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Edited Transcript of TLRY.OQ earnings conference call or presentation 13-Aug-19 9:00pm GMT

Q2 2019 Tilray Inc Earnings Call

Aug 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Tilray Inc earnings conference call or presentation Tuesday, August 13, 2019 at 9:00:00pm 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

* Brett Michael Hundley

Seaport Global Securities LLC, Research Division - Research Analyst

* Graeme Kreindler

Eight Capital, Research Division - Research Analyst

* Michael John Grondahl

Northland Capital Markets, Research Division - Head of Equity Research & Senior Research Analyst

* Michael Joseph Hickey

The Benchmark Company, LLC, Research Division - Research Analyst

* Michael Scott Lavery

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

* Rupesh Dhinoj Parikh

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* Tamy Chen

BMO Capital Markets Equity Research - Analyst

* Vivien Nicole Azer

Cowen and Company, LLC, Research Division - MD and Senior 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 welcome to Tilray's Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference may be recorded.

I'd now like to introduce your host for today's conference, Ms. Rachel Perkins. Ma'am, please go ahead.

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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 Second 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 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 overview of the progress we have made on our global growth strategy. Mark will then review our second quarter 2019 financial results in more detail and discuss our long-term financial targets. After that, we will open the call for your questions.

The global paradigm shift with regard to cannabis is still in its early stages. Tilray currently serves tens of thousands of patients and consumers in 13 countries spanning 5 continents. We aspire to be the world's most trusted cannabis company, and to do that, we are building a global platform to be a multibillion-dollar consumer packaged goods company with a portfolio of world-class brands supported by a multinational supply chain. We're taking decisive actions in order to create an infrastructure that can be scaled around the world and are committed to deploying capital in a way that creates shareholder value over the long term.

We are pleased with our second quarter results, which included the first full quarter of Manitoba Harvest sales. Revenue increased 371% year-over-year to USD 45.9 million, and total kilogram equivalents sold increased both sequentially and on a year-over-year basis to 5,588 kilograms. Adult-use revenue nearly doubled from the first quarter to second quarter with revenue of USD 15 million.

In the next 12 to 18 months, we believe there could be a supply balance in Canada as the market finds an equilibrium between supply and demand. While the industry continues to ramp up production, we have seen improved performance across LPs, and we have signed long-term wholesale supply agreements to support our cultivation asset-light model and enable us to focus on the cannabis value chain further downstream.

We expect to be ready for the second phase of adult-use cannabis in Canada later this year with a broad-based portfolio of brands and new innovative cannabis products and formats, including vapes, edibles, oral strips, topicals and beverages as regulations allow.

And as we've previously announced, we're investing USD 32.6 million across 3 of our 5 Canadian facilities to increase our production capacity to support this. The investments are focused on Tilray's cannabis production space in Nanaimo, British Columbia; High Park Gardens production space in Leamington, Ontario; and the High Park processing facility in London, Ontario. The High Park processing facility is ready to manufacture the new form factors. The other 2 expansion projects are on track.

We have expanded our international export capacity with a standard manufacturing license and GMP certification for our EU campus in Portugal that allows us to manufacture and export GMP-certified dried cannabis for medicinal products. We expect to receive 2 additional GMP certifications in the second half of this year, which will enable us to scale in international markets, particularly Europe.

Just last week, we also announced our definitive agreement with Esporão, one of the largest and most sophisticated agricultural businesses in Portugal. This agreement increases our international export capacity with an additional 20 hectares of outdoor cultivation space in Alentejo, Portugal. We will grow, harvest and dry medical cannabis materials at the new site and then transport it to our EU campus for processing, manufacturing and distribution across Europe and other international markets. The entire outdoor cultivation site was successfully planted and a harvest is expected in fall of 2019.

We expect a significant ramp in international revenue on top of the strong growth we've already seen. Our global growth strategy remains focused on 6 top line performance drivers that we expect to generate strong returns as the business continues to grow.

First, 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 and retailers to scale distribution of our products further and faster; 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 sixth, pioneer the future of our industry by investing in innovation, research and development and clinical research.

We expect our strategic partnerships and acquisitions to accelerate our growth. Our strategic partnership with Authentic Brands Group, which we announced in Q1, continues to build momentum with our first product launch planned for the second half of the year in the United States. The ABG partnership is a first-of-its-kind deal, leveraging ABG's portfolio of more than 50 of the world's most iconic brands for the global CBD market.

We continue to make progress on our research partnerships with AB InBev on nonalcohol cannabinoid-infused beverages. We will be ready to launch beverages in Canada as regulations allow later this year. As we have more supply available for international markets, we expect to add additional new countries in the second half of this year, working with Sandoz and our other large in-country pharmaceutical companies, depending on the market.

Our acquisition of Manitoba Harvest earlier this year provides an immense opportunity in North America. Late in the second quarter, we launched a broad-spectrum hemp extract line that is Generally Recognized As Safe in the U.S., marking Tilray's first entry into the U.S. CBD market under the Manitoba Harvest brand. Our products are thoroughly tested for quality, consistency and safety, and we have ensured all of the products are FDA-compliant. We are starting to execute against our thesis of taking a trusted brand and supply chain in hemp foods and leveraging this asset to deliver CBD products.

