Tilray Brands, Inc. (NASDAQ:TLRY) Q3 2024 Earnings Call Transcript

Tilray Brands, Inc. (NASDAQ:TLRY) Q3 2024 Earnings Call Transcript April 9, 2024

Tilray Brands, Inc. beats earnings expectations. Reported EPS is $-0.0001, expectations were $-0.04. Tilray Brands, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for joining today’s conference call to discuss Tilray Brand’s Financial Results for the Third Quarter of Fiscal Year 2024 ended February 29, 2024. 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. I will now turn the call over to Ms. Berrin Noorata, Tilray Brand’s Chief Corporate Affairs and Communications Officer. Thank you. You may now begin.

Berrin Noorata: Thank you, operator, and good morning, everyone. By now, you should have access to the earnings press release, which is available on the investors section of the Tilray Brands website at tilray.com and has been filed with the SEC and SEDAR. Please note that during today’s call, we will be referring to various non-GAAP financial measures that 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 those forward-looking statements. The text in our earnings press release includes many of the risks and uncertainties associated with such forward-looking statements. Today, we will be hearing from key members of our senior leadership team beginning with Irwin Simon, Chairman and Chief Executive Officer, who will provide opening remarks and commentary; followed by Carl Merton, Chief Financial Officer, who will review our quarterly financial results for the third quarter and update our financial guidance for the fiscal year 2024.

Also joining us for the question-and-answer segment are Denise Faltischek, Chief Strategy Officer and Head of International; Blair MacNeil, President of Tilray Canada; and Ty Gilmore, President of our US 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. Good morning, everyone, and thank you for joining us. At Tilray Brands, we take great pride in our mission to be the most responsible, trusted and market leading cannabis and consumer products company across the globe. Today, with our complementary business units, we believe Tilray Brands is the best positioned company in the world to take advantage of all the positive regulatory tailwinds happening globally with cannabis legalization and drug policy reform. In Canada, Tilray continues to lead the cannabis industry with the leading portfolio of adult-use brands and the number one market share. In the event, the current excise tax regime were to be replaced with a 10% Ad Valorem Tax based on the value of the product sold and not a per gram tax, we expect an annual savings of $80 million.

We also expect to benefit from additional cannabis related regulatory reforms around marketing and THC potencies. I’ll take a deeper dive in the Canadian market shortly. In Germany, Tilray has the leading cannabis market share by revenue for the trailing 12-months and we believe we are best positioned to capture a large portion of the expected growth in the medical market with both our in-country cultivation facility in Germany and our state-of-the-art facility in Portugal. We also have the ability to ship products from Canada to Germany. In the U.S., Tilray has multiple options and, in particular, is well positioned to benefit from the federal legalization of medical cannabis as a result of rescheduling. Yes, we believe that the rescheduling of cannabis from Schedule I to Schedule III in the U.S. would provide a path for Tilray to sell pharmaceutical grade medical cannabis in the U.S. subject to doctor prescriptions.

This is a different strategy from what MSOs are doing today. We believe there’s an opportunity to supply medical cannabis products from our existing operations into the U.S. for medical purposes. Further in the event of a future federal adult-use and medical cannabis legalization in the U.S., we believe Tilray is well positioned to immediately leverage its strong global leadership position, know-how and strategic strengths across operations, distribution and brands to sell THC infused products across its robust distribution network and sales channels in the U.S. Today, Tilray is a clear outlier in the global cannabis industry, because we’re the only company with global expertise in both adult-use and medical cannabis. Our innovation comes from GMP certified pharmaceutical grade medicines through all recreational cannabis formats, including THC infused beverages, which also parlays into our beverage strategy.

We have rigorous cannabis quality control, regulatory affairs, branding, marketing, sales and distribution. We also have the number one cannabis market share in Canada, the number one cannabis market share in Germany as measured by revenue and we distribute medical cannabis in over 20 countries around the world. Since 2019, we quickly developed a diversified and award-winning portfolio of brands backed by a best-in-class operations in Canada, U.S., Europe, Australia and Latin America that supports our goals of becoming a multi-billion dollar cannabis and consumer products company that addresses the needs of consumers and patients we serve today. As you know, the leadership team at Tilray has the expertise of buying CPG brands and building them into somewhat greater than they were before.

Our creative portfolio of beverage brands includes craft beers, spirits, ready to drink cocktails, ciders and non-alcoholic beverages. We are now the 5th largest craft brewer in the U.S. with a 4.5% share of the craft beer market. With over 500 beer distributors alone, Tilray is now dominating key regions across the U.S. with our craft beer brands in the Northeast, Pacific Northwest, Midwest and Southeast, along with one of the most awarded bourbon brands with Breckenridge Distillery, which continues to gain market share across whiskey, vodka and gin products. Our wellness brands include Manitoba Harvest, hemp-based food products, ingredients and snacks, as well as our Happy Flower, our CBD infused beverages and our recently relaunched HiBall Energy drinks, which in its first month on Amazon received over $1 million in orders.

