in December 2021, coupled with our more recent acquisition of Montauk in November 2022. We remain bullish on expanding this segment over time as we leverage our increased distribution, regain brand acceptance with Green Flash and Alpine, foster brand acceptance with SweetWater in California, build out an extensive innovation pipeline, and potentially pursue other acquisitions. Beverage alcohol gross profit increased 28% to $10 million from $7.8 million in the prior year quarter. Adjusted gross profit, which includes $1.1 million in purchase price accounting step-up, rose 42% to $11.1 million. However, adjusted gross margin of 52% decreased from 57% in the same period in the prior year. This decline is a result of the SweetWater Colorado expansion, which is still in the startup phase of operations compared to last year when the expansion had not yet begun. Also, the Breckenridge and Montauk acquisitions were not completed in the prior year comparison and operate at a slightly lower margin than SweetWater. Finally, for our wellness segment, revenue decreased 8% to $12.7 million from $13.8 million in Q2 last year. Adjusted wellness gross profit was $3.9 million, up slightly from $3.8 million in the prior year quarter, while gross margin increased to 31% from 28%. Turning back to the topic of free cash flow, we took steps during Q2 to pivot from business lines in both our distribution and European cannabis businesses that were no longer accretive so that we could focus on areas of the business that generate positive cash flow. This, along with the strategic decision to reduce production in our cannabis facilities, have provided the necessary cash savings to achieve free cash flow of almost $25 million in the quarter—a roughly $50 million improvement from the same period last year. Our cash, cash equivalent, and marketable securities balance as of November 30 was a healthy $433.5 million, a more than $100 million increase from the year-ago period. Our working capital balance, which allows us to meet our operational and capital requirements, decreased to $388.2 million from $393.4 million over that same time horizon. For fiscal 2023, we are reaffirming our expectations of generating $70 million to $80 million of adjusted EBITDA and being free cash flow positive across all business segments for the year. In conclusion, I am focused on improving our industry-leading balance sheet, continuing to reduce our debt, thriving free cash flow, aligning product with demand, minimizing CapEx, and properly aligning our expenses with revenue expectations. With that, I will conclude our prepared remarks and open the lines for questions from our covering analysts. Afterwards, we will take a few questions from our retail shareholders through the safe platform. Operator, what's the first question?

Our first question is from Vivien Azer with Cowen & Company. Please go ahead with your question.

This is Victor Ma on for Vivien Azer, and thank you for taking the questions. So first off, based on Hifyre trends ex-Quebec, it seems like that the share recovery is continuing as you gained dollar share sequentially in Q2. But there are still some losses in pre-rolls and vapes. I know innovation will address these losses over time. But can you maybe offer some color to dimensionalize the headwind from legacy pre-rolls and vapes SKUs, and then the tailwind from new SKUs and also comment on the stickiness of new innovation? Thank you.

So I'm going to let Blair jump in here because he's on the call with us to talk about it. But I think a lot of it has to do with timing and when we're able to get these products into the different provinces. And Blair will tell you how many new products that we have and the timing. Blair, you want to jump in and just go through what's happening with vapes and pre-rolls and just how many new products that you have coming out?

Yes. Thanks, Irwin, and thank you, Victor, for the question. Certainly, what we've noticed in vapes, I'll start there, is the higher potencies and fruit-forward nature of vape. We definitely have a plan to build up on the potency side. And to Irwin's point, you'll see over 150 new listings from us in vapes and pre-rolls over the next two quarters. On the pre-roll side, you're really moving to fruit-forward infused pre-rolls, really stealing share from traditional pre-rolls. We have some big news coming in Q3 and Q4, good supply that you'll see us be very consistent with that trend. Just a comment on the stickiness of innovation overall, if you look at Q2 in Ontario alone, there were 859 new products in a market that was sequentially at least from a quarter standpoint flat. So there's definitely some dilution of SKU productivity moving forward. We're calculating that into our innovation pipeline. We're cognizant of the dilution effect of that, and we feel very confident that with leveraging our insights and leveraging our category dynamics and leveraging our coverage model we'll be very strong in these categories over the next two quarters.

