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Edited Transcript of TLRY.OQ earnings conference call or presentation 12-Nov-19 10:00pm GMT

Q3 2019 Tilray Inc Earnings Call

Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Tilray Inc earnings conference call or presentation Tuesday, November 12, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brendan Kennedy

Tilray, Inc. - Chairman, President & CEO

* Mark Castaneda

Tilray, Inc. - CFO & Treasurer

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Conference Call Participants

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* Aaron Thomas Grey

Alliance Global Partners, Research Division - MD & Head of Consumer Research

* Douglas Miehm

RBC Capital Markets, Research Division - Analyst

* Graeme Kreindler

Eight Capital, Research Division - Principal

* Michael Scott Lavery

Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst

* Steven Jason Schneiderman

Cowen and Company, LLC, Research Division - Research Associate

* Tamy Chen

BMO Capital Markets Equity Research - Analyst

* William Andrew Carter

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP

* Rachel Perkins

ICR, LLC - VP

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Tilray Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) Now I would like to hand the conference over to your speaker today, Ms. Rachel Perkins.

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Rachel Perkins, ICR, LLC - VP [2]

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Good afternoon and thank you for joining us on Tilray's Third Quarter 2019 Earnings Conference Call. On today's call are Brendan Kennedy, President and Chief Executive Officer; and Mark Castaneda, Chief Financial Officer.

Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could differ materially from actual events and those described in these forward-looking statements. Please refer to Tilray's reports filed from time to time with the Securities and Exchange Commission and Canadian securities regulators and its press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

Finally, please note on today's call, management will refer to adjusted EBITDA and adjusted net loss, which are non-GAAP financial measures. While the company believes adjusted EBITDA and adjusted net loss provide useful information for investors, 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. Please refer to today's press release for a reconciliation of adjusted EBITDA to net loss, the most comparable measure prepared in accordance with GAAP.

Now I would like to turn the call over to Brendan.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [3]

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Thank you, Rachel. Good afternoon, everyone, and thanks for joining us. Today, I will provide an update on the progress we continue to make on our strategy to be a leading cannabinoid-based global consumer packaged good company with a portfolio of best-in-class brands supported by multinational supply chain. In just a few moments, Mark will review our third quarter 2019 financial results in some detail and discuss our long-term financial targets. But first, I would like to provide some highlights.

In the third quarter, our revenue increased 409% year-over-year to USD 51.1 million. And total kilogram equivalent sold nearly doubled sequentially to 10,848 kilograms. With receipt of our first GMP certification for our Portugal facility, revenue from international medical sales grew more than fivefold compared to the prior year period. This is in line with the expectations we shared earlier this year that growth for our global businesses would accelerate in the second half of 2019 and into 2020.

While the cannabis industry is still in its early stages of development, the global paradigm shift regarding the legalization and use of cannabis as medicine and mainstream consumer products continues to play out as anticipated. To capitalize on this opportunity, we are prudently investing to build the global infrastructure required to drive long-term growth and shareholder value creation. Today, our products are available in 20 countries spanning 5 continents. Over the next 2 to 3 years, we expect a number of additional countries to legalize medical cannabis followed by adult-use, and our global footprint puts us in an advantaged position to enter new markets when we are legally permitted to do so.

Let me share some details. In Canada, over the next 12 months, we believe the market has the potential to reach a balance between supply and demand for raw materials including flower and oil. As such, we remain confident in our cultivation asset-light model and ability to sign long-term wholesale supply agreements as we focus on the cannabis value chain further downstream. We view ourselves as builders of high-quality trusted brands, not farmers.

Consistent with this, we are ready for the second phase of adult-use cannabis in Canada with a broad product portfolio set to launch over the course of the next few quarters as regulations permit. Our expanded portfolio under High Park includes innovative cannabis products and formats such as CBD beverages, edibles and vape products. We will launch new products under celebrated existing brands Marley Natural and Goodship as well as new brands The Batch, Chowie Wowie and Rmdy. Our popular existing Canadian brands Canaca and Dubon will also broaden their product offerings. Across the board, we are committed to launching high-quality products that are safe for our consumers. We are eagerly awaiting the commercial launch of this next phase of legal cannabis products to address consumer's desires for our broader selection of legal products and form factors that are safe and tested to meet rigorous quality standards.

Internationally, during the third quarter, we continued to build inventory at our EU Campus in Portugal as we await additional GMP certifications. We are pleased to announce that we successfully exported our first shipment of medical cannabis from Portugal to Germany in September through a 3 million euro-dollar (sic) [EUR 3 million] agreement with Cannamedical Pharma GmbH to supply patients. This represents a major milestone for Tilray as our EU Campus ramps up international export output through the end of this year. We are awaiting our finished product GMP certification, which we expect by the end of the year. And once received, we expect a significant ramp in international revenue on top of the very strong growth we've already seen.

As we discussed last quarter, in addition to our own 10-acre outdoor crop, we grew an outdoor crop with our cultivation partner, Esporão, on an additional 20 hectares, which is the equivalent of roughly 50 acres. We are currently in the early stages of processing this harvest, and we'll determine yields in the coming weeks.