With the appropriate approvals, we’re also looking to introduce hemp-based delta-9 beverages and products with our Happy Flower brand and across other wellness brands in the U.S. And finally, we own and operate a European medical cannabis and pharmaceutical distribution business in Germany, CC Pharma, also known as Tilray Pharma, with a robust footprint reaching 13,000 pharmacies in Germany alone. With broader medical cannabis use, doctor prescriptions in Germany, we expect there to be tremendous demand for medical cannabis within pharmacies. I can’t predict the future, but my belief is there will be a lot of cannabis regulatory changes we’ve seen with Germany, in Canada and U.S., and Tilray is best equipped to reach these underlying opportunities and we have the assets and the tools to reach our goal for Tilray brands to deliver industry leading profitable growth and sustainable long-term shareholder value through a focus on these three fundamentals.

Maximizing profitable revenue growth through organic growth and strategic acquisitions with strong synergy opportunities, realizing the benefits of optimized asset utilization and cost management to ensure an efficient cost structure across all our business segments and to strengthen our industry leading balance sheet and cash position. During Q3, we achieved net revenue of $188 million, representing approximately 30% growth over the previous year. We grew our revenue across our core business segments. This was achieved by focusing on organic growth of legacy brands and enhancing the performance of our more recent strategic acquisitions. Gross profit was $49.4 million, despite impact of the newly acquired craft beverage brands, which have a lower margin.

Our net loss was $105 million, which only $4.5 million represented loss from operations and cash used in operating activities was $15.6 million. Adjusted gross profit was $51.6 million, adjusted EBITDA was $10.2 million, adjusted net income of $900,000 and adjusted EPS of $0.00, we delivered positive adjusted free cash flow for the quarter. Over the last three quarters, we significantly reduced our convertible debt by $205 million, decreasing our net debt to approximately $175 million and we’ll work to continue reducing our indebtedness, optimizing our capital structure, and enhancing our financial flexibility. The net reduction in our convertible debt will decrease our annual interest expense by $9.8 million, which flows directly to adjusted net loss and adjusted free cash flow.

Let’s now dive deeper into each of our business segments. We grew our global cannabis net revenue by 33% to $63.4 million in Q3, compared to the previous year quarter, driven by our acquisition of HEXO and Truss, as well as our international business and innovation in the Canadian markets. Net Canadian cannabis revenue grew 31% to $49.4 million in Q3, compared to the previous year. We achieved this growth with the HEXO acquisition despite price compression building $3.1 million from the prior year quarter and a crippling tax structure that has allowed taxes to spike while prices declined by more than 50%. Excise tax increased by $8.2 million and amounted to $21.8 million or 32% of our gross Canadian cannabis revenue in Q3, compared to $13.6 million or 26% in the same quarter last year.

Recent enforcement efforts by Canada Revenue Agency garnishing LP payments from the provincial boards is already having an impact on our competitors, over 1,000 of whom have negligible market share. The continued enforcement by CRA, we believe, will lead to further and necessary industry consolidation, perhaps on a mass level. Canada continues to be the largest federal legal and commercial adult-use cannabis market in the world and Tilray brands maintains that number one market share position in the country. We are number one in Ontario, number one in Quebec, number one in British Columbia, which together represents over 60% of the population of Canada. We’re also number one in cannabis flower, oils, concentrates and THC beverages; number two in pre rolls; and number four in vapes and in the top 10 in all other categories, all while operating under rigorous, high quality control standards.

Our focus in Canada is on two things: First, growing sales primarily through continuous launches of new product innovation. And second, taking more and more costs out of our businesses. On a latter, on large part of our acquisition strategy for HEXO and Truss involves removing legacy costs and SKU rationalization from these businesses. For HEXO, we originally target $27 million, but then increase that to between $30 million and $35 million, of which we’ve already achieved $27.5 million in savings on an annualized run rate basis of which $15.6 million is realized cost savings during the period. Our HEXO integration plan includes streamlining our Canadian operations, improving utilization of our core facilities, improving margins and maximizing cash opportunities by pursuing divestitures and consolidating facilities.

We plan to close the Cayuga facility and move its cannabis cultivation to our existing Canadian production lines. Sell our Masson facility in Quebec which is currently cultivating cucumbers as a vegetable operator and sell the Belleville facility and move our manufacturing to our London facility for our beverages. We expect this plan to result in one-time $70 million to $85 million of Canadian cash flow — inflow opportunity and accretive to margins and net income by $5 million to $7 million on an annual basis. From a regulatory standpoint, the expert panel appointed by the federal government clearly highlights three areas of focus, which Tilray would benefit from once implemented. First, excise tax reduction, which I’ve talked about both in adult recreation and medical would benefit Tilray $80 million.

Secondly, there is a proposed opportunity for pharmacies to carry CBD and medical cannabis for medical patients, which would move plant-based medicines into the mainstream as an option for patients to treat ailments. And finally, enforcement against illicit websites, dispensaries that don’t contribute to excise tax and put youth at risk through unregulated product channels available easily online with e-transfer and Canadian Post e-mail. We think Canada Post and the Canadian banking systems are responsible for shutting down access to these unlawful establishments. Turning to international cannabis, we grew net revenue organically by 44% year-over-year to $14 million and we remain the number one market leader in medical cannabis across Europe with a leading market share in Germany and Poland.