Thank you, Blair. Victor, just let me emphasize two things. We have the number one share; we're 176 basis points ahead of our closest rival, number one. Number two, this year versus last year in our revenue, it's almost $12 million of price compression where prices have come down over a year ago. As we see the market settling out, and Blair has a plan in place between new innovation, new distribution, taking share, and potentially other acquisitions in the Canadian market, how he gets to a double-digit share back in that marketplace. Yes, we lost some share. I think it's timing, but considering the price compression and the marketplace, I think where Tilray is situated in Canada today is in a very good place. The innovation that is coming out is tremendous, and that should help share and growth overall.

And just pivoting to beverage alcohol for my second question, with downgrading in beer and wine apparent in Nielsen's scan data. Just curious if you've noticed consumer weakness in your beverage alcohol portfolio, and could you remind us of your annual pricing algorithm for SweetWater, Breckenridge, and now Montauk? Thank you.

So again, I'll just switch it over to Ty for a second, but we're still from SweetWater, the 10th largest craft brewer in the U.S.; Montauk, which we just acquired in December, is the number one craft brewery in New York City, a tremendous brand, only sold in New York with some sold in New Jersey, Connecticut, and a few surrounding areas. From a pricing standpoint, and I'll let Ty talk about it, there are some pricing opportunities. We probably have been a little slower in taking price increases, but it has to endorse some of the higher costs. From a Nielsen standpoint, I think we've picked up some distribution. Recently, we picked up a lot from a Kroger standpoint. So, Ty, do you want to jump in here for a second and introduce yourself?

Yes. Thanks, Irwin. Good question, Victor. Yes, we're definitely seeing some downgrading going on, but we're also seeing some consumer trade-up across several segments: super premium domestic Mexican imports, flavors, and higher ABV. So we continue to see some tailwinds in the space that we operate in and expect as we go into Q1 of 2023 that there will be continued pricing opportunities that we're going to take advantage of, both in the on and off-premise, which will be beneficial.

There is also a major pipeline. One of the things we've done in SweetWater and Montauk is now on the timing of when we can launch products. We have numerous new products that will be launched as we move into the spring. We have our 420 Fest, which is coming up, so there is a lot of event marketing based around our beer business. The other thing, Victor, just something you mentioned, we've seen a nice increase in our Breckenridge Distillery, our bourbon business and some great increases in our vodka business moving over to RNDC and some of the new distribution. So we're quite happy, and you can see we're up nicely on our beer and our spirits business quarter-over-quarter and year-over-year.

The next question is from the line of Nadine Sarwat with Bernstein. Please proceed with your question.

Two questions for me. So first of all, you called out that we grew our international cannabis business in your prepared remarks. Could you break down the factors driving this in more detail on how we should think about this part of the business performing in the remainder of the fiscal year? And my second question, nice to see Canadian adult-use sales actually growing year-on-year. Could you break down this growth between volume, mix, and price since there's a lot going on there? And how are you thinking about that over the coming quarters? Thank you.

Great. So number one, let me switch over the piece on Europe to Denise, who runs our European operations. But I think, listen, a lot going on in Europe—whether we can blame it on the war or blame it on the economy over there or costs—but I think as we're situated in Europe today, with our facility in Portugal and our facility in Germany, where we sell in over 20 countries from a medical standpoint, we're well situated. We spent a lot of time in Europe. You heard me say how much costs were taken out, and we've combined our businesses in Europe to one business unit between our CC Pharma, which is our distribution business into 13,000 drug stores and our operations in Portugal and Germany. We remain confident that even in the absence of adult use, we are still very well positioned to win in the medical business. Denise, do you want to jump in and add to that?

Yes. Thanks, Irwin. So just building on what Irwin said, our business in Europe is very strong. As Irwin mentioned, we are deprioritizing certain markets. We really made some active decisions to not pursue certain revenue streams, such as Israel's volatile market. Looking ahead, the medical market in Europe is projected to reach $13.8 billion by 2028, and we do feel very confident about the business.

And I think as we look at Europe, I like Europe as opportunistic. I think that there's a population of over 600 million people. Europeans want cannabis legalized, and I think it’s just working through the EU. We are ready and will look for other business opportunities in that European market where we can grow and be profitable. In Canada, flower is still number one, and it is the only market in the world where adult-use cannabis is legalized. We are well positioned in our growth facilities. We have great brands and tremendous innovation, and you're going to see a lot of fallout of that market with other LPs. It is a tough market, but whoever wins there will have big opportunities.

If I could just squeeze one more, given that you mentioned Germany, what are you seeing with regards to adult-use legalization in particular, with a focus on the EU Commission when you think it could be a realistic outcome? Thank you.