As the progress in Canada and Europe demonstrates, our global growth strategy remains unchanged: First, selectively increase our production and manufacturing capacity to serve the rapidly growing global medical market as well as the adult-use market in Canada and other markets over time; second, maintain a rigorous focus on quality as we scale; third, partner with established distributors, retailers and consumer packaged good companies where relevant to scale distribution of our products further and faster in a capital-efficient manner; fourth, build a differentiated portfolio of brands and products that appeal to a diverse set of patients and consumers; fifth, expand the addressable medical market by fostering mainstream acceptance with the medical community and governments; and finally, sixth, pioneer the future of our industry by investing in innovation, R&D and clinical research.

As part of these pillars of growth, our strategic partnerships and acquisitions are important business drivers for us. And I want to update you on our progress, starting with our strategic partnership with Authentic Brands Group. We recently completed some initial pilot marketing with Nine West. We expect our first product launch to be in the United States in the near future. Tilray is also working with ABG to commercialize other brands in Europe by early 2020. We recently announced plans to distribute CBD Beverages in Canada once regulations allow through our joint venture with AB InBev named Fluent Beverage Company. Fluent intends to have CBD-infused beverages available for sale to adult consumers in Canada as early as next month. We continue to conduct research related to nonalcohol cannabinoid-infused beverages containing THC.

We continue to work collaboratively with our pharmaceutical partner, Sandoz, the generic drug business of Novartis, to evaluate new markets to enter into together. Depending on the market, however, we may work with Sandoz and/or other large in-country pharmaceutical companies. We currently co-brand medical products in Canada with Sandoz, and the Sandoz sales force reps our products.

Manitoba Harvest continues to perform well with branded revenue growing 4% year-to-date on an as-reported basis. Excluding the impact of a onetime promotion in the prior year, the company has grown 10.5% year-to-date in branded product sales. We remain excited about the immense opportunity in North America as we look to expand the Manitoba Harvest product portfolio, consistent with our thesis of taking a trusted brand and supply chain in hemp foods and then leveraging it to deliver differentiated hemp food and CBD products. As we gain more regulatory clarity from the FDA, we believe we are well positioned to capitalize on the CBD market with our existing retail relationships.

Through our acquisition of Smith & Sinclair, which crafts edible candies, fragrances and unique consumable products, we are launching Pollen, a new brand under Smith & Sinclair's umbrella of innovation in the CBD space. The brand is focusing on redefining wellness with a range of high-quality, ingestible products for the initial launch, which will be available in retail stores and online across the U.S. and the U.K. before the end of the year.

We also partnered with Cannfections Group, a leader in the infused confectionery space, to expedite innovation and new products to market for Phase 2 of Canadian adult-use legalization. The founders of Cannfections hail from a legacy confectionery business with over 85 years of experience servicing legacy consumer packaged goods companies such as Nestlé, Hershey's and Mondelez. This past quarter, we announced a definitive agreement to acquire FOUR20, an adult-use cannabis retail operator with 8 operational retail stores in Alberta and licenses for 14 more. The transaction is expected to close by the end of Q1 2020. In addition to FOUR20, we have made strategic minority investments in other Canadian cannabis retailers, including Inner Spirit, Westleaf, Kiaro and Fire & Flower to both increase shelf space and gain key consumer insights.

We believe our strategic global partnerships and acquisitions demonstrate our focus on the diversification of our global opportunities for long-term growth. Going forward, we will continue to pursue strategic M&A in order to enter new markets, increase capacity, introduce new form factors and other technologies and enter new retail channels.

Looking at our business geographically. The challenges in the Canadian market are ongoing with a limited number of retail locations and a supply/demand imbalance. That being said, our team has executed on our strategy and we look forward to launching our new form factors, which will allow consumers to safely choose more of their preferred formats. Even as we continue to capitalize on the opportunity we see in Canada, we expect the United States and Europe to be 2 of the largest cannabis markets long term.

Our strategy for the United States is all around building a portfolio of trusted CBD brands in states where legally permitted to do so and building strategic partnerships that will allow us to expedite our entry into the THC market when legally permitted to do so. While we have a foothold with Manitoba Harvest, we will continue to build a platform of brands and products through acquisitions and partnerships such as Smith & Sinclair and Authentic Brands Group, both of which we expect to launch CBD products by the end of the year.

Turning to Europe. In July, we announced that we had successfully exported GMP-certified finished medical cannabis oil solutions from Canada to Ireland. And in September, we exported our first shipment of medical cannabis from our EU Campus in Portugal to Germany. As I mentioned earlier, we expect to significantly ramp our exports from our EU Campus very soon. We have built an incredible team in Portugal, which will be our international hub for operations with indoor, outdoor and greenhouse cultivation sites as well as research labs, processing, packaging and distribution sites for medical products. Our processing capacity is greater than our cultivation capacity. So we have ample runway to grow, scale and prepare finished goods with raw materials from third parties in addition to our own cultivation capacity.