On July 11, we also acquired Smith & Sinclair, which crafts edible candies, cocktails and fragrances in the United Kingdom, and enables Tilray to develop CBD-infused edibles for distribution in the United States and other markets as regulations permit. This acquisition reflects our focus on expanding our consumer brand portfolio with exciting brands known for disruptive innovation.

We expect the United States and Europe will be 2 of the largest cannabis markets long term, which is why we continue to invest in our global operations, particularly in those markets. 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 mergers and acquisitions that opens new territories, increases our capacity, increases our brand offerings through innovative form factors, brings us research and development technologies, provides access to strategic retail distribution channels.

Our strategy to capitalize on the estimated USD 22 billion hemp-derived CBD industry in the United States is centered on building a portfolio of trusted brands. With Manitoba Harvest as our foundation, we will continue to add to our portfolio whether it be via acquisitions such as Smith & Sinclair, partnerships such as Authentic Brands Group or by building our own brands. Our products in the United States will not include any THC until it is federally legal.

Turning to Europe. As I mentioned earlier, we have expanded our international export capacity with our EU campus located in Cantanhede, Portugal, which will be our international hub for operations. The facility includes indoor, outdoor and greenhouse cultivation sites as well as research labs, processing, packaging and distribution sites for medical products. We have begun shipping some product already under our current manufacturing license. And as we are awaiting the next phase of GMP certification to utilize the full capacity of the facility later this year, we will continue to build our inventory.

In the second quarter, we imported a wholesale supply of medical cannabis oil solutions into the United Kingdom to provide authorized patients with a locally maintained supply. We currently have 6 medical cannabis products approved for medical use in the United Kingdom. And as demand ramps up, we are well positioned to be a leading supplier of products.

In July, we announced that we had successfully imported GMP-certified finished medical cannabis oil solutions into Ireland. This makes Ireland the 13th country with Tilray medical cannabis products. The cannabis oil solution is intended for nationwide distribution in the second half of this year under the Medical Cannabis Access Programme. Additionally, as I mentioned earlier, our definitive agreement with Esporão adds 20 hectares of outdoor cultivation space to our EU campus' existing 5 hectares of indoor and outdoor cultivation and 6,500 square meters of manufacturing, processing and research space.

The Canadian market remains challenged with a lack of quality supply and a limited number of retail outlets today, but we're excited for the launch of the next phase of adult-use cannabis products across Canada as regulations allow in mid-December. The second wave of legalization allows consumers to choose more of their preferred formats while we deliver the best possible experiences.

In addition to High Park launching a number of new and innovative cannabis form factors across various brands, including vapes, edibles, oral strips, topicals and beverages, Tilray is at the forefront of clinical research in the medical cannabis field. There's a serious need for more data in the industry, and we believe clinical research will help foster mainstream acceptance within the medical community and governments.

In the second quarter, we announced our support of 2 new clinical studies in Australia and Canada. And just last week, we announced our participation in 2 clinical trials led by the NYU School of Medicine for patients with alcohol-use disorders and post-traumatic stress disorder with alcohol-use disorder. We already received approval from the U.S. government and successfully imported an initial shipment of medical cannabinoids into the U.S. to support the 2 new trials at NYU.

For the balance of the year and into 2020, we anticipate continued expansion in the markets we already serve and entering new ones, continuing investment in clinical trials and additional strategic partnerships and transactions that will enable us to drive global growth.

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; increasing capacity of our facility in Portugal and obtaining additional GMP certifications in Portugal in the second half of this year; further expanding Nanaimo and Leamington, and obtaining production and sales licenses for High Park's processing facility in London, Ontario; initiating additional clinical trials. We added 2 during the second quarter and 2 already in the third quarter; recruiting additional executives from outside the industry to further strengthen our management team. We added several during the second quarter; announcing a final agreement with Privateer Holdings for the downstream merger, which we expect to close before the end of the year; and finally, adding strategic partnerships that enable us to further accelerate our growth.

Now before I hand the call over to Mark, I can say in summary that our team continues to execute on our strategic growth initiatives, firing on all cylinders. I am pleased with the progress we have made to date and expect our growth to further accelerate in the back half of this year and into next year. We have multiple avenues for growth and are confident we can drive strong long-term shareholder value.

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 for today's call and webcast. It is a pleasure speaking with you today.

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

We had a strong start to the year and believe we'll continue to gain momentum in the second half of this year.

Focusing on our Q2 results in more detail. Q2 revenue more than tripled to USD 45.9 million or CAD 60.9 million compared to the second quarter of last year. Excluding excise taxes, revenue was $42 million. These results exceeded our internal estimates due to improved output from our cultivation facilities, which allowed us to ship more adult-use product. Revenue growth compared to the prior year was primarily driven by the Manitoba Harvest acquisition, the legalization of the Canadian adult-use market and growth in international medical markets.

Extract products represented 15% of non-hemp food revenue for the second quarter of 2019 compared to 46% of revenue for the same period last year. The reduction in extract products is primarily due to the significant growth in the adult-use markets in Canada, which are driven by flower and pre-rolls. We are pleased with our performance in the Canadian adult-use market so far, which represents 33% of revenue for the second quarter. Adult-use revenues grew approximately 91% sequentially from Q1 to Q2.

