Tilray Brands, Inc.
Q4 2019 Earnings Call Transcript

Published: 2 Mar 2020

[Operator:]

Good afternoon and thank you for joining us on Tilray’s Fourth Quarter and Full Fiscal Year 2019 Earnings Conference Call. On today's call are Brendan Kennedy, Chief Executive Officer; Mark Castaneda, current Chief Financial Officer; Michael Kruteck, incoming 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 Private Securities Litigation Reform Act of 1995 as amended. 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.

[Brendan Kennedy:]

Thank you, Rachel. Good afternoon, everyone, and thanks for joining us. I will begin this call with the brief recap of Tilray's 2019 performance, followed by perspectives on the state of the cannabis industry in the markets in which we operate. I will conclude with remarks on our focus for the months ahead in 2020. Then, Mark will review our fourth quarter, and full 2019 financial results in detail. 2019 was a year of firsts for Tilray, but not a year without its challenges. In the face of market volatility, I'm proud of our team and how we executed to drive our business forward to position Tilray for long-term shareholder value creation. In 2019, our revenue increased 287% year-over-year to US$167 million. We built a highly diversified cannabis business across three core markets, global medical, Canada adult-use, and hemp. These businesses generated approximately 16%, 36% and 36% of total 2019 revenue, respectively, with the remaining 12% of revenue coming from bulk product sales. Our medical cannabis products now are available in 15 countries on 5 continents around the world. Our hemp products are available in over 17,000 retail doors in 20 countries around the world. We have a diversified asset base, with facilities and offices in Canada, the United States, Europe, Australia, and Latin America. We're the only cannabis company to have GMP-certified cultivation facilities in two countries, Canada and Portugal. Over the course of 2019, key milestones we achieved that position Tilray well to compete on the global stage include the following

[Mark Castaneda:]

Thanks, Brendan. Good afternoon to those of you joining us on today's call and webcast. It is a pleasure to be speaking with you today. This will be my last earnings call as Chief Financial Officer. I'd like to welcome Michael Kruteck, who will be taking over after we file annual report and Form 10-K. I've been working with Michael since he joined in January and I'm confident it will be a smooth transition. I'm excited to move into my new role, strategic business development to focus on strategic initiatives for Tilray. Turning to our results. Please note that all the financial information we discussed today is prepared in accordance with U.S. GAAP and U.S. dollars unless otherwise indicated. On balance, Q4 was a challenging quarter for the industry. As Brendan articulated, the lack of points of distribution among other things has kept the illicit market robust in Canada and has moderated the rate of growth in legal markets. However, against that backdrop of broader industry challenges, I'm encouraged by the fundamental performance of our key businesses relative to our peers. Specifically, we put up strong sequential quarterly growth numbers over Q3 in our adult-use business, which included an uptick in average selling price. Similarly, we experienced sequential quarterly growth in our hemp products business. Given the state of the industry, we also determine, it’s prudent at this point to de-risk our balance sheet by taking non-cash impairment charges related to the uncertainty in the U.S. CBD market, as well as non-cash inventory valuation adjustments; addressing significant industry-wide supply of cannabis extracts and extracts feedstock.

[Operator:]

Thank you. And our first question comes from Chris Carey with Bank of America. Your line is open.

[Chris Carey:]

Hi. So, clearly, there was a material step-up in OpEx this quarter and you had just noted, Mark, that you expect that to -- I think you put a decrease materially in 2020. And so, I guess, in the context of expectations for OpEx to come down, it sounds like you're still kind of implying that you can get to over 40s gross margin in 2020, though it feels like we’re kind of a far away from that place today. But, can you help me bridge the gap between what you just did on the quarter and how you think you can still get to Q4 ‘20 EBITDA by yearend? Is that over 40% gross margin, correct? How we think about our OpEx coming down? And then I suppose, revenue assumptions are just a plug there. So, I realize that's kind of a standard modeling question, but, I think it's important enough to start out with that. And I just have one follow-up.