As we focus on becoming a leading global cannabis business, clinical research remains a core focus. The industry is lacking data, and we believe clinical research will help foster mainstream acceptance within the medical community and among governments. In the third quarter, we announced our participation in 2 clinical trials led by the NYU School of Medicine for patients with alcohol use disorder and post-traumatic stress disorder. We have since announced that we have imported medical cannabis into the United States from Canada for a new clinical trial evaluating the efficacy of medical cannabis as treatment for taxane-induced peripheral neuropathy or TIPN. TIPN affects more than 67% of women undergoing breast cancer treatment, and we are excited to be part of this groundbreaking trial to find a new treatment option. That trial is being conducted by Columbia University.

For the balance of the year and into 2020, we anticipate making disciplined strategic investments to drive continued expansion in the markets we already serve, enter new ones and embark upon additional strategic partnerships and transactions that will enable us to drive global growth.

Some highlights we anticipate include: Exporting Tilray medical products to new countries and expanding our medical cannabis product offerings in the international markets we currently serve; extending our pharmaceutical partnerships to additional countries and regions; completing the build-out of our facility in Portugal and obtaining additional GMP certifications in Portugal as well as further expanding our Nanaimo and Leamington facilities; launching additional form factors for adult-use in Canada; initiating additional clinical trials, we added 2 during the third quarter and 1 already in the fourth quarter; closing the downstream merger with Privateer Holdings; and finally, entering into strategic partnerships that enable us to further accelerate our growth.

With that, I would like to turn the call over to Mark.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [4]

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Thanks, Brendan. Good afternoon to those of you joining us on the call today and webcast. It is a pleasure to be speaking with you today.

Please note, all the financial information we discuss today is prepared in accordance with U.S. GAAP and is in U.S. dollars, unless otherwise indicated.

Our momentum for the first half of the year continued through the third quarter, and we believe our strong growth will continue in Q4 and throughout next year.

Focusing on our Q3 results in more detail. Q3 revenue grew more than fivefold to $51.1 million or CAD 67.8 million compared to the third quarter last year. To put this in perspective, our Q3 revenue alone was 18% greater than our revenue for full year of 2018. Revenue growth was primarily driven by the Canadian adult-use market, the Manitoba Harvest acquisition and growth in international medical markets as a result of our first GMP certification of our Portugal facility.

Our performance in the Canadian adult-use market so far has been in line with our expectations. Adult-use represented 31% of revenue in the third quarter and increased sequentially from Q2 to Q3. With additional retail distribution and new form factors becoming available, we expect adult-use revenue to continue to drive our growth.

Additionally, the adult-use channel has driven our average selling price, or ASP, down compared to the prior year due to 2 factors: First, a lower mix of higher value-added extract products, which represented 17% of non-hemp revenue for the third quarter of 2019 compared to 52% of revenue in the same period last year. We expect the introduction of cannabis 2.0 products that ASPs will increase as edibles, beverages and vapes all sell at higher prices overall. Additionally, we will likely transition our key operating metrics to focus on units as grams become less relevant in 2.0 products.

Secondly, we introduced a new value brand, The Batch, in response to consumer demand for lower-priced products, which is important for new consumer trial. This introduction in Q3 resulted in higher mix of lower-priced products, which brought down our average selling price during the quarter. Our average net selling price per gram for adult-use products decreased in Q3 to $2.88 per gram from $4.89 per gram in Q2. Pricing in our other SKUs are generally unchanged, but there was a high mix of sell-in to the channel of this new value brand.

Next, our hemp product revenue was $15.7 million in Q3. As a result, this revenue was from our Manitoba Harvest acquisition in February of this year. There is some seasonality to this business, which is reflected in the results for the quarter, which were down slightly from the prior quarter. U.S. CBD sales were minor as we began rolling out these products during the quarter. We currently are available in less than 1,000 locations and expect with FDA clarity, we could be available in significantly more locations including major retailers.

On the international side, our revenues grew more than 5x to $5.7 million in the third quarter from $950,000 in the prior year. As a percentage of total sales, international revenue increased to 11% versus 4% in the second quarter of this year. The growth is driven primarily by our first export of cannabis flower to Cannamedical Pharma to supply patients in Germany, which contributed over $3 million in the quarter. We expect our international sales to accelerate upon receipt of GMP 1 certification and as we ramp up our EU Campus in Portugal. We believe that supplying the German market from the EU is a significant competitive advantage and look forward to ramping our sales from this facility, which have higher ASPs and higher margin than our Canadian adult-use business.

Moving on to operational metrics, excluding our hemp products. Total kilogram equivalent sold increased over sixfold to 10,848 kilograms from 1,613 kilograms in the same quarter last year. The overall net selling price per gram was USD 3.25 or CAD 4.32 and USD 2.98 or CAD 3.96 excluding excise tax. This compares to USD 6.21 in the prior year's third quarter, which is primarily direct-to-patient medical sales. Pricing was impacted by channel and product mix.

Gross margin for Q3 increased sequentially to 31% from 27% in the second quarter and 23% in the first quarter as we expected. Compared to the prior year, gross margins were flat as we continue to expect gross margin to increase sequentially going forward as we bring greater scale and benefit from positive product and channel mix. As Brendan mentioned, we expect that our Portugal facility will increase exports with full GMP certification and beginning next month will have the ability to sell higher value-added adult-use products in Canada.