We only have a limited number of products available due to regulations. In the second half of this year, we expect adult-use revenue to continue to ramp with additional retail distribution and new form factors becoming available later in the fourth quarter.

On the hemp food side, this was our first full quarter of Manitoba Harvest being included in our results. As we expected, Manitoba Harvest contributed approximately $20 million in Q2. On the international side, our revenues more than tripled to $1.9 million from $477,000 in the prior year. Growth was driven primarily by Germany and Australia. We expect our international sales to accelerate in the second half of this year as our EU campus in Portugal begins to export product to our international markets.

Moving on to operational metrics, excluding hemp foods. Total kilogram equivalents sold more than tripled to 5,588 kilograms from 1,514 kilograms in the same quarter of last year. The overall average net selling price per gram was USD 4.61 or CAD 6.12 and USD 3.92 or CAD 5.20, excluding excise tax. This compares to USD 6.38 in the prior year's first quarter. Price per gram decreased compared to the prior year due to a reduced mix of higher-priced extract products and a greater mix of adult-use revenues, which are low prices per gram compared to other channels.

Gross margin for the second quarter increased sequentially to 27%, up from 23% in the first quarter and 20% in the fourth quarter. Gross margin was slightly ahead of our internal plans due to improved productivity. Gross margin continues to be impacted by increased costs and the ramping up of cultivation facilities as well as high-cost third-party supply. In addition, hemp food margins were impacted by approximately $1.4 million noncash charge related to purchase accounting for fair value of inventory.

We expect gross margin to continue to increase sequentially for the second half of this year as we gain scale as a result of our Portugal facility coming online with full GMP certification and the ability to sell higher value-added products in Canada adult-use markets.

Total operating expenses increased to $44.8 million, which includes $7.6 million noncash stock compensation and $2.5 million of acquisition-related expenses. Excluding these items, operating expenses increased by $25.2 million compared to the prior year's second quarter, which is primarily comprised of an increase of G&A of $11.1 million and an increase in sales and marketing of $11.1 million. The increase was driven by increased headcount related to growth activities, public company costs and operating costs added to our recent acquisitions.

Net loss for the quarter was $35.1 million or $0.36 per share compared to a loss of $12.8 million or $0.17 per share in the second quarter of 2018. The non-GAAP adjusted net loss for the quarter was $31.2 million or $0.32 per share for the second quarter of 2019. The adjustments to net loss are nonrecurring acquisition-related charges and a nonrecurring noncash charge related to purchase accounting for the fair value of inventory.

We reported adjusted net loss of $17.9 million compared to a loss of $4.7 million in the second quarter of last year. The increase in net loss and adjusted EBITDA was primarily due to increase in operating expenses related to growth initiatives, interest expense from convertible notes and the addition of Manitoba Harvest and Natura businesses and the expansion of international teams.

Turning to the balance sheet. We ended the quarter with cash, cash equivalents and short-term investments of approximately $221 million. We continue to believe that we have sufficient capital to execute on our growth plans for the next 12-plus months. We continue to believe we have significant growth opportunities with multiple paths for value creation and expect to achieve strong growth for years to come.

Long term, we continue to expect to capture a sizable share of the global cannabis market with estimated gross margins of 50%-plus and adjusted EBITDA margins of 25% to 30%. The EBITDA margins are based on the legal markets that exist today. And as new markets are added, we'll invest and develop those markets, which may have a short-term impact on EBITDA margins but also provide for greater future revenue upside.

In summary, we are very pleased with our results in the second quarter. We continue to make investments in order to position the company for long-term profitable growth and have been consistent in executing our strategy.

This concludes our prepared remarks. Brendan and I are now open to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Our first question comes from the line of Vivien Azer with Cowen.

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Vivien Nicole Azer, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [2]

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So terrifically strong quarter from a revenue perspective, a little better than we were looking for, in particular on the adult-use. And so as we think about that in the back half of the year, can you guys just offer a little bit more color about how we should think about kind of the phasing of kind of the first commercial shipments? Do you anticipate there being like pretty meaningful channel load in the fourth quarter? Or will it be a little bit more balanced between 4Q and 1Q?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [3]

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Yes, originally, Vivian -- as you know that the original plan was that we were going to start selling in the October time frame, so we thought would be very strong shipments in Q4. With now the regulations talking about December -- mid-December as the time frame, we expect most of that to shift to Q1 as we don't think the Crown corporations are going to carry a lot of inventory going into the holidays.

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Vivien Nicole Azer, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [4]

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Okay, that seems reasonable enough. On the international side, that was a little bit light but it sounds like you guys have a lot of pieces in place to meaningfully improve that revenue generation in the back half and then going into 2020 with 2 new GMP certifications. So how should we think about the ramp there, given that you now even have more capacity? What is the ultimate like revenue opportunity just from those Portugal assets?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [5]

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Yes. So to be clear, in the first half or in the first 2 quarters we reported, none of those sales were from Portugal. Portugal was not turned on or fully -- or GMP-certified. We do have the certification, 1 of 3 that we're looking for now, and we'll be able to start seeing some sales. So you'll see a nice little step-change in the EU sales in Q3 and in Q4. So a big improvement. All the products we've sold so far today has been produced through Canada.