[Mark Castaneda:]

Yes. Chris, so first your point is there on the Q4 G&A, we had a couple of nonrecurring items of charges in there of about $8 million to $10 million, really closer to $10 million. And what the biggest piece of that was $8 million was tied to some tax costs -- tied to some RSUs or some equity issuances for some cross border. It was a pretty unique situation, but it was an $8 million charge during the quarter for that specifically. And then there was another 1.5 million regarding some legal fees tied really to some acquisition type transactions. So, those would not be recurring. So first, you got a cut off roughly $9 million, and when you look at the runway rate. And then, we had some changes in our G&A as we announced -- as Brendan mentioned of 10%, on the headcount side. We expect G&A to get into the $40 million to $45 million range, closer to $40 million by the end of the year, which is actually when you look at total SG&A for 2019, at average $37.5 million, I know the last quarter was higher because of some onetime costs, but we actually will see a little bit of an increase from 2019 kind of on average for the quarter to -- in the $40 million to $45 million range. And so, yes, we do expect gross margin to move from where we're at today. There were some cleanup items in the quarter. We were on trend to increase a couple hundred basis points, 200 basis points to 300 basis points per quarter. We'll see some stronger increases this year. And the visibility we have on that is the throughputs in our existing facilities are going to increase substantially with no increase in space. So, we'll be able to absorb more of those fixed costs. Secondly, we will be ramping up our Portugal facility. So, we do expect gross margins closer to the 40% to 45% range. And as you said, the revenue is kind of that last plug.

[Chris Carey:]

Okay. That's very helpful. Thanks for that. And then, I guess just one other on -- you had -- Brendan, I think it was you that had said that you could look at optimizing some of your footprint. And I don't know if that was kind of regarding OpEx or whether there was something a bit more strategic there. And if I could, I guess, the way that I think about this is, you're all in the industry producing so much of this flower and there's going to be a volume game there. And certainly it's a notable part of categories long-term, but there's not a lot of evidence that matters to brands. And so, if there's all this extract out there and 2.0 is really where all this is going, is that comment a function of you looking at how much capacity you have and the expansion plans that you had before, and thinking maybe you don't need to do that in Canada, or did I misread that? And if I did, if you could just talk about broadly, 2.0 trajectory from here? Thank you.

[Brendan Kennedy:]

Yes. And In terms of optimizing the footprint, it's doubtful that we would invest additional CapEx in building out additional capacity inside of Canada, certainly cultivation capacity. We have been investing in our facilities for cannabis Phase 2.0. products. And what you'll see quarter by quarter throughout this year is the facilities that we operate will become more efficient. If you think about what we experienced in Canada six years ago, what we experienced in Canada a year and a half ago with the launch of adult use, and really in Q4 with the launch of 2.0 products, we're just making a whole bunch of stuff we've never made before. And the first time you make it is never -- you're never the most efficient. It's like turning on one of our cultivation facilities, yield goes up with each harvest. And so the first time you make a chocolate bar or the first time you -- first time we made a beverage and canned it, it's not as efficient as the 10th time or the 100th time you operate that particular facility. So, we'll get -- we’ll optimize our footprint, optimize our yield, optimize our unit costs throughout the course of this year. In terms of Phase 2.O products, the second the second part of your question, alongside our partners at Fluent Beverage Company, High Park is the only producer to ship edibles, vapes and beverages on day one of Phase 2 legalization. And as of the week of February 28th, Fluent Beverages shipped the first and only sparkling beverage in the market. And so, there's Fluent Beverage products, sparkling beverages are in I believe six provinces today

[Chris Carey:]

Okay, thanks. I’ll get back in.

[Brendan Kennedy:]

Yes, and except for -- one final point there, Chris. Except for the canned beverages, we had reorders on all of the Phase 2 products and the reason Fluent hasn’t had them on beverages yet is that they're too new.

[Operator:]

Thank you. And our next question comes from Michael Lavery with Piper Sandler. Your line is open.

[Michael Lavery:]

Thank you. I just want to try to understand pricing dynamics a little bit better. And the bulk sale disclosure is helpful. But, I think if I'm looking on this right, your -- sequentially, your bulk sales went down -- I think you had a few kilograms up but revenues fell, even with a little bit of 2.0 products, catching tail end of the year. Can you just help us understand what some of the drivers are and how to think about the total Company price mix for you, and is there a pricing pressure, is it mixed driven? What are some of the key moving parts we should be focused on?