On to expenses. Our total operating expenses increased to $39.2 million, which includes $8.3 million noncash stock compensation. Excluding stock compensation expense, operating expenses increased by $19.3 million compared to the prior year's third quarter, which is primarily comprised of an increase in G&A of $13 million and an increase in sales and marketing of $13.5 million. The increase was driven by increased headcount related to growth initiatives for the adult-use cannabis team in Canada and European leadership team in Portugal, public company costs and operating costs added through our recent acquisitions. The increase in G&A from prior quarter was driven by third-party costs to implement systems and controls for upcoming Sarbanes-Oxley attestation, which we believe results in the highest levels of internal control processes. These increases in costs will continue for the next couple of quarters, then it will start to decrease. On the sales and marketing side, we ramped up our investment in staffing to launch our U.S. CBD and international medical sales, which are investments ahead of revenues that we expect to start providing returns in the coming quarters.

Next, I'd like to explain our gain on acquisition-related costs. Because we are in the early stages of this industry, there's lots of uncertainty regarding forward revenue forecast, which is why we structure our acquisitions with a large mix of earnouts and other performance-based metrics. As we gain more data points on the results, we estimated that our Natura and Manitoba Harvest acquisitions will not achieve their full earnout. So in accordance with GAAP, we adjusted the earnout liability down, which created a gain in acquisition-related activities. The full earnout will be calculated over the next couple of quarters.

The net loss for the quarter was $35.7 million, $0.36 per share compared to a loss of $18.7 million or $0.20 per share in the third quarter 2018. We reported an adjusted EBITDA loss of $23.5 million compared to a loss of $7.4 million in the third quarter of last year. The increase in net loss and adjusted EBITDA was primarily due to increases in operating expenses related to the growth initiatives, expansion of international teams in addition to the Manitoba Harvest and Natura businesses.

Turning to the balance sheet. We ended the quarter with cash and cash equivalents of approximately $122.4 million. We continue to believe that we have sufficient capital and access to capital to execute our growth plans until we achieve positive EBITDA, which we expect in Q4 of 2020. Our cash burn in Q3 included deferred payments for M&A as well as deposits for future inventory. We expect our quarterly cash burn will decrease each quarter going forward. We continue to actively explore opportunities for financing and will likely tap the debt markets in the next coming quarters. Today, we have over $300 million in unsecured assets that we can leverage.

Additionally, I'd like to update investors on our inventory balances, which during the quarter have increased. As we have reported, we have been cultivating product and building inventory in our Portugal facility for almost a year and this quarter just began selling this inventory. We are in the process of a couple more GMP certifications for selling finished product and for extraction. Until we receive these certifications, we will continue to add some inventory in Portugal.

Additionally, in Canada, based on current regulations, we primarily sell flower and flower products, which leaves by-product for extraction in large supply, and 2.0 products are not allowed to sell today. We expect this inventory imbalance to continue until we are able to convert this inventory to 2.0 products. We expect inventory levels to start to decrease throughout 2020.

Long term, we continue to expect to capture a sizable share of the global cannabis market with estimated gross margin of 50%-plus and adjusted EBITDA margins of 25% to 30%. As new markets are added, we will invest to develop in those markets, which may have a short-term impact to margins but also provide for greater long-term revenue upside.

In summary, our third quarter results demonstrate that we are successfully executing on our strategy. We continue to believe we have a long runway for growth and multiple paths for shareholder value creation.

This concludes our prepared remarks. Brendan and I are now available to take your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Vivien Azer with Cowen and Company.

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Steven Jason Schneiderman, Cowen and Company, LLC, Research Division - Research Associate [2]

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This is Steve Schneiderman pinch-hitting for Vivien tonight. Let's start off on Fluent. Can you talk a little bit more about the opportunity you are seeing with CBD Beverages specifically within the market? And in addition, can you provide any color regarding the delay on the rollout for THC beverages?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [3]

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Sure. Yes. So in the quarter, we announced the name, Fluent, as well as the CEO. And the team at Fluent has been working -- since we announced the partnership with AB InBev last December, they've been working on developing formulations, form factors, brands and packaging for the products that we will -- or they will launch in December. I believe that they will announce -- showcase their products before the end of the month. They've been out selling them to the various provincial buyers, Crown corporations throughout Canada. They've been showing the products to those buyers and expect to -- we expect to ship those products December 17. The CBD beverages became a focus for them based on a lot of market research that they did. And so they'll launch those products for sale to adult consumers in Canada in December. They continue to do research on THC beverages, and they expect to launch them sometime next year.

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Steven Jason Schneiderman, Cowen and Company, LLC, Research Division - Research Associate [4]

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On Portugal, I want to double back to this real quick. On the GMP certification [staff], I understand that the finished manufacturing license will -- you expect by the end of the year. Correct me if I'm mistaken, but wasn't there another license you were waiting on in order to be able to have full access to sell the full product suite? And also, based on what you are licensed for today versus what you hope to be licensed for by the end of the year, what percentage of your product mix is available today versus what you're waiting on?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [5]

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Yes. So currently, obviously, we've been investing in Portugal since 2000 -- I made my first trip there in 2015, signed an MOU with the government in 2016 and started buying property and designing the facility in 2017. We planted -- built out the building in 2018 and put our first plants in our greenhouse in November, December of last year. And so we've been harvesting product for almost a year now. In Q3, we announced our first export. It was a EUR 3 million, $3.3 million bulk export from Portugal to Germany. So it's always exciting to generate that first dollar of revenue from a project like that, and we are looking forward to significantly increasing revenue from Portugal in Q4 and throughout 2020.