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Vivien Nicole Azer, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [6]

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Understood. That's really helpful. And just a follow-up to that, and I'll jump back in the queue. One of the things that we've, I think, all been waiting for is to see how the expanded Sandoz relationship materializes after having announced that back in December, I believe. And so I'm just wondering whether it's really this scaling of the Portugal facility that's prevented you guys from coming to terms with a relationship with Sandoz in, say, a market like Germany, for instance?

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

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We added 2 countries in the quarter, so we now have 6 products available at a pharmaceutical wholesale distributor in the U.K., and we have wholesale supply in Ireland. So the suppliers in Ireland will start to see revenue in the second half of the year. And we expect to -- we still expect to add 4 to 6 countries, additional countries in the second half of the year. And depending on the country, Sandoz may or may not be the sort of distribution, sales, marketing, branding partner. Based on some of the conversations that we've been having, we may go with other distributors that have a better footprint in certain countries, for example, in Latin America.

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Operator [8]

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Our next question comes from the line of Michael Lavery with Piper Jaffray.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [9]

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So could you just clarify specifically on Portugal? You said you have 1 of 3 EU GMP certifications. Is that by portion of the building? What's the right way to think about -- you have some you can ship, but it sounds like maybe it's small? Could you just elaborate there just a little bit more?

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

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Yes. So there's 2 parts of GMP. Part 2 is for a -- an API, so a pharmaceutical -- an active pharmaceutical ingredient, API. Part 1 is for a finished pharmaceutical product. Currently, we have a Part 2 certification for -- so essentially for an active pharmaceutical ingredient, API, for whole flower. We're awaiting a Part 1, a whole flower GMP certification, and then Parts 1 and Parts 2 for oil. But those will come together. And it's not really for a portion of a building, it's really for a type of product.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [11]

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No, that makes sense. And just back to the outlook for capacity relative to demand. Can you give a little sense of maybe exactly what you're expecting there and some amount of how you might adapt and adjust. And you've obviously mentioned ways you could be an opportunistic buyer. Would you potentially adjust your own capacity if it looks like the industry has too much? How do you think about the next 12 or maybe 18 months?

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

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I think in order to think about that, you can't really look at it holistically. I think you need to separate out Canada from the rest of the world. And so in Canada, we've made relatively small investments, $32 million in increasing capacity. A lot of that increased capacity -- and that's across 3 different facilities. A lot of that increased capacity is about processing space. Two of the facilities, it's mostly about processing space. At the third facility in Leamington, it is about some additional cultivation capacity.

But in Canada, despite those -- or that investment, we are seeing some third-party supply, quality third-party supply come online. And so we expect to hopefully see more and more of our supply come from third-party farmers. And we've seen -- it feels like a slight easing of supply over the last 6 to 8 weeks. We announced 1 supply deal and hope to announce several more where we'll buy from -- essentially, we'll buy from farmers. That's the situation for Canada.

For other -- for the rest of the world, we'll continue to invest in building global supply. There's a severe lack of global supply outside of Canada. And so we tripled our cultivation, manufacturing and processing space over the last -- really over the last 2 quarters. We've gone from about 1.1 million square feet at the start of the year to about 3.4 million square feet today. A lot of that's outdoors. So we have about -- see, 1 location in Portugal. We have 20 hectares, so 50 acres outdoor. In another facility, another location, we have 4 hectares or 10 acres outdoors, so 60 acres outdoor.

We continue to invest heavily in Portugal. We'll build additional greenhouse space there and additional to the -- in addition to the 1 hectare that we have. We'll build additional greenhouse and indoor capacity in Portugal and expect to continue to invest heavily in Portugal in the coming quarters and years. We're building supply there, we're building inventory as we await those GMP licenses, and we'll continue to harvest on a weekly and monthly basis and build inventory until we have those additional GMP certifications.

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Michael Scott Lavery, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [13]

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And can you give us a sense of how big that inventory build is? And how quickly you could sell it once you get the green light?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [14]

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Yes. So from a cost standpoint -- and because we're U.S. GAAP, we're reporting costs. We don't mark up our inventory. So from a cost standpoint, we have about $4 million at the end of Q2 of inventory in Portugal. As you know, inventory or product in the EU sells at a much higher rate than it does in Canada. So you could do the math on what value it is for revenue value.

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Operator [15]

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Our next question comes from Mike Hickey with Benchmark.

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Michael Joseph Hickey, The Benchmark Company, LLC, Research Division - Research Analyst [16]

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Great job on sales for the quarter. I guess just maybe looking at the Canadian market from a little higher view, what's your estimate now as we approach sort of 1 year into legalization? What percentage of the sort of flower market or what's been legalized is going through legal channels versus illegal channels and sort of how you expect that to trend?

And then I'm sort of curious on the retail. Obviously, retail on the dispensary side, it's been limited. I'm curious how many stores are open in Canada, where that goes in '19, where that goes in '20, if you can. I'm sure you've done it. And how many illegal stores are you sort of competing with? Just looking at sort of broad brush strokes on the market as it develops.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [17]

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I think there's still a severe distribution constraint in Canada. Some of the provinces have more retail locations open than others. Alberta, for example, continues to open stores at a fairly fast clip. But Ontario and Québec don't -- certainly don't have as many stores open as one would expect. In Washington State, there's more than 450 stores. Ontario, which is larger, I think has less than 100 open today.