[Brendan Kennedy:]

Yes. Michael, I think most of that will be mixed driven. So, when you look at the bulk, the bulk came down pretty dramatically in Q4 versus Q3. And we expect it to be again, somewhat non-existent in 2020. So, that does take some of the pressure off from the overall average pricing. Actually, the beginning part of the year, we actually made some pretty good margin on both just because there was a product available. But as far as the 2.O products, we did ship in December, it was the last couple of weeks of December. So, the impact to Q4 was negligible. So, relatively small dollars, a few shipments here and there, but it's -- you'll see more of an impact going forward from an ASP standpoint. So, mix will matter. So adult-use 2.0, and international medical markets, we expect those two to be the fastest growing segments, which have a positive impact on ASPs going forward.

[Michael Lavery:]

I guess, I still don't see what the real drag is, is somehow bulk sales following a headwind to pricing? I would think that's low price per gram. Am I wrong?

[Brendan Kennedy:]

No, you are correct. So, the headwind is on the flower side. So, flower pricing is such that when we talked about our lower priced flower offerings, so we put in the market last quarter, those are lower priced. And those are meant to compete with the illicit market and those are going to be at lower ASPs. Like I said, as mix changes going forward with more 2.0 and more medical, you'll see overall ASPs come up.

[Michael Lavery:]

And just one last one on this. The premium higher THC flower is not necessarily synonymous, but it seems to me that the consumer a lot of times is where you have the pricing power that shrink meaningfully -- how much were you able to supply that? And just how big did your value segment grow, just to get a sense of how they are proportionately and the level of mixed drag we should expect going forward?

[Brendan Kennedy:]

Yes. So, the value segment’s been a larger part of the mix in Q3 and in Q4 was drove down the overall ASPs. What we've done with our higher THC percentage product or higher quality products is really been going to the medical markets. And the medical markets -- and that's all coming from the Nanaimo or from our facility in Canada. As our facility ramps up now in Portugal, you'll see more of that shift that allow us to keep some of that product, the higher value product here in Canada as well. So, yes, the greenhouse product is a bigger percentage of our volume and a bigger percentage of our overall adult-use revenue, and thus primarily will change as the 2.0 starts to kick in.

[Operator:]

Thank you. Our next question comes from Rupesh Parikh with Oppenheimer. Your line is open.

[Rupesh Parikh:]

So, I was hoping to I guess, dive a little bit deeper into how you guys are thinking about the Canadian international medical markets for this year. Any more color you can provide on the top line in terms of how you guys see the growth ramping in both of those segments throughout the year?

[Brendan Kennedy:]

So, on the Canadian medical, we actually saw it decrease this year versus last year. That decrease was primarily due to supply concerns really in the first half of the year. As you could see in Q3, we kind of got our footings back. And then, Q4, slightly turned back down just for some, again, having to allocate product to different markets. In 2020, we do expect to see strong growth in that market, growth back to -- about the $4 million level per quarter in revenue, so north of every quarter of this year for Canada medical. For international medical, we expect to see significant growth in the second half of the year and a slower ramp in the first half of the year. So, second half could, we do expect to see some significant growth.

[Rupesh Parikh:]

And then, one follow-up question. So clearly on the CBD front of the U.S., there's been some challenges given some of the delays from the FDA. How are you going forward approaching U.S CBD at this point? Is it just slowing down investments or just anymore color there in terms of how you guys are approaching that?

[Brendan Kennedy:]

It's definitely slowing down investments until we have some sort of clarity from the FDA. Until the FDA provides us with some sort of clarity, we’ll continue to invest in Manitoba harvest from a hemp food perspective and continue to meet with various retailers to discuss the Manitoba Harvest, CBD products and portfolio. But, most of the retailers certainly from an ingestible perspective are still sitting on the sidelines.

[Operator:]

Thank you. Our next question comes from Vivien Azer with Cowen. Your line is open.

[Steve Schneiderman:]

Hi. This is Steve Schneiderman pinch hitting for Vivien tonight. Brendan, you mentioned off the top, you guys want UPS to be ready to go right away, both in vapor and in edibles, but can you just kind of provide an update on your 2.0 supply chain? And how long do you think it's going to take before we start seeing equilibrium in this respective market, in particular for edibles, given the out of stock that we're seeing in the market today?