Tilray’s international growth has also been driven by increased sales in our existing market such as Portugal, Italy, the U.K., Australia and New Zealand. The new German medical market opportunity is projected to be approximately $3 billion in the medium term while the European opportunity could represent a potential $45 billion medical market alone in the long-term. Our presence in Europe allows Tilray to grow our global brand portfolio to a base of over 700 million people in Europe, which is twice the population of U.S. While much of the media attention related to the new cannabis reform in Germany has been centered around cultivation for personal use and the establishment of cannabis social clubs, the new opportunities for Tilray flow mostly from the removal of medical cannabis from the Narcotics act.

This de-scheduled change is expected to significantly expand the medical cannabis market in Germany as it would allow for more doctors to prescribe medical cannabis more easily to patients and potentially allow for broader health insurance coverage. We will therefore be increasing our educational efforts to bring more and more health professionals on board with medical cannabis as therapeutic options. We estimate that less than 0.4% of the population in Germany are presently buying medical cannabis, compared with 4% in states like Pennsylvania. In Germany, we also stand the benefit from the abolishment of the tender process for in -country cultivation of medicinal cannabis, which is being replaced with a licensing scheme. We are currently one of the only three in-country cultivation facilities in Germany today and these legislative changes would allow us to better meet patients need by expanding our medical cannabis product offerings.

This would in turn significantly increase our cannabis production in Germany by 5 times more than double our revenue opportunities. Tilray opportunities in U.S. cannabis remain strong. Over the past several years, our playbook of expanding our business beyond cannabis to adjacencies in complementary markets has positioned Tilray well for the current environment, as well for future growth opportunities. While we currently do not engage in any U.S. cannabis operations because of federal regulations, we are well positioned to participate and win in a federally legalized market when that changes either rescheduling or medical cannabis or the passage of federal cannabis legalization, given our deep knowledge, global expertise in medical and adult use cannabis and the regulatory compliance in play.

Tilray’s playbook in the U.S. is to build and deliver iconic sawed-off brands in the beverage alcohol and the CPG backed by product excellence and innovation, educate consumers about our brands and our stringent quality standards to encourage trial and faster loyalty, and last but not least, to drive and scale and distribute to get our brands into consumer hands to grow our market share. Moving to our beverage segment, which is quickly approaching approximately $300 million annualized. As mentioned earlier, Tilray Brands is now the fifth largest craft brewer in the U.S. with a 4.5% craft beer market share and we aspire to be a top 12 beverage company in the U.S. Q3 beverage alcohol net revenue was $54.7 million, representing 165% growth year-over-year.

Tilray now holds a 4.5% of the craft beer market share in the U.S. and we’re just getting started and ramping up. Of this our legacy brands of SweetWater, Montauk, Alpines, Nelson and Green Flash demonstrates our ability to successfully grow existing brands along with our recent acquisition of 12 craft brands from AB InBev. We have gained in scale and see further expansion opportunities. SweetWater remains the number one brand family in Georgia multi outlets. Montauk remains the number one brand family in Metro New York, having increased its distribution by 28% versus last year. Tilray is now the number one craft supplier year to date in the Pacific Northwest. 10 Barrel’s volume growth increased by 413 basis points since Tilray took over the brand and we’re now capitalizing on the success of 10 Barrel Pub Beer brand extensions by adding Pub Ice, Pub Cerveza and line extensions.

Both innovations we are extremely excited to launch, growing 24% Pub Beer is now the top 20 brand on the West Coast with only half the distribution of top competitors, due to its focus on the Pacific Northwest states. Still our vision is to be much higher as we’re aiming and uniquely positioned to become a top 12 beverage alcohol business. This will be accomplished by leveraging our portfolio to win more occasions through core products such as craft beer and beyond through innovation to categories like flavored malt beverages, ready to drink cocktails and spirits. But ultimately our plans go beyond alcohol as we will be expanding into sparkling water, energy drinks and other categories. This is important because we have the manufacturing facilities, the distribution and the sales and marketing infrastructure to drive Tilray businesses.

Working with BCG, we developed a clear and focused strategy to drive top line and bottom line growth for our beverage businesses. The three-pronged approach will deploy our regional strategy called Dual to stabilize scale brands such as SweetWater, Montauk, Blue Point in their respective key adjacent regional markets across the U.S. and maximize their potential to gain market share from competitors. Dual is already paying off. According to BI sales to retail data, Tilray has increased its market share of total beer at 13 states, including key beer markets such as Oregon, Washington, Colorado, Idaho, Minnesota and Arizona, when comparing share before and after the craft acquisition. In the Southeast alone, we’ve improved trends by 4.6% post-acquisition.

For Q3, 10 Barrel has seen a 12.3% increase in distribution amongst our top 10 distributors, when compared to the same time last year. And when comparing six months preacquisition with the five months post-acquisition, overall trends have improved 3.5%. Overall trends for Blue Point have improved 1.3%, while its number one distributor has improved trends by 3.8% and those are just a few examples. We are also executing a national brand strategy beginning with revitalizing Shock Top to win as a national craft beer over time by targeting share and connect occasions to reach mainstream male and female drinkers. We think there is tremendous upside with Shock Top as according to our qualitative research, Shock Top has the highest purchase intent among 12 of the largest beer brands.