And so I think that's 1 big constraint in Canada that is constricting -- it's really doing 2 things. It's restricting the growth of retail revenue. I think the other thing that's -- that it's doing is continuing to fuel the illicit market in Canada. And different sources estimate that the illicit market in Canada is still in the $6 billion range. And so that would suggest that the legal market has captured somewhere between 15% and 20% of the overall market. We do expect that number to continue to grow, not the illicit market but the legal market, as new products and form factors come online.

One other factor that's different between the legal market and the illicit market is that you have a full range of products from flower and pre-rolls to oils and concentrates and vapes and edibles and beverages. All of those products are already available in the illicit market.

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Michael Joseph Hickey, The Benchmark Company, LLC, Research Division - Research Analyst [18]

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Okay. That's helpful. The -- obviously, in the States, there are some states that have less retail, maybe even California, relative obviously to the size of the population there. But on the adult-use side, some of the tension on distribution's been alleviated through delivery services. Obviously, I think in Canada on the medical side, you can ship directly to your patients. But do you expect any sort of potential relief in terms of an ability to deliver adult-use product or deliver it directly from the dispensary, call it, to the consumer?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [19]

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Yes. I think one of the things that's really different about the Canadian market is that with the -- looking at 2 -- really looking at 2 provinces, Ontario and Québec, the OCS in Ontario and the SQDC in Québec, both have online stores where consumers, adult-use consumers can go online and purchase cannabis from their provincial government, which is really different from the United States. Now those products are generally packaged in -- assuming you place an order today, they're packaged and shipped within 24 to 48 hours. And so you would get the product essentially 72 hours -- 72 to 96 hours after you order it, which is -- you don't -- there's no model like that in the United States today.

What doesn't really exist in Canada today is sort of immediate delivery, like you see if you order a pizza or like you see in some U.S. states. There are some companies in some provinces that are trying to do it, but you don't have that sort of place an order and receive it from some sort of delivery driver within an hour or 2 like you see in U.S. states.

I expect that you will see that at some point in Canada, but it doesn't -- there are a few exceptions, but it doesn't really exist today on the legal market. There's lots of such services that are available for that illicit product.

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Michael Joseph Hickey, The Benchmark Company, LLC, Research Division - Research Analyst [20]

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Last question. Just -- I was curious on the sort of the Cannabis 2.0. Edibles seems like maybe it's being overregulated. Curious of your view on that. But maybe the low-hanging fruit is sort of vape. So I was hoping maybe you could dig into your vape strategy, hardware, et cetera, that would be helpful.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [21]

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We expect to distribute a number of different vape products under multiple brands. I would sort of segment the vape products into sort of 3 broad categories by form factor, not by brand on this call. But by form factor, we expect to have a full line of products available that are disposable vape. That'll be the first category. The second category would be an interchangeable 510-thread like you see in most U.S. states. And then the third category would be essentially some sort of cartridge that fits into someone else's proprietary delivery system, also like you see in some U.S. states.

So we expect to have a full product line across those 3 different form factors available whenever the regulations allow us to sell those products. We've been stockpiling oil for vapes beginning this quarter, and we'll continue to build on that inventory in preparation for the end of the year.

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Operator [22]

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Our next question comes from Rupesh Parikh with Oppenheimer.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [23]

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So I wanted to touch a little bit more on the U.S. CBD market. So just curious if you guys can provide more color in terms of how you see the ramp in the back half of the year on the CBD front. And also on the Manitoba Harvest CBD launch, I was also curious in terms of how much distribution you've gotten so far.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [24]

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Yes. Currently, the Manitoba Harvest food products, the hemp food products, are available in about 16,000 stores in North America, so -- in the U.S., meant U.S., [13,000] stores in the U.S. today. Their broad-spectrum hemp extract products, their CBD products are -- we've launched those products this quarter in Q2, and they're in nearly 1,000 stores today. We expect that number to continue to grow significantly in the second half of this year. I think we're all looking forward to clarification in regulation from the FDA on CBD products and broad-spectrum hemp extract products.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [25]

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Okay, great. And I was just also hoping for potentially more color in terms of how you guys see the ramp on the CBD side in the U.S. in the back half of the year.

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

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So the ramp will be somewhat dependent upon how much clarity the FDA does give. We do see a lot of the major retailers holding off, especially on the ingestible products until they have more clarity. If that clarity comes in the second half, we see a significant ramp in the second half of the year. If it does not, we see a much slower ramp on the CBD side for, again, on the ingestible side.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [27]

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Okay. Okay, great. And then maybe just 1 housekeeping question. So Mark, I was hoping to see if you can provide more color in terms of how you guys should think about G&A expenses and sales and marketing in the back half of the year. Looks like, at least on the sales and marketing front, it's leveled off at about 30% of sales. So just curious if there's any additional color you can provide on either line item.