Yes. So we originally expected that we might see adult-use legalization take effect as early as 2024, based on where we are today. I think we view that it might be later in 2024 than originally expected.

And I think if Germany could make that decision for itself without the effects of the rest of the EU, it would happen much quicker. But as we all know, borders are open. Once it's legal in Germany, how do you stop it from going to the other borders? That's one of the biggest issues there. And listen, we have a plan in place to expand our medical business.

The next question is from the line of Andrew Carter with Stifel. Please proceed with your question.

I'll ask one question this morning, just a multipart, I guess. Looking at the sequential you've reiterated EBITDA guidance for the year, $70 million to $80 million. Regarding the step-up that you need to achieve that in the second half, could you walk us through the incremental cost savings? I get the bad debt expense isn't going to repeat. The Canadian adult use was shipments well below consumption. Could you give us an idea of the magnitude of what that hit was? And then incremental EBITDA from Montauk in the second half, as well as remind us on the seasonality of beverage alcohol? Thanks.

Thanks, Andrew. Let me just try to walk through as many of those pieces as I can. There was about $3.1 million impact on sales in the quarter related to returns. We had about $4.2 million that came out in my script on the slowdown in production, which is the effectively unabsorbed overhead. We see that the majority of our optimization plans will come into play late in Q3 and Q4.

I think the big thing is, as Carl was saying, a lot of our cost savings are back-end loaded. There's additional cost savings coming out of Europe. In regards to beverage alcohol, our beer business is back loaded in regards to sales there, and the same with our bourbon business with RNDC, now getting into distribution expansion in more and more states. But back to your point, we talked about it before, Canada has a major plan in place with a lot of innovation and growth in its back half, and that's a big part of it. So, it’s about growing our volumes, growing our distribution, and managing our costs.

The next question is from the line of Aaron Grey with Alliance Global Partners. Please proceed with your question.

So just for me, I want to talk a bit on M&A opportunities available to you, specifically in Canada. You mentioned getting back to double-digit share in your prepared remarks. The market is tough, doing business there for excise tax impacting a lot of the smaller players. Are you starting to see more attractive opportunities that have come up in the market? There appear to be an increase in CCAA. So, from your standpoint, are you seeing a shakeout that might present you with more M&A opportunities? Thank you.

In the Canadian sector, absolutely. I think we have two major facilities in Leamington, Ontario. It affected us from an absorption standpoint; there's a cash benefit to it. Bringing more grow into our facilities is absolutely very accretive to our gross margins and accretive to our earnings. As competitors come out of the marketplace, there's less competition, and it helps with some of the price compression. It has to make sense and fit within our growth facilities and be accretive to our shareholders. So we are interested. The Canadian market is the only market out there. It's a $10 billion projected growth market at retail. It's still a big market, and it's preparing for when legalization does happen in the U.S. We're focused on additional acquisitions and diversifying this company because we don't know when legalization is going to happen.

Our next question is from the line of Owen Bennett with Jefferies. Please proceed with your question.

I wanted to come back to your comments around exploring manufacturing partnerships with other LPs in Canada. Could you give some more details here on what these agreements would look like exactly? Have you had any initial interest? And you're able to do this due to spare capacity in your facilities currently; what would happen when demand increases and you perhaps need that in your own product again?

I'm going to let Blair answer that because he's doing that. We have the ability to grow in our facilities over 265,000 kilos. We're not worried about running at capacity. We’re looking at filling these facilities up to 265,000 kilos, which would change our financials tremendously. We're also exploring utilization potentially for growing fruits and vegetables in some of these facilities to supply food where there are major shortages. But, Blair, do you want to address that in regards to some of the stuff that you're working on in Canada?

Yes. Thanks, Irwin, and thanks, Owen, for the question. We've got a tremendous amount of capacity on the flower production side at a low-cost opportunity. The team has built world-class facilities that can operate at a low cost. There’s interest from many competitors focused more on survivability rather than sustainability. From our conversations, yes, they’re productive and fruitful. I think we'll partner up in the near future with those opportunities moving forward.

The next question is from the line of John Zamparo with CIBC. Please proceed with your question.

It's a relatively simple question. It's on the guidance, which implies a pretty significant step-up in EBITDA even if you account for Montauk. I wonder if you can get to the EBITDA guide with the current level of revenue, or does your guidance assume some pretty meaningful sales growth?