There are 3 -- really 3 main steps in the EU GMP certification. Those certifications are issued by a regulator in Portugal, INFARMED. The first was issued. So GMP part 2, which enables us -- well, that's what enabled us to ship that GMP flower from Portugal in bulk, so think about roughly 50-kilo sized packages from Portugal to Germany. So we have that first EU GMP part 2 certification. We are waiting EU GMP part 1, and that enables us to produce and package flower products and oil products in finished form factors, so actually, in the end, product package that a patient in Germany or any other EU country would actually receive from a pharmacist. Like you said, we expect that certification before the end of the year. We actually expect it before the end of the month. And so we are awaiting that. The final GMP certification that we're looking for is likely to come in Q1, and that would enable us to extract oil from flower and by-product at our Portugal facility. And that one is going to take a little bit longer because we've produced the -- I believe we've produced the test batches, but that one won't happen till Q1.

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Steven Jason Schneiderman, Cowen and Company, LLC, Research Division - Research Associate [6]

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Okay. Thanks for clarifying on that one. And last one for me. Can you provide an update on the holiday rollout of CBD offerings through ABG? It sounds like you're going to be able to get something out by the end of the year. Was there any additional detail that you can offer beyond that?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [7]

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Yes. So we -- obviously, we completed the acquisition of Manitoba Harvest in Q1 and launched those products at the end of May, start of June. And those products are currently in about 1,000 -- a little over 1,000 retailers in the U.S. We have developed the first product set through the ABG partnership. And those products have been produced. They've been introduced in a very small rollout and expect them to be in market before the end of the year. In addition, in terms of U.S. CBD, we acquired Smith & Sinclair in Q3 and expect to launch those products -- their CBD products in the U.S. before year-end.

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Operator [8]

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Our next question comes from Doug Miehm with RBC Capital Markets.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [9]

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A couple questions, starting with EU. Could you maybe frame what you see the opportunity is? You talked about the increase in revenues in Q4 and then into next year. But I'm guessing that this is going to be really tied to that GMP part 1. And could you provide of a few metrics around how you see that market developing for you over the next several quarters?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [10]

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Sure. So we had -- Tilray was the first company to ever legally export medical cannabis from North America, and that was an export we did from Canada in June of 2016 to the EU. Since then, we've exported to -- our products are in 13 countries, a handful of them, about 6, I think, in the EU. So we've exported to Australia and New Zealand, Latin America, South Africa, the U.S. for clinical trials and then I think 6 EU countries. Our products are now in Ireland, in the U.K., Germany, Croatia, Czech Republic, Cyprus, and we continue to look to new countries to export our products to. And we'll likely add one before the end of the year and one either before the end of the year or just at the start of Q2.

And when we look at the patient and prescription count in Germany, it's actually very similar to the old ACMPR patient model in Canada in terms of patient ramp. And so we are encouraged by the number of patients that are getting prescriptions in Germany. And so when we look at what we built in Portugal, we expect to not only significantly increase revenue through bulk exports to Germany and other EU countries, but with this final GMP or the next GMP certification, we will be able to ship finished package product. And that will really have 2 effects. It will, one, increase overall revenue because the revenue for our finished packaged product per gram is significantly higher than a bulk export per gram. And then secondly, it will increase our profit margins because the profit margin on the finished packaged product is also significantly higher than a bulk export.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [11]

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Okay. And then just to wrap up. With respect to the consumer insights that you noted based on some of the agreements that you have in place, could you speak to that? And then also, maybe Mark could speak to the B2B market, what you're seeing there in terms of pricing and the quality of product? And I'll leave it there.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [12]

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So when we've done -- performed market research on Canadian consumers, we've seen increased interests from older demographics around CBD, and there's certainly -- there's obviously a lot of interest around CBD. And if you look at Google search results for CBD in the U.S., you see significant growth over -- quarter-over-quarter. We see the same interest in Canada. And so we've done some segmentation of the consumer base there. And we'll introduce not only new form factors, edibles, vapes for that demographic in Canada but also the beverage brands and products that we will launch in December will target the consumer segments that we identified in that research. We are actually doing some work with Deloitte on consumer segmentation in Canada, and we'll publish some of those results in 2020. And so we use that data as well as other data we have access to, to not only develop new brands and products but refine the brands and products within our existing portfolio.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [13]

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And the second part of the question was the bulk market and what the spot market looks like in Canada. And so what we've -- we still cannot find high-quality or high-potency flower in the market really almost at any price. It's very rare to find. There is more and more lower-potency product on the market, and pricing is coming down for that bulk market. And there's also a lot of by-product on the market that people are using for extraction. So the pricing of by-product and low potency is continuing to come down, but there is this hole in the market for trying to buy some higher-potency product.

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Operator [14]

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And our next question is from Andrew Carter with Stifel.