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

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Yes. So on the sales and marketing this quarter, you saw a little bit of a bump, and a lot of that was because of the Manitoba Harvest -- or a big portion of that bump was the Manitoba Harvest, having it in there for the full quarter. From a percent of sales, you'll see that come down as a percent of sales slightly, but pretty small ticks down for the second half of the year.

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Operator [29]

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Our next question comes from Mike Grondahl with Northland Securities.

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Michael John Grondahl, Northland Capital Markets, Research Division - Head of Equity Research & Senior Research Analyst [30]

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On the Authentic Brands, you talked about a first product. Any insight into kind of what that product's going to be? And what does the pipeline look like for other products in the back half?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [31]

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We haven't announced it yet. The first line of products and the first brand will be a set of topical products. We haven't announced the brand yet, but I would expect in the next -- I guess in the next 3 months to announce the brand. And it's about -- I can't remember if it's 5 or 6 SKUs that we'll -- product SKUs that we'll launch, but we'll make that announcement in conjunction with our partners at Authentic Brands Group.

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Michael John Grondahl, Northland Capital Markets, Research Division - Head of Equity Research & Senior Research Analyst [32]

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Got it. And just the pipeline, Brendan, for other products?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [33]

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So have -- the pipeline of -- with ABG, on the product and branding side and then the team at Manitoba Harvest on the product innovation and form factor side as well as we made an acquisition, small acquisition this quarter of a company called Smith & Sinclair. We expect to bring additional products, brands, form factors to market in the U.S. CBD space.

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Operator [34]

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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 [35]

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First question is I'm just trying to understand what really drove the notable increase in sales volumes this quarter into the recreational channel, considering the past several quarters have had more modest volume. So was it just a function of you have been constrained on your own production and now you're really turning the corner there? Or was it that heading into Q2, you managed to procure more third-party supply? Or was it that in previous quarters, you were prioritizing production to take advantage of good LP wholesale pricing before?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [36]

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So Tamy, it's been a combination of many things. But as you pointed out, it is, A, getting some third-party supply as well as ramping our own cultivation. You saw the amount we harvested was up almost 40% this quarter versus last, so we're continuing to ramp our own cultivation as well as we're continuing to provide more sources for quality third-party supply. So I think if you look at kind of us versus some of the competitors, we're probably one of the biggest increases in Q2 for sales for adult-use than -- in the industry.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [37]

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And I'm wondering, could you break down the other channel for cannabis, so the nondirect channel, the -- I believe it was $9.1 million of gross revenues. How much of that was direct to medical patients versus continuing to sell to other licensed producers?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [38]

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So about $2.5 million was direct to other medical patients.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [39]

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And the rest was to other licensed producers?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [40]

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That's correct.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [41]

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Okay. And just a housekeeping item. I was wondering, Mark, if you could provide this, your gross average selling price specifically for the recreational channel. Just trying to understand how the pricing in the different channels worked out because you did have the decline in total average selling prices.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [42]

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Yes. So the adult-use pricing, price per gram overall was USD 5.17 or about CAD 7. Is that what you're looking for, Tamy?

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [43]

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Yes, it was, and that's gross?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [44]

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That's correct.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [45]

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Okay. And I just had 1 last question, this is on Manitoba Harvest, the broad-spectrum hemp extract. First, I'm just wondering like why is it branded that way versus being named or called CBD oil? And secondly, you were talking about the FDA issues there. So are you currently just selling in terms of products, the topicals or do you have some sort of ingestibles that you are selling right now?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [46]

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So clearly, there are -- there are 4 different product types. There's a -- an extract product that's in a dropper bottle, there's a gel cap product, there's a spray and then there's a protein powder.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [47]

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And Tammy, it is CBD. Oil is -- CBD is one of the ingredients, and you'll see that on the package. So it is CBD.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [48]

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One of the reasons we market it as a broad-spectrum hemp extract product is that Manitoba Harvest is a hemp brand. They're, like I mentioned, in over 16,000 retailers in the U.S., and so we wanted to continue that language. And when we did some consumer testing, it was really important to -- in our market research, that consumers were interested in broad-spectrum hemp extracts as opposed to CBD isolate. And there's certainly uncertainty with what the FDA is going to do around CBD isolate based on the GW Epidiolex product authorization in the U.S. And so we were much more comfortable with the broad-spectrum hemp extract language based on the product that's in those individual form factors.

The other thing that's important in how we distinguish that product from a lot of the other CBD products that are in the market is that the Manitoba Harvest team has attained a self-affirmed GRAS, Generally Regarded as Safe, (sic) [Generally Recognized As Safe] status. And so that makes Manitoba Harvest the first company, to our knowledge, to achieve that distinction, and it demonstrates our commitment to compliance and building consumer trust.

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Operator [49]

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Our next question comes from Aaron Grey with Alliance Global Partners.

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Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [50]

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Nice to see the improvement in gross margin sequentially. Just any color you could provide on how much the gross margin should trend in the back half just as utilization improves. And then as we look to next year, with increased sales in the international markets with carried higher margins as well as novel form factors coming online, just help us think about gross margins over the next 18 months.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [51]

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Yes. So as we talked about in the last call, we did expect to see gross margins improve about 300 basis points. We're actually ahead of that this quarter. We expect probably another 300 basis points through the back half of this year. So we do expect to be in the 30%-plus range for gross margins kind of by the end of the year.