So, if you remember from the start, John, we talked about the one-time sales adjustment that we had. We're using that more as a base than the $144 that was in our financial statements this quarter. The answer is, yes, with the cost savings we have coming from the addition of Montauk, the $7 million cost reduction we’re looking at in Europe, more than half of which will be achieved by the end of the year, we see that as the basis for reiterating our guidance.

But, yes, we're looking at absolutely sales growth, and sales growth is a part of it.

Next question is from the line of Michael Lavery with Piper Sandler. Please proceed with your question.

I wanted to come back to a comment you made about some of the capacity and how to think about opportunities. You mentioned things like fruits and vegetables as an opportunity. But you also reiterated how you think about the Company's name and Tilray brands, and you don’t really see branded produce at least not with margins and multiples that are interesting. So how do you think about weighing those trade-offs?

There’s multiple going into it. Having invested significantly into our world-class facilities, getting utilization is important. Our goal is to use these facilities to contribute cash while focusing on our brands and driving growth. Let me clarify, we’re not entering into the branded vegetable business. Still, utilizing our assets effectively to maximize cash flow is key.

The next question is from the line of Pablo Zuanic with Cantor Fitzgerald. Please proceed with your question.

Look, two questions. First, remind us how you're thinking about the target of $4 billion in revenue by fiscal year '24. Given the delays on legalization, could there be a scenario where you decide to bulk up the branded, high-margin beer and alcohol business, and could that account for a significant amount of Tilray brands revenues? Secondly, if we follow what Canopy has said, if NASDAQ doesn't allow them to approve the Canopy U.S.A. structure, would you consider following, potentially leaving the NASDAQ to buy U.S. assets?

Number one, I always made sure that the $4 billion target was contingent on legalization. The spirits business has been profitable and has good margins. Companies like Constellation and Diageo are looking at cannabis, and I am sure they will continue to grow in this space. If I can't do anything in the U.S., focusing on craft breweries is a great approach. Regarding your second question, currently being on the NASDAQ is important for us. Right now, we don't look to exit NASDAQ.

Our next question is from the line of Matt Bottomley with Canaccord. Please proceed with your question.

I wanted to pivot back to the M&A side, particularly in the U.S. area. Given the disappointment at the federal level, does that change your view on how to allocate capital or how to position yourself?

We are not going to buy options and pieces of U.S. companies. We want to focus on the brands and adjacencies. Our approach will not be dictated by politicians in Washington. We will continue our focus on cannabis in Canada and Europe and build on our existing strong brands.

Our next question is from the line of Frederico Gomes with ATB Capital. Please proceed with your question.

Just on the price environment in Canada, in 2022, we continued to see price compression. Do you expect any significant shift in Canada in 2023 in terms of pricing? What could be the drivers there?

Cannabis is probably the only product where inflation hasn't hit, but there's a lot going on. Price compression has been minimal quarter-over-quarter, yet year-over-year, we've seen $12 million price compression. Focus should be on building brands and innovation quality that will ultimately help with pricing.

I would say it's unlikely to see price changes over the next 12 months. You may see some category mix shifts, particularly if we see a resurgence of interest in pre-rolls, which can improve pricing.

Cannabis in Canada is a relatively new business, and building strong brands takes time. Over time, I expect we will see a significant opportunity in the beverage category, where consumers can easily buy THC-infused products in their convenience stores.

Any additional questions at this time?

Thank you. We will now take questions from the Say Technologies platform. The first question is: What are some positives to look forward to in 2023?

Listen, I think there're a lot of positives. Tilray is a diversified company with strong opportunities for growth in adult-use cannabis, medical cannabis, beverages, and wellness. We’ve built out a solid balance sheet with over $400 million cash on hand and an excellent management team focused on executing our strategies.

Thank you. And the final question is: What are the plans to increase the stock value in this economic environment?

The markets have been tough. The cannabis industry is down over 50%. We need to focus on diversifying our business to ensure growth and not just depend on legalization decisions from politicians. When legalization happens, we'll be ready to pursue those opportunities.

Thank you, everybody. As you can see, there's a lot going on, with a great team in place to help execute. We have a strategy, and we're focused on top-line growth, cash, and acquisitions to build our business. Thank you for joining us today, and I look forward to speaking again soon.

This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.