Tilray Brands, Inc. (NASDAQ:TLRY) Q2 2023 Earnings Call Transcript January 9, 2023
Operator: 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.
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Berrin Noorata: Thank you, and good morning. By now, everyone should have access to the earning press release, which is available on the Investors section of the Tilray brands website at tilray.com and has been filed with this 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 tax 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.
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 real-line 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 this. Maintaining our number one leadership position and growing market share in recreational cannabis in Canada, the largest federated 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 does occur. And 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 resonates powerfully with consumers that 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 essentially creating a broad set of cannabis-infused and focus CPG brands.
We are also, of course, diligently focused on optimizing our global operations while remaining that low-cost producer. And last but not least, strengthening our industry-leading balance sheet and driving our cash position because it affords us opportunities for growth, expansion, including through cannabis adjacencies within the context of economically on certain environment. I want to emphasize the value potential of Tilray brands built on growth opportunities and our foresight to diversify both organic and acquisitive. I am confident in the fundamental potential of Tilray brands as the most diversified cannabis lifestyle company and consumer packaged good leader. We have already made notable progress in quarter two and exceeding against these priorities.
As it is evident by significant improvements in operating cash flow despite a challenging top line performance, we have, of course, a long view generating free cash as an integral part of our business model, in turn, enable us to deliver on our highest priority delivering sustained durable shareholder value. Close observers of Tilray brands and our team know one thing, we moved quickly and decisively to adapt to the market changes. And I’m proud to highlight that even with the breadth of the platform and our sheer scale, we remain agile, pivoted quickly making smart strategic decisions and executed against them with our free cash flow objective accomplished. For example, during the quarter, we opt 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 a lead built-to-last platform. I want 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, represents 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. And 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 to 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 compressions and high excise tax, forcing both industry consolidation and a reduction in roughly 925 licensed producers that are operating today. Despite these challenging conditions, Tilray remains the number one cannabis market share position with an 8.3% market share in Q2. In Q1, Tilray led the next largest license producer by 54 basis points while in Q2, we 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 more accurate reflection of the marketplace. We continue to build a thoughtful approach to innovation, 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 understand clearly what consumer values are 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, pre-roll packaging to half, diverting 158,000 kilos of plastic away from landfill sites.
In Canada today, we have the leading internal capabilities in low-cost flower production infused and non-infuse pre-roll automation, BHO, live resin, distillate, vape production and state-of-the-art beverage formulation and production and further manage overhead more efficiently, help stabilization and sustain Canadian cannabis industry, we have reached out to numerous industry partners to leverage our expertise low-cost environment and existing capacity in coal manufacturing partnerships. We understand the challenging nature of cannabis in Canada. Our investment in consumer insights, innovation, cost optimization and market-leading sales coverage have allowed us to be stable during a time of instability. From our vantage point, we think we’re best situated to thrive as these dynamic play outs and we intend to stay the course for the long term.
In Europe, we are seeing momentum across the continent that we expect to 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 expect to follow over the next couple of years. When this happens, we’re strongly positioned to further seize on the opportunity. European cannabis business offers having built an unrivaled platform through our growing facilities in Portugal and Germany. The shift is supported by growing acceptance of medical cannabis for treatment of numerous conditions and followed by growing support for cannabis legalization of 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 are contending with a difficult economic environment in Europe because of soaring inflation which is due at least in part to the ongoing war in Ukraine. This is affecting all key cost inputs, but particularly energy prices and is doing so 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 a constant 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 quarter three. Consistent with our approach of all our businesses, we are relentless focused on both improving the quality and consistency of our medical cannabis products as well as our cost structure in order to be that low-cost producer in Europe.
Therefore, we have developed a plan to take approximately $7 million of cost out of our European business. We strongly believe that our competitive differentiators in Europe are being that low-cost producer of high-quality consistent cannabis. Our integration of CC Pharma, our medical cannabis teams to enhance and improve our sales function with CC Pharma’s strong pharma relationships, both in Germany and throughout Europe, bringing credibility to cannabis. 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 and 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 touch 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. And 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.
Our past year SweetWater and our two iconic Southern California brands, Green Flash and Alpine have vastly expanded distribution throughout our partnership with Reyes, the largest beer distributor in the U.S. In November, we acquired Montauk Brewing Company the fastest craft growing beer and number one craft brewer in Metro New York. Its success has been driven by its loved product portfolio, premium price point and over 4,700 points of distribution including top national retailers, including Target, Whole Foods, Trader Joe’s, Stop & Shop, King Colin, Walmart and 7-Eleven also 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 growth across key national markets, including California, Georgia, Florida, Connecticut, and 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 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 a very important segment for us as we move forward. Our wellness segment continues to grow its branded hemp food business, Manitoba Harvest in quarter two and Manitoba Harvest is the world’s leader in hemp-based foods where product distribution across 17,000 North American stores and present in 15 established international markets. The Manitoba Harvest brand expanded its U.S. market share leadership position in quarter two continued to deliver a better than 50% dollar share within branded hemp seed and growing over 10% and 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, Whole Foods, Sprouts, Walmart and Kroger.
Manitoba Harvest market share in Canada remains near 80%. The drivers of growth include distribution expansion, a strong innovation pipeline and pricing put in place in quarter two and coupled with our increasing consumer interest in hemp products given the key role they can play in plant-based, low carb and keto diet. Tilray wellness will be launching a new CBD wellness beverage Happy Flower via direct-to-consumer e-commerce platform in early 2020 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 of hemp foods and beverages with more to come.
And with that, I will now turn the call over to Carl Merton, our Chief Financial Officer, to discuss financials in greater detail. Carl?
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Carl Merton: Thank you, Irwin. Our focus on operating efficiency or adjusted EBITDA and free cash flow have 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 on 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.
And 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% and 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 and even if it resulted in a reduction in adjusted EBITDA. Further, absent the onetime 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 was 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 resulted in $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, reductions in 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 has 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% and 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, of course, 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 can 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?
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