For next year, we do expect to see expansion as we get into other form factors and have more product available for international markets, which do carry higher margins. So you'll see us getting -- probably starting in the mid-30s and getting mid-40s by the end of the year and potentially even higher.

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Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [52]

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Okay. All right. Great. And then just overall, thinking about EBITDA, any sense you could provide on how we should think about moving closer to breakeven and then profitability just as thinking about SG&A, along with what you just provided on gross margins as you look into potentially spending on some marketing with some form factors coming online, the U.S. with CBD and some marketing around that? Just how best to think about overall EBITDA.

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

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Yes. For our overall EBITDA, I think as you look at the levels that we're at this quarter, we'll probably something similar for next quarter and then start to see some improvement in Q4 and then some improvements going forward. If the world were to stop and there is no new countries to invest in, we do believe that we'd be positive EBITDA by the end of next year. As far as other new markets, we want to be successful in the U.S., and we will continue to invest in the U.S. markets.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [54]

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I'll just pipe in here. If your company's a small- to mid-sized LP in Canada or an MSO in the United States that can export to other countries, then I think those countries -- those companies should be focused on profitability.

But you only see an opportunity like this once in your lifetime. And if you're trying to dominate a global industry, you'd be constraining yourself if you were focusing entirely on profitability at this point. Globally, it's very early in the emergence of a $200 billion industry. And globally, if now is not the time to invest, I don't know when is.

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Operator [55]

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Our next question comes from Graeme Kreindler with Eight Capital.

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Graeme Kreindler, Eight Capital, Research Division - Research Analyst [56]

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First question I had, just to follow up on the comments earlier in the call about seeing a supply balance in Canada in the next 12 to 18 months. Understanding that there's -- potentially you get supply balance there, how does the company think about how much of that supply could be of the necessary quality that it would be something they'd look to actually source and put their own label and brand on that?

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

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I think that's a big difference for the last -- really in the last 6 to 8 weeks. The last time we did this call, I was really frustrated with the lack of quality supply. We announced 1 supply agreement over the last month or so, and we were pleased with the quality of that product. And I know that our sourcing team has a few more similar agreements that they've been working on with similar quality suppliers.

And so I don't want to sound too optimistic but I am certainly more optimistic today than I have been that, that quality supply will continue to come online in Canada. And that's a pretty big difference from what we were talking about 90 days ago.

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Graeme Kreindler, Eight Capital, Research Division - Research Analyst [58]

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Okay, got it. Appreciate the color there. And then just on another note here, with respect to the average selling price seen in the quarter or with the sequential decrease quarter-over-quarter, is there any sort of thoughts on how that might trend in the long term? Obviously, there's more supply and quality supply that could be coming into the market and also partially offset by the introduction of derivatives. So just curious in terms of where the company sees that heading in the medium term.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [59]

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Yes. So Graeme, let me give you a little bit more color on that as well. So some of that is mix. So if you look at our product mix this quarter, extracts -- extract products for adult-use was really 1% of sales. It was much higher in the past. So our pricing actually hasn't come down. It's been more a function of mix and to which provinces that we're selling in.

So we do expect pricing to -- from a mix standpoint, as adult-use becomes a higher percentage of the mix in the second half of the year, we do expect pricing -- or to have some pressure on pricing. Offsetting that is 2020, where we do think pricing will go up from an overall mix standpoint with other novel form factors. Also, international will be taking a bigger portion of the mix which helps on the overall pricing. But if you're looking purely at Canadian adult-use pricing, yes, that will be down primarily because of just mix.

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Graeme Kreindler, Eight Capital, Research Division - Research Analyst [60]

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Got it. And lastly to follow up there, Mark, in terms of the mix in the quarter where you said the extracts for adult-use, was that because of what was happening on the provincial supplier side of things in terms of what they wanted? Or does that have to do with taking any capacity sort of off-line to stockpile inventory or process some oils ahead of the derivatives launch?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [61]

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It's actually a combination of both. But mostly, we did -- the provinces are looking for flower, and they're looking for -- primarily for flower and less for extracts today.

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Operator [62]

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Our next question comes from Andrew Carter with Stifel.

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William Andrew Carter, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP [63]

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Just a quick question, just to kind of understand the revenue potential that's out there in the second half of the year. Just kind of want to understand, you've obviously kind of alluded to the fact that the second wave is going to start in the first quarter next year. So want to understand how you're balancing kind of your ability to supply the market right now, what you have to hold back. Should we see -- should it be a meaningful revenue acceleration? Kind of help me understand if it's constrained or there's a lot of opportunity for the second half of the year.

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [64]

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So it really depends on the channel. So as we look at the international channel, we see some pretty significant increases on the revenue side. For the Canadian adult-use channel, we do see the growth from here to be a little bit more muted as it will be heavily flower-related, and as the buyers start shifting their inventory mix to getting ready for Q1, which will have the other form factors.

So the stores aren't getting any bigger, they're just going to be changing the mix in the stores. So you'll see some muted -- we expect to see some muted orders over the next couple of quarters, except for new retail locations by the Crown corporations. So from a, I guess, revenue for the back half, you'll see growth. You won't see the doubling of growth like we had this past quarter. You'll see a much more muted growth into the channel for adult use.