[Brendan Kennedy:]

Yes. I think it’s going to take longer than most people thought. Frankly, we were positively surprised by demand. We were expecting something similar to October 2018. When there were so many LPs entering the market with so many different products and that really just hasn't happened this time. And so, we're racing at this point to increase our supply of vape, edible and beverage products. And so, we're expanding our manufacturing lines and increasing our shifts, so that we can get more of those products to market. We were surprised, not only by the demand but the lack of -- really the lack of competition. It seems like a lot of the LPs just decided to sit on the sidelines. It's a good problem, but it's still problem.

[Steve Schneiderman:]

In terms of value dry f lower, do you have a sense of how -- of what your share is in that market or how you're competing? And just teasing out some of those Mark’s commentary about batches impact on ASPs, what portion of your dry flower volumes come from, either the batch or the value segment?

[Mark Castaneda:]

So, as far as market share, it really varies by province, and there's a couple provinces where we’re in the top couple points or top couple areas. As far as the mix of overall product, it's one of the largest pieces of our mix. Today, again, I expect that the change because of the 2.0 products. Now 2.0 in just in Q4 was, I guess, effectively one shipment to the provinces to several provinces, but the dollars in -- for one week or two weeks’ worth of sales are pretty small in Q4. You'll see that increase in Q1. So, the mix of the value segment products will come down as those other segments go up.

[Steve Schneiderman:]

Okay. Well, understood. And last one for me. What expectations are you currently baking in for store openings in Ontario with the province indicating they're going to approve 20 store authorizations beginning in April. How much are you baking into your plants?

[Brendan Kennedy:]

So our plan -- I think there's around 800 stores today in total. I think, Ontario has in what 45ish. And I think Quebec is pretty similar. We expect the full -- at the end of the year to be just over 1.000 locations, with Ontario probably doubling where they're at today. But, we are not planning a significant increase in locations. Just from an execution standpoint, we just want to be conservative.

[Mark Castaneda:]

Obviously, if we get to 1,100 or 1,250 stores by the end of the year that will be positive. But, we've been burned before by active retail openings. And so, we're taking a little bit of a conservative view at this point.

[Operator:]

Thank you. Our next question comes from Aaron Gray with Alliance Global. Your line is open.

[Aaron Gray:]

So, first, I just want to jump back in terms of the question that was asked early on bulk. Can you just talk about the volume increased during the quarter. It looks like it was up about 40%. I just want to know exactly how much of that was driven by bulk because it looks like that was good amount of the volume increase and then how best to think about the run rate for volume going forward. And I know it's a little bit difficult with 2.0 product coming online, but any color that will be helpful. Thanks.

[Brendan Kennedy:]

Yes, you're exactly right. The bulk drove a lot of the volume but not the dollars, right? And bulk is in different types of products. And so, this bulk, we effectively sold lots of byproduct, which had lots of weight but not a lot of dollars to it. We expect that to have less of an impact going forward, especially in the 2020.

[Aaron Gray:]

Okay, great. Thanks. And there's one other question that's been asked a couple of different ways and want to kind of put off together, just as we touch on your expectations to hit EBITDA positive by 4Q ‘20 and specifically on your top line expectations, what would you expect the mix to be between Canadian adult-use, medical, international and Manitoba? I know there's a lot of variables there, but how best you think about the drivers of where you are today and we expect to be in 4Q in order to hit that target?

[Brendan Kennedy:]

So, I think if you look at the just in general overall doubling of where Q4 was for 2019, doubling that for 2020. And the key drivers of that growth are going to be more on the cannabis side. So like the adult-use, we expect for more than double; Canadian medical, we expect to actually increase less than double, slightly less; international medical, we expect to grow significantly more than double; and bulk effectively going away. So, you'll see that international medical and adult-use were going to be the main drivers for next year. On the hemp side, we expect to see some growth in hemp. One growth area is just having a full year's worth. We only had 10 months worth of activity. But as far as the overall growth is going to be -- and just base growth is going to be on 10% plus provision for the full year. So hopefully that gives