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William Andrew Carter, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP [15]

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So I wanted to understand kind of the commentary around expecting a continued acceleration in the fourth quarter and some of the channels you have there, starting with medical. I think kind of at that level, should we expect that as you kind of potentially get the GMP certification coming up? And then from the adult-use, are you thinking January or December shipments of adult-use products in Canada?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [16]

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So we do expect a small amount of shipments in Q4, but the bulk of it will be shipped in Q1. So there will be a small amount but not a material amount in Q4 for the adult-use 2.0 products. We do expect our adult-use revenues to be up versus Q3 on just the flower products.

And going around to the other channels, as Brendan mentioned, our medical -- international medical, we expect to see continued strong growth, as we have prefaced, the first half of the year that we thought there will be some nice step changes in that market, and that is playing out as we expected.

On the Canadian medical and the Canadian -- we group Canadian medical and Canadian bulk together. The bulk portion of that will come down. There's just less opportunities for us, and we are keeping all that by-product or oil that we've been selling. So it will be kind of a mix. You'll see some strength in Canadian adult-use and strength in international medical.

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William Andrew Carter, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP [17]

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Got it. And then kind of a second question, I want to step back and ask about The Batch kind of the discount offering. You and another competitor have kind of put something out there. Just kind of the -- to step back from that and with kind of some the restrictions you have in Canada, limited retail availability and really kind of a limited ability to kind of communicate that to consumer, do you think you'll be able to get this offering to the intended user, which can convert the illicit market users? And also, just one other follow-on, would this product be incremental to -- or be accretive to your gross margin long-term guidance?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [18]

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Maybe I'll talk about the first part, and Mark will answer the second part of that question. When we looked out and surveyed the various products in various provincial retail stores, it seems like there was a gap in that there weren't a whole lot of brands focused on the value consumer. And certainly, when we look at U.S. states, you do see products that target that consumer segment. And so we've launched that product and that brand in Canada, and we were very pleased with the results. A lot of that product is typically product that we wouldn't sell under our existing higher-quality, higher-priced brands. And so this -- these products gave us an opportunity to generate revenue from a product that otherwise would have either been sold to another LP or extracted. And so it was -- it gave us the opportunity to generate additional revenue.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [19]

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Yes. And from a margin standpoint, the margin on that is slightly lower than our overall averages of margins. But as we get into 2.0, we do expect there to be higher margins from the 2.0 products.

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Operator [20]

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Our next question comes from Tamy Chen with BMO Capital Markets.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [21]

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First question is for a quick clarification. Mark, did you say that guidance, you're expecting positive EBITDA by the fourth quarter of 2020?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [22]

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That is correct. We expect to be positive fourth quarter 2020.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [23]

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Okay. So I just wanted to understand how you're getting there given that you mentioned you have this new value product. You have been talking to -- that you expect Rec 2.0 will be margin accretive. But I just wanted to get a sense of kind of the sensitivity towards that because presumably, there will be a ramp associated with the Rec 2.0, and it's a totally different ramp from cultivation. There's a lot more manufacturing now. So have you thought about what the potential, I guess, risks could be associated with that ramp? Could that, in the interim, further pressure your margins before things get better? So I just wanted to better understand how you're seeing that trajectory of positive EBITDA by the fourth quarter of 2020.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [24]

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Yes. So Tamy, as you saw this quarter, despite having sell-in of The Batch product, which is at lower cost and at lower margin, our -- actually, gross margins were up 200 basis points. So as our facilities -- as we put more product through our facilities, any factory that you start running at a fuller capacity, you cover more of your fixed costs. So it brings down your overall costs and expands your margins.

Additionally, with our international business, international medical is by far the highest margin part of the mix. And we expect significant increases in that business to offset any kind of risk on the Canadian adult-use side. So I think having that extra leg of growth at high margin is a good hedge against the -- some of the risk in the Canadian adult-use market. And so yes, the way we get there is we do see for the full year over 40% margins in 2020. We do see our expenses, from an overall expense, kind of averaging around $45 million a quarter, lower in the earlier quarters, a little bit higher in the later quarters. And with revenue ramp, you get to a gross margin that covers your operating expenses. So that's how we get to positive EBITDA in Q4.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [25]

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Okay. And on the cash side here, you said that you're expecting the quarterly cash burn will come down in each quarter. But I'm wondering, net working capital, for example, is one area as well as CapEx. How should we think about that going forward? Because again, there is the Rec 2.0 aspect that's coming down the pipeline. So how do you think of -- can we get more color on that guidance you're giving for cash burn to decline over the coming quarters?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [26]

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Yes. So if you think about this quarter and next quarter, we will probably peak in inventory at least for some time. And inventory, as you saw, was around $110 million. We also have about $60 million in deposits, which are primarily prepaid inventory. We expect that number this time next year or at the end of next year to be around $100 million. So we expect a benefit on the working capital side of around $70 million. So that kind of helps with negating some of the cash burn going forward. We effectively prepaid for a lot of our cost of sales. So when you look at the operating expenses from a cash burn standpoint, you're looking at around $65 million in cash burn over the next 4 quarters. And so that's negated by kind of the working capital benefit. So then we have interest expense of around $25 million and CapEx between $25 million and $35 million, which gets you to $50 million to $60 million in net usage against our $120 million cash.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [27]

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Okay. And sorry, if I could squeeze in one more here. When you talk about you're likely to tap the debt markets, you're talking about -- because you mentioned also assets on the book about $300 million, if I heard that right. So are you talking about credit facility? And just wondering why you said it's likely you'll tap that if, by your math, your -- the current cash you have on hand, you believe, will be sufficient until you get to EBITDA positive?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [28]

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Yes. We will likely tap it. I didn't say that we would for sure tap the markets, but we want to make sure we have plenty of cushion in our operating plan. And as you know, in running businesses, working capital fluctuates within a quarter and within a month. So you need some of that cushion sometimes to help absorb some of those seasonality or movements around working capital during the month.