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William Andrew Carter, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP [65]

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Okay, great. And then just kind of last question. Now that we have the Health Canada regulation kind of fully out there, I guess I wanted to get your perspective on kind of the approval processes that remain outstanding, how you view any risk of getting product to market from here.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [66]

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Are you talking -- sorry, Andrew. Are you talking specifically around the sort of Cannabis 2.0 form factors?

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William Andrew Carter, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP [67]

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Yes, sorry. What I was kind of getting at, I know that they've thrown a 60-day window. I've heard conflicting things about strict that's going to be. Is it expiration you can start shipping? Can you ship before? That's kind of what I'm trying to understand here.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [68]

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Yes. We expect to be able to ship those products sometime on or before December -- I think it's December 19. What's really unknown is not really the Health Canada regulations but whether or not the Crown corporations are going to be willing to place significant orders at the end of November, December just as they're going through their end of the year and the holidays, or whether some of them might just hit pause on the new form factors and place those orders in January. It's -- I've sort of given up on trying to predict how these entities will act.

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Operator [69]

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Our next question comes from the line of Brett Hundley with Seaport Global.

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Brett Michael Hundley, Seaport Global Securities LLC, Research Division - Research Analyst [70]

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So I just wanted to follow up on the discussion regarding additional third-party supply in Canada. So as you guys look to potentially sign up more third-party supply agreements going forward, the entities that are willing to sign up for these supply agreements, would you characterize them as larger peers or would you more so characterize them as smaller entities?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [71]

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It's a mix. Some of the smaller ones are entirely focused on either 1 or 2 strains, and we've seen some high-quality products out of some of those sort of craft cannabis farmers. On the other hand, we announced a large supply agreement with Zenabis. And they were in need of capital. And rather than do a round of capital or go to markets at an unfavorable time, we were able to structure a deal that made a whole lot of sense for us and guaranteed us a supply of high-quality products at an aggressive price.

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Brett Michael Hundley, Seaport Global Securities LLC, Research Division - Research Analyst [72]

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And then I also wanted to revisit a discussion about CBD in the U.S. So I guess on the supply chain side, when you look at hemp and broad-spectrum cannabinoids in the U.S., prices have really been declining year-to-date in the States. We'll see what happens as we get out of harvest this year and how much hemp makes it out of the field and onto store shelves. But I wanted to better understand your own supply chain at this point in time. I mean, I understand this could change if and as you guys conduct M&A or partnerships ahead. But can you just update us on your hemp and CBD supply chain approach in the States at this point in time right now?

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [73]

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We've announced a couple of different agreements with farmers and I guess collectives of farmers in the U.S. We've procured supply from a company in Montana called LiveWell, and that's some supply for Tilray and for the Authentic Brands Group products. We've also, through Manitoba Harvest, signed a supply agreement for high-potency CBD hemp from a group of farmers out of Oregon. And the name of that group is slipping my mind right now, so I can't name them.

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Brett Michael Hundley, Seaport Global Securities LLC, Research Division - Research Analyst [74]

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I appreciate that. And then just last for me. I just wanted to revisit the profitability discussion. I personally agree with what you guys are saying insofar as building for the long term. I think we've seen examples within the space where maybe that leniency hasn't been there on some of your peers, at least from their owner set. And then, of course, you just have views that seem to change across the broader marketplace from the investment community.

Can you guys -- maybe just looking at profitability differently, can you characterize how important it might be for you guys to get free cash flow positive within the next, let's say, 3 to 5 years? Let's look out longer. I mean, did you think that you have enough leeway from your ownership and the broader market to continue running at negative cash flow for longer periods of time in order to position your platform for that longer-term size and success? Can you just talk about a little bit as it relates to your ownership and your views of the broader market and its acceptance of what you're trying to build long term?

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Mark Castaneda, Tilray, Inc. - CFO & Treasurer [75]

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Yes. So from an ownership standpoint, we do have a concentrated ownership, which we think is an advantage because the ownerships are taking a long view of this opportunity. And investors are looking at it and rewarding us for that long view. When you look at the multiples in the market, we're one of the highest-multiple stocks. So I think people that have the long view are taking the ride with us.

Obviously, there's companies that are taking a much shorter view. So our approach in the next 3 to 5 years, yes, we do expect to be cash flow positive during that time frame. But we're looking at today as kind of day 1. So we're really maybe a year from the day we've gone IPO, so we're really a couple -- a year into it. There's still -- it's still such early days, and we -- we're building this thing to be one of the leaders in this space globally. We're not looking to just be the biggest company or one of the biggest in Canada.

So I agree with your thoughts about long term. We do have patient investors and we have people that are betting on us.

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Operator [76]

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And that will conclude today's question-and-answer session. I'd like to turn the call back to Mr. Kennedy for closing remarks.

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Brendan Kennedy, Tilray, Inc. - Chairman, President & CEO [77]

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Thank you, everyone.

I want to thank more than 1,300 employees of Tilray for their dedication and extraordinary efforts in building our company and for improving the lives of patients and consumers through cannabis.

We appreciate everyone's questions and participation on today's call. Have a great evening.

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Operator [78]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.