This is why we’re focused on increasing distribution and getting this brand back into the hands of consumers. We are already on our way. In Q3, Shock Top’s number one distributor has increased distribution 24% versus last year, while on-premise distribution has increased 0.5% over last year among Shock Top’s top 10 distributors. We are aggressively launching new and often disruptive innovation across our beer and non-alcoholic crafts to increase portfolio brand appeal to new consumers and new occasions. Many of our newly acquired brands have not had innovation in the last couple of years among many others. Recent examples include Liquid Love for heartfelt hydration; Runner’s High, a non-alcoholic craft brew for athletes; Eyeball and Hardball, a non-carbonated 10% ABV products sold in 16.9 ounce plastic resealable containers and non-carbonated Shock Top LiiT Hard Tea.

Let me say that we’re working to get the cost structure right, transforming the productivity and profitability of the breweries we acquired. We expect that our beer gross margins will increase once we fully realize the cost savings achieved in connection with the fully integrated beverage alcohol platform as we move away from the existing co-packing manufacturing agreements with ABI and increased our productivity in our newly acquired breweries and 13 brew pubs. Finally, let’s discuss our wellness segment, represented mostly by Manitoba Harvest, which is fostering a positive impact on people and the planet through hemp by making ongoing commitments to sustainability with breakthrough initiatives such as investment in regenerated agriculture.

Revenue grew 12% in Q3 to $13.4 million, compared to last year. We partnered with bioactive company BrightSea to revolutionize the functional fiber market and breakthrough product, Manitoba Harvest bioactive fiber, which is now exclusively available at whole foods markets nationwide. Incredibly, 95% of Americans do not consume the recommended daily intake of fiber. This product provides 6 grams of both soluble and insoluble fiber per serving and is the only fiber solution containing two powerful hemp based bioactive for gut health. Moving forward, the team continues to assess the opportunity to bring hemp derivative delta-9 beverages to market under Happy Flower and Tilray brands. With that, I now turn the call over to Carl to discuss our financials in greater detail.

Carl?

Carl Merton: Thank you, Irwin. Recall that we present our financial results in accordance with U.S. GAAP and in U.S. dollars. Throughout our discussion, we will be referring to both GAAP and non-GAAP adjusted results and we encourage you to review the reconciliation contained within our press release of our reported results under GAAP to the corresponding non-GAAP measures. Let’s now review our quarterly performance for the three months ended February 29, 2024. Q3 total net revenue rose to $188.3 million, compared to the prior year quarter of $145.6 million, representing almost 30% growth. Excluding acquisitions completed within the fiscal year and the $8.7 million HEXO advisory fee captured in the prior year quarter, our legacy businesses remain consistent, despite a 13% revenue decline in our lowest margin segment.

We continuously emphasize the strategic importance of our adjacency business model, which is a key differentiator for us. This is best reflected by the contribution of our four segments to our overall results, which shows that we are not too dependent on any individual segment having a disproportionate impact on our sales or profit growth. Each segment is also, in our view, on a path to sustainable long-term growth. Looking at each segment now, during Q3 and compared against the prior year period, net beverage alcohol rose 165% and represented 25% of our total revenue mix, more than double relative to last year’s 14% of total mix. Net cannabis revenue grows 33% and represented 34% of total mix, up slightly from 33% last year. Distribution revenue decreased 13% and represented 30% of total mix, down from 45% last year.

And wellness revenue rose 12% and represented about 7% of total mix, down only slightly from 8% last year, respectively. Diversification is also reflected in our geographic footprint. During Q3, more than 62% of our net revenue was generated in North America, roughly 36% was generated in EMEA and the remaining 2% coming from other parts of the world. This compares to about half from North America and EMEA in Q3 last year with the variance related to the North American acquisitions we completed since that time, namely HEXO, the craft acquisition brands and the remainder of Truss beverages. Let me first touch on the key current item related to cannabis before moving onto a discussion on profitability. We incurred $21.8 million in Canadian cannabis excise taxes during Q3, which are a reduction to revenue, compared to only $13.6 million last year.

The increase in excise taxes is reflected by a sharp increase in cannabis revenue generated in Canada versus the year ago period, due in part to the HEXO and Truss acquisitions and a change in our revenue mix to higher excise tax products. Through the first three quarters of our fiscal year, we have incurred more than $75 million in excise taxes versus $47 million for the year ago nine-month period. For many quarters, we have been on the record with respect to the inherent unfairness as how the excise tax is predominantly computed, which is largely a fixed price on grams sold rather than as a percentage of the selling price. Because the selling price has declined meaningfully since the law was first enacted in 2018, it has made the excise tax a larger and larger component of net revenue over time, particularly as current growth categories like infused pre-rolls and concentrates become the biggest part of our sales mix.

To prove this point further, excise tax amounted to 32% of gross Canadian cannabis revenue in Q3, compared to 26% in the same quarter last year. All through the first three quarters of the year, excise tax came to 34% of gross cannabis revenue versus 27% for the first nine months of fiscal 2023. In our view and in the view of so many others, this price-based tax structure is crippling as it has allowed taxes to spike as the price of cannabis has declined by more than 50% since legalization. In late February, the Canadian House of Commons Standing Committee on Finance issued a report outlining several recommendations regarding the regulated adult-use cannabis industry, including the recommendation to adjust the tax structure. Recommendation three to nine, in particular, calls on legislators to make adjustment to the excise duty formula for cannabis, so that it’s limited to a 10% Ad Valorem Rate.

If enacted, this would be a welcome change that could result in $80 million in annualized revenue for our cannabis business, which would largely fall to the bottom line. The key to the government’s plan and needed relief for our industry is that the provinces not enact their own excise tax, reflect the loss in taxes they are reaping from the status quo, increase their profits at the boards or mandate that the tax savings are passed on directly to the consumer in the form of lower pricing. The budget announcement is next week and we’ll be following developments closely, but are resolute in our view that reform is greatly needed and measures must be enacted to stabilize the Canadian cannabis industry. Turning back to our performance, gross profit was $49.4 million, compared to a loss of $11.7 million in the prior year quarter.

While gross margin increased to 26% from negative 8% in the prior year quarter, adjusted gross margin decreased to 27%, compared to 30% in the prior year quarter. I will discuss adjusted gross margin by individual segment in a moment. However, the majority of the decrease relates to the addition of the new craft brands, which are subject to a co-manufacturing agreement with ABI until at least the end of Q1 next year and the prior year figure including the HEXO advisory fees. Net loss improved to $105 million, compared to a net loss of $1.2 billion in the prior year quarter, which included $934 million of impairments. On a per share basis, this amounted to a net loss of $0.12 versus $1.90 in the prior year quarter. Recall that last quarter we introduced two new reporting metrics to our discussions, adjusted net income loss and adjusted earnings per share.

The definitions of both are identified in the press release along with the relevant reconciliations and calculations. For Q3, we are reporting an adjusted net income of $900,000, which when calculated on a per share basis, results in EPS of $0.00 for the quarter. Adjusted EBITDA was $10.2 million, down from $13.3 million in the prior year quarter. This is mainly a consequence of the negative impact the cannabis gross margin related to wholesale revenue, the termination of the HEXO advisory services contract on our acquisition of HEXO in June and the co-manufacturing agreements with the new craft brands as I will explain shortly. During the quarter, we made great progress against the HEXO synergy plan, which we had previously increased to between $30 million and $35 million.

As of the end of Q3, we achieved $27.5 million in savings on an annualized run rate basis, of which $15.6 million represented actual cost savings during the period. Operating cash flow was negative $15.4 million, compared to negative $18.6 million in the prior year quarter. This improvement in cash used during Q3 this year was primarily related to achieved synergies of previously identified cost savings plans. Turning now to our four big business segments. Beverage-alcohol revenue was $54.7 million, up 165% from $20.6 million in the prior year quarter. The positive delta was due to contributions from the craft brands, which were purchased last fall. However, we note that the impact of dry January was far more of a headwind than it was for the industry in previous years.

Beverage alcohol gross profit increased to $18.9 million, compared to $10 million, while beverage-alcohol gross margin decreased to 34% from 48% in the prior year quarter. Adjusted gross margin fell to 38% from 53%. Both of these outcomes were a result of the craft brands, which currently have lower margins than our historical business. This is primarily due to the co-manufacturing agreements for brewing. For greater context, adjusted gross margin for our legacy beverage business was 59% compared to the prior year quarter of 53%, primarily as a result of an agreement with a distributor related to our spirits business. Adjusted gross margin from the crafts brands was 26%. The improvement of gross margins in the beverage alcohol business, primarily in the beer portion of the business, represents a major focus for the organization.

Gross cannabis revenue of $85.2 million was comprised of $62.1 million in Canadian adult-use revenue, $14 million in international cannabis revenue, $6.4 million in Canadian medical cannabis revenue and $2.8 million in wholesale cannabis revenue. Net cannabis revenue, which excludes the aforementioned $21.8 million in excise taxes, was $63.4 million, representing a 33% increase from the year ago period. The positive variance is related to the increased organic growth of over 14%, combined with contributions from the acquisitions of HEXO and Truss. Offsetting the increase in net cannabis revenue was the elimination of advisory services revenue totaling $8.7 million from the prior year quarter, due to the HEXO acquisition, which terminated the previous strategic arrangement that was in place.

While revenue from Canadian medical cannabis grew only slightly as a category is being impacted by competition from the adult-use market and its related price compression, revenue from Canadian adult-use grows 37%, which was driven by new product innovation and increased revenue from HEXO and Truss. International cannabis grew 44%, largely because of growth in our existing markets and the expansion into emerging international medical markets. Wholesale cannabis revenue increased to $2.8 million from essentially zero last year as these sales are opportunistic and variable. We entered into this wholesale agreement to optimize our inventory levels and prioritize the generation of positive operating cash flow, however, it unfavorably impacted our gross profit and EBITDA.

Cannabis gross profit was $20.9 million and cannabis gross margin was 33%, compared to negative $32.8 million and negative 69% in the prior year quarter. Excluding the impact of the noncash fair value purchase price accounting step up and inventory valuation adjustments, adjusted gross margin decreased to 33% from 47%. As I said earlier, a portion of the margin decrease is a result of the termination of the HEXO advisory services agreement, which contributed zero gross profit in the current year, compared to $8.7 million in the prior year, which if excluded would decrease adjusted gross margin to 35%, essentially meaning that our cannabis gross margin was largely flat year-over-year. Distribution revenue derived predominantly through Tilray Pharma decreased 13% to $56.8 million from $65.4 million in the prior year quarter.

Revenue was negatively impacted by infrastructure outages and weather, which impacted revenue by just over $3 million and short-term challenges related to new rebate regulations. Tilray pharma gross profit decreased to $5.6 million, compared to $7.5 million in the prior year period. Tilray pharma gross margin decreased to 10% from 11% in the prior year quarter because of product mix. Wellness revenue grew to 12% at $13.4 million from $12 million in the prior year quarter. The increase was driven by our strategic focus on targeted advertising campaigns aligned with emerging trends in healthier lifestyles, particularly around the new year coupled with our continuous innovation efforts. Wellness gross profit was $4.1 million, up from $3.7 million in the prior year quarter and gross margin held at 30%, compared to 31% in the prior year period as we experienced a change in sales mix towards more bulk retail sales.

Our cash and marketable securities balance as of February 29 was $225.9 million, down from $408.3 million in the year ago period. The majority of the variance was related to the payment on maturity of the Tilray ’23s, our cash acquisition of the new craft brands and settling assumed liabilities from HEXO, including unpaid excise tax, as well as legacy litigation settlements. Having now completed three quarters of our fiscal year, it is clear that our prior fiscal 2024 guidance of adjusted EBITDA between $68 million and $78 million is no longer feasible. We have therefore lowered our adjusted EBITDA range to be between $60 million and $63 million, which takes into consideration our performance through the three quarters over $12 million year-to-date in price compression in the cannabis business and continued expectations for the fourth quarter.

Still, the fourth quarter represents a major increase from the current quarter, which is traditionally our lowest quarter due to the seasonality within our segment. The fourth quarter seasonality improvement is a function of our beer business leading up to the summer, a historically busy season. New innovation scheduled to be launched as part of the spring reset. New innovation in our cannabis business along with expected wholesale sales and in our distribution business as pharmacies buy in bulk for their customers ahead of them going on summer vacation. Recall that we also projected positive adjusted free cash flow from operations for the entire fiscal year, excluding our integration cost HEXO, Truss, the new craft brands and the cash income taxes associated with Aphria Diamond.

Due to the timing of collecting the cash on the various asset sales mentioned, we now do not expect to achieve this prior adjusted free cash flow guidance. While we were adjusted free cash flow positive in the current quarter, our current expectations are for a very strong fourth quarter of adjusted positive free cash flow. Of course, we will continue managing CapEx as part of our efforts to strengthen our industry leading balance sheet. Let me now conclude our prepared remarks and open the lines for questions from our covering analysts. Operator, what’s the first question?

See also 10 Stocks Receiving a Massive Vote of Approval From Wall Street Analysts and 12 Best Packaging Stocks to Buy According to Hedge Funds.

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Andrew Carter with Stifel. Please proceed with your question.

Andrew Carter: Hey, thank you. Good morning. Wanted to ask about the German changes. I mean, obviously it’s going to likely manifest in a big uptick in patients with doctors now having more freedom to prescribe cannabis. But kind of thinking through this competitively, how do you see this as your position unique in being able to attack this market? I know that for the past five years, we’ve seen a lot of decks with Germany circled and capacity to hit that market. Is that capacity still out there? How expensive it is to maintain this? And can you give us a reminder of kind of the stringent quality standards you have to have in place to serve the German market? Thanks.

Irwin Simon: Andrew, thank you, and great question. Number one — listen, we see the opportunities in Germany in multiple ways. We have a facility in Germany today and that Germany before only would serve as a tender to the German government. Now that tender will — process will go away and we’ll be able to sell product into the marketplace, so that’s number one. Number two is before only a certain amount of doctors were able to prescribe cannabis and it was a very small amount for specialty reasons. And now every doctor, because it’s no longer a narcotic, will be able to prescribe cannabis. Number three, we also have a facility in Portugal, which will be able to supply Germany. Number four is we have something called Tilray Pharma, CC Pharma, which is a distribution company that distributes cannabis and other medicines to over 13,000 drug stores.

We have a team based in Germany. We have a sales team based in Germany. We have R&D. We have quality insurance. So we’ve been there for four or five years. And we’ve had some tough four or five years because of what’s happening. The other big thing here is Europe is a big country. And with no longer being a narcotic and decriminalized, we see lots of other places — countries opening up. I have Denise Faltischek to check here as head of Europe. Denise, is there anything I missed here or anything that you should add?

Denise Faltischek: Yeah, no Irwin, you did not miss anything. Just to add a little bit more in terms of facts. So in terms of that abolishment of the tender that Irwin spoke about and the fact that under the new regulations, we’ll be able to apply for a license with our facility in Neumunster. So today, just to refresh, everyone’s memory, we are subject to a tender contract. We are capped at about 1,000 kilograms that we can grow every year and that is done pursuant to certain pricing. So with the abolishment of the tender, we now open up into a licensing process where we are now subject to just market conditions as it relates to patient demand. And so we can utilize that facility to meet that demand, which would allow us to increase our capacities.

We have the ability to today grow up to about 5,000 kilograms to 6,000 kilograms without any additional CapEx. And we can basically then also have pricing that is subject to market demand today. So that is an immediate benefit there. In terms of the ability to prescribe, we are amping up our ability to be in front of doctors and working on symposiums and educational platforms. One of the things we’ve done on the prescription platform software, if a doctor wants to prescribe medical cannabis, they go to that page and there’s a Tilray banner at the bottom which shows all of our portfolio of products, what the conditions are, how to prescribe, so we are out there also providing basically information for doctors who are willing to prescribe and want to prescribe.

Irwin Simon: I think the big thing is, Andrew, we do have a brand, in Tilray brand, but the whole thing of socialized medicine and prescription and paying for it, we see lots of changes happening. So we have been working in the German market in regards to products for pain, for anxiety, for sleep, for cancer, for epilepsy. So we’ve been all over that and take our expertise of what we do at medical cannabis in Canada and translated there. And secondly, like I said, there is a market out there that will be looking for medical cannabis, but ultimately using it for recreational cannabis. So from a standpoint, we really are excited about what’s happened in Germany. It does not affect us in regards to the social measures that have come in place there. And we have the team, we have the grow, we have the infrastructure, the research and development ready to go here and it’s effective now.

Andrew Carter: Thanks. I’ll pass it on.

Irwin Simon: Thank you.

Operator: Thank you. Our next question comes from the line of Nadine Sarwat with Bernstein. Please proceed with your question.

Nadine Sarwat: Hi, thank you. Two for me, please. First, on the guidance, I appreciate the added color that you gave. Could you be a little bit more specific in perhaps what exactly has changed versus last quarter and this quarter? What sort of surprised to the downside and how do you see that progressing over the quarters to come? And then my second question, I know you guys called out your number one position in Canadian cannabis, so looking at the market share numbers you guys quote in the press release, I think that’s on the downward trend for the last couple of quarters? So could you break down what’s driving that? And if you think you can regain that over the quarters to come? And if so, how do you anticipate doing that? Thank you.

Irwin Simon: So I’m going to take — start part of it. Number one, not all quarters are equal. This third quarter being one of our lowest quarters in regards to bev-alcohol and our cannabis business, our fourth quarters and our first quarter, second quarter. So that’s as you look at our quarters and absolutely there’s seasonality within all these businesses. Secondly, we did lose some share in Canada. Some of it was again coming back to price compression and some of it was coming back to some of the prices in regards to our flower. The other thing would happen is we have a lot of innovation that was coming into the marketplace that we didn’t get into the market in our third quarter, which we expect to get back in our fourth quarter.

I think what’s important here, again there’s been lots of price compression in Canada there in regards to we talked about our percentage in excise tax. And the market is changing dramatically there in regards to potencies and being infused pre rolls, et cetera. So some of it is just timing and do I expect to get it back? Blair, you’re on the line. Do you expect to get your share back?

Blair MacNeil: Yes. Thanks, Irwin. And thanks, Nadine, for the call. Just to add a little bit more color to what Irwin was talking about, Q2 and Q3 were our most operational complex period. So, in addition to what Irwin talked about, what we also saw is when you are moving the location of SKUs and where they’re going to be distributed from. And one of the things we’ve done is centralized all our packaging and logistics out of Bloomington. That requires us to draw down inventories in each of the boards and then rebuild that inventory once we’ve changed the source location. So what you’re seeing in some of the numbers is in addition to the price compression Irwin talked about and the innovation side is just a reflection of the operational complexity we implemented in Q2 and Q3.

Once that is completed and it was all completed inside of Q3, that will generate very strong operational efficiencies for us moving forward as everything outside of beverages will be shipped out of one location.

Irwin Simon: Carl?

Carl Merton: Yes, so just — I’ll add a couple things to — for the explanation as well. In our beverage-alcohol business and I think in the entire industry, was hit a little bit harder than it has in the past in terms of dry January. So that took away a bit of a portion of our sales expectation for the year. The beverage alcohol business with the new acquisition of the new brands, those brands are at a lower gross margin than the rest of our businesses. We’re working very hard to bring those pieces up and we will get that up over time. As I said in the script, we expect to be able to bring those up much closer to the historical margins that we’ve achieved. But it’s going to take a few quarters. And so it’s coming. It’s really a function of the co-manufacturing agreements that we have and getting that production moved and into our facilities and organized in an effective manner while not causing operational problems during that move.

And in terms of the free cash flow guidance, we had some expectations on cash receipts, on some of the bigger things, including some of the make hole provisions inside of the spirits business, which we now see coming in, in June or July as opposed to in May and that’s really what’s led to that thing.

Irwin Simon: I think the big thing here is just timing and that’s — I can’t always predict things. And with our beer businesses, the ABI businesses bought lower margins. But just from an integration standpoint, we had a trans-service agreement with ABI. We’re moving away from that at the end of May, moving it into our facilities. We expect to get our margins up into the high ‘30s, low ‘40s today. With our SweetWater and our legacy businesses, we’re running margins at that rate. So, with that, we look to those margins. In regards to the Canadian cannabis businesses, as Blair said, integrating HEXO with SKU rationalization with some of the strains and looking at some of the potencies and timing and when you’re dealing with agriculture products, not everything lose accordingly here.