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Operator [29]

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Our next question comes from Aaron Grey with Alliance Global.

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Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [30]

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Just wanted to dive back again into kind of the assumptions to get to the 4Q EBITDA positive. Just in terms of the revenue ramp, can you talk a little more in terms of sensitivity on that, just given the strong things that are out of your control in terms of just increased brick-and-mortar in Canada and then also U.S. with CBD and regulations coming from the FDA? What kind of sensitivity do you have in terms of any kind of a delay or ramp-up in brick-and-mortar in Canada?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [31]

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Yes. So in looking at the revenue ramp for really more 2020, there's very little CBD -- U.S. CBD in those numbers. So that would primarily be upside. On the Canadian side, we do expect the 2.0 products in more locations. We do expect around 1,000 locations by the end of next year. Our sensitivities go to -- from 800 to 1,000. So we think even at 800 locations, we will be positive on the EBITDA in Q4. So that -- there is a sensitivity. If there's no new locations, that could put that into jeopardy. I don't think that's going to be the case. But if there is no new Canadian locations, that could put positive EBITDA out maybe another quarter. So those are the 2 -- like I said, the offset is international medical, which is high margins and significantly high growth.

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Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [32]

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That's helpful. And then just on price per gram, we've seen that kind of fall again sequentially. Just how best to think about the puts and takes of that as we kind of go forward, as we have international kind of sales coming online? And then also, cannabis 2.0 products, which will have a higher ASP, when should we best expect that to ramp up? And also, as we begin to see that offset, too, with kind of a balance in terms of supply and demand, you talked about in the next 12 months, do you expect to see pricing pressure overall? So just have us think about price per gram going forward.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [33]

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Yes. We do expect price per gram to be going up, probably going up from here primarily because of international medical will be a bigger mix of the overall revenues as well as the 2.0 products would be a bigger mix of the overall revenues. Less impact in Q4, more impact in 2020. So with those higher-priced items, you'll see ASPs go up. And what was the second part of the question?

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Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [34]

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Just in terms of supply/demand equilibrium, you talked about in the next 12 months and impacts that would have.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [35]

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Yes. So supply/demand is a little tricky because there's so many subcategories of the products. So I would say we're getting close to supply/demand balance on low-quality by-product and for low-potency product. But for high-potency product and products that consumers want, there's just not enough supply. I think we'll see the same thing in the 2.0 products, especially as we start out of the box. It'll be pretty lumpy as people ramp up their manufacturing processes. But maybe within a year, we might be within a good supply/demand balance in Canada, at least.

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Operator [36]

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And our next question is from Graeme Kreindler with Eight Capital.

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Graeme Kreindler, Eight Capital, Research Division - Principal [37]

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I just wanted to follow up with respect to the hemp CBD in the U.S. market. If I caught it correctly earlier on the call, you said you're in about 1,000 stores right now. I was just wondering if you have any targets or milestones with respect to what you're looking for in terms of increasing that distribution over time as you ramp up the supply chain as well as introducing more brands and products.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [38]

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Yes. It's something that we're focused on and building -- continuing to build out the team that will execute on that strategy. There's still a lot of retailers in the U.S. that will not -- they will not buy or they won't sell, they won't stock products that are -- that contain CBD and are edible, digestible. And so nutritional supplements, dietary supplements, they're waiting for some clarification from the FDA. And that's where a large part of the market in the U.S. is right now in terms of digestible products. And so they're sort of at the starting block waiting to be allowed to sell those products.

On the other hand, there are retailers who are interested in selling topical products that contain CBD. It's why with the ABG agreement, the first products that we're introducing there are topicals. And then generally, the smaller retailers in the U.S., some of the smaller sort of health and wellness-focused grocery retailers, are stocking some digestible, edible CBD products. But it's still growing gradually. And so we're out meeting with those buyers and introducing them to the ABG and Manitoba Harvest and Smith & Sinclair products, but even they are waiting a bit to see what sort clarification comes from the FDA.

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Graeme Kreindler, Eight Capital, Research Division - Principal [39]

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And then on an unrelated note, just going back to the mention of the prepaid inventory balances, the prepaid supply agreements there. Just wondering given the comments on what you're seeing in the wholesale market in terms of product being available but maybe not necessarily the type of product you want to source? Just what's involved in terms of managing the counterparty risk there? And making sure that ultimately, the product that you're going to be getting in those agreements is going to be something you'll be able to place either in the derivative product or potentially in that category of high-quality flower that there seems to be a shortage of?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [40]

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Yes. So we went out and we met with the partners, the suppliers, and they're suppliers and partners that we've used in the past. And so we were familiar with them. We're familiar with their facilities, and we're familiar with their quality and their potency. However, we do continue to monitor them. So it's not -- this is not an industry where you sign a contract and then wait for the product to be shipped to you. We believe in trust but verify. And so we send people out to regularly inspect the crops that we're buying. And within the supply contracts, there are mechanisms. There's potency ranges in the contracts that determine the price we ultimately pay for the finished product.

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Graeme Kreindler, Eight Capital, Research Division - Principal [41]

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And just one final follow-up with respect to the potency ranges and the prices that you pay. Is there further mechanism that adjusts the band of pricing really depending on what's seen in the larger market, as that can be -- looking like it's quite volatile in a short amount of time?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [42]

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There are not -- it's hard to get an accurate spot price unlike a lot of -- unlike corn or other products like that. There's not necessarily a market price on a daily basis that you can point to. At some point, we may have a contract like that. But what we've done is for these contracts that we've prepaid, the price is so far below the current spot price that we're comfortable that they're -- the spot price is just never going to get to -- certainly not in the lifetime of these contracts, the spot price is just never going to approach the price that we've negotiated for these contracts.

We have time for about one more question because I guess we are running out of time.

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Operator [43]

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And we have a question from Michael Lavery with Piper Jaffray.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [44]

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Can you just touch on the hemp Manitoba Harvest business a little bit and help us understand what drove the sequential declines from last quarter to this one?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [45]

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Yes. Actually, when we were performing due diligence a year ago, when we went back and looked at their historical revenue, one of the things that surprised us was that there is an element of seasonality, cyclicality in their revenue numbers. And it happened every Q3 historically. And when we looked at it, the rationale is that a lot of their products are consumed on a sort of daily ritual routine basis, whether it's breakfast, lunch or dinner. And during the summer months when children are on vacation, those daily routines get -- they get disrupted. And so that's the real reason behind the Q3 decline. And we talked about it a lot at the time of the acquisition, probably haven't talked about it -- at the time of the acquisition, we sort of talked and discussed this issue with analysts that this typically happens. It's probably something we should continue to keep everyone informed that this does happen on a Q3 basis annually.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [46]

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Yes. And I will add that Q1 and Q2 are their strongest quarters. Q1 is everyone wants to eat healthier, and this is viewed as a kind of a healthy -- healthier diet type of product.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [47]

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Is the 3Q number up versus last year's?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [48]

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Actually, last year, they did a special with one of the large retailers of a discount. So it is slightly down. But excluding that special discount, the overall branded products are up.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [49]

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And how much contribution did you have from the -- it looks like if I'm reading it right, you renamed it from food products last quarter to hemp products this quarter. I assume that's to reflect the tinctures in the broader portfolio. How much did that contribute? And was it still even just down year-over-year because of the comparison with the promotion?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [50]

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Yes. The promotion made a big difference year-over-year. The CBD or full broad spectrum products just launched in this quarter, and it's still very early. So it's relatively small portion of the overall revenues for the quarter.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [51]

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And can you just give a sense of your thinking on the brand approach? I guess part of the question is, what does the Pollen brand add? Why -- put that on top of the one you already have, how do you think about what those mean differently and how to go to the consumer in the U.S.?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [52]

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Yes. When we first started having conversations with Smith & Sinclair, that acquisition was really about a number of different things. It was about the management team, the Founder and the Chief Formulator that they have. They have innovative products that are clever and liked in the U.K. And so when we were meeting with them and saw the products that she wanted to introduce into the U.S. and into the U.K., they were different from everything that we had seen out there. And what we liked? We liked the brand, we liked the products. And so that's what justified the acquisition in our opinion. And the brand is different and the products are differentiated from our existing product set.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [53]

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And they'd be filled in some different channels as well. So it's a broader coverage for consumers.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [54]

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No. That's great. That's all very helpful. And then just to add it all up, what should we be thinking about modeling this segment looking ahead into next year? And how much momentum -- now better recognizing the seasonality, what on top of that do we -- should we be expecting in terms of a growth profile or run rate?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [55]

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Yes. So on just the kind of -- we kind of bifurcate the food versus the CBD. And the CBD internally, our models are pretty conservative just because we are waiting for the FDA. And we do believe that with the FDA clearance, that will be a step change. We just can't -- we don't know what that timing is. So we're modeling pretty conservatively for 2020 for U.S. CBD. Until we have that regulatory change, we're not going to adjust our numbers up. So the Manitoba Harvest business, we are looking at that. Last year was around a kind of a full year USD 75 million business, and we see 10% plus -- or increases in the revenue on that just on the food side.

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Operator [56]

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And now I would like to hand the call over to management for their final remarks.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [57]

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Thank you. I want to thank our more than 1,400 employees and team members for all of their hard work improving patients' and consumers' lives through cannabis. We appreciate everyone's questions and participation on today's call. Have a great evening.

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Operator [58]

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And with that, ladies and gentlemen, we thank you for participating in today's conference. You may now disconnect. Have a wonderful evening.