We’ve made some moves in regards to our Cayuga, in regards to Molson, in regards to Belleville, and consolidating our businesses there, taking out costs. So Again, as we look at guidance, yes, there’s guidance out there, but a lot of it is just timing. And as we move forward, we have four quarters, not six quarters, otherwise for six quarters, it would be different.

Nadine Sarwat: Understood. Thank you.

Irwin Simon: Thank you.

Operator: Thank you. Our next question comes from the line of Aaron Grey with Alliance Global Partners. Please proceed with your question.

Remington Smith: Hi, good morning. Thank you for the question. This is Remington Smith on for Aaron Grey. My first question is in term of the CRA having the provinces garnish wages, have you started to see any changes in purchase habits from provinces of your overall competitive environment yet? And then with kind of greater focus on those LPs paying their taxes?

Carl Merton: I don’t think we’ve necessarily seen changes in purchasing patterns. I think we saw very quickly after CRA started garnishing those wages a couple of LPs filed for protection within the same week. And then I think there’s been a few more that have filed since that period of time. And so someone who’s excessively behind on their excise tax and having the payments garners are looking at four, five, maybe six months of time before they’re going to get their next payment, they just don’t have a lot of choices. And so they’re having to file for that protection. I don’t think the Boards are actually changing those patterns yet. I think that will probably happen over the next three or four months as more of these LPs realize and get caught up in the garnishment.

Irwin Simon: But there’s a lot of the Boards out there that have been asked by CRA to garnish excise tax when they sell into it. And I think the big thing for us is we’re finally seeing the Canadian government taking that serious and those that weren’t paying excise tax could keep going and putting the rest of us at a disadvantage. So I think we’re going to continuously see changes. And we’ve talked about the study that’s come out there in regards to changes, in regards to excise tax and marketing medical cannabis, et cetera, I think there are some major things here that could really benefit the Canadian Cannabis industry.

Remington Smith: Great. Thank you. I appreciate the color there. And then my second question. Go ahead.

Irwin Simon: No, go ahead.

Remington Smith: My second question just regards the excise change — excise tax changes that you mentioned that could potentially occur in the budget is really next week. You mentioned tax savings essentially of $80 million for Tilray. So I guess with those savings, you expect it to mostly be realized by the LPs or could there be some benefit realized in the province and the retailer as well? Any color that would be helpful.

Irwin Simon: You know, good question. I think as we know provinces and we know government, I’m sure they’re going to try and grab some of that. But I think, listen, as we’ve said and we’ve openly said it’s about $80 million to Tilray. And the big thing is you got price compression and you still have the same amount of excise tax that you pay. And I think in this quarter, it was 32%, 33% of our sales was going to excise tax, so something has to be done. I don’t mind if some of it goes back to the governments on education and promoting the safety, bringing awareness, marketing and allow us to do these things. So again, if we got half of the $40 million back to best scrapping the business. I think it would be tremendous beneficial to Tilray and other LPs.

Carl Merton: Yes. And I think the key in this piece is that if the government is making a change to strength in the industry because the tax became in a way impressive, they need to avoid creating new things that pull that money back. I mean you allow it to go to the industry to help the industry continue to grow and strengthen.

Remington Smith: Great. Thank you for the answer today.

Operator: Thank you. Our next question comes from the line of Bill Kirk with Roth MKM. Please proceed with your question.

Bill Kirk: Thank you for taking the questions. Maybe I missed it in the prepared remarks, but what is the $29 million in assets that have been moved to held for sale? I imagine some of it might be facilities that you mentioned earlier, but what specifically is in that number? And how was it determined?

Carl Merton: So that number is the Cayuga facility. It’s Molson and it’s the Belleville facility that we acquired as part of Truss. And so in each case, it’s a facility, it isn’t the business. The business is being reorganized within our existing footprints. And then we’re releasing or selling that what become redundant assets at that point in time.

Bill Kirk: Okay. Got it. That’s what I was looking for on and not the businesses, okay. And then in the third quarter, compared to 2Q, selling, marketing expenses up a little bit [Technical Difficulty]

Irwin Simon: Did we lose you Bill?

Operator: I’m sorry, it seems that his line may have a technical difficulty. Our next question comes from the line of Michael Lavery with Piper Sandler. Please proceed with your question.

Michael Lavery: . Thank you. Good morning. I just wanted to touch on the U.S. and I understand at the moment, it’s — strictly speaking, a little bit hypothetical still. But if rescheduling occurs, you laid out at a high level how you’re thinking about it and a more pharmaceutical approach? I guess a couple of questions just maybe what’s your patients level if it does come to that just because the FDA certainly is known not for its speed? And so — is your understanding just that obviously, if that door opens, it could still take quite some time? Or how are you thinking about that? And in the release as well, you reminded us about the connection to MedMen. And how would that fit into that potentially? Is that something that would still stay separate or could potentially become sort of like pharmacies? I guess just maybe lay out some of how you’re thinking about potential U.S. opportunities should regulatory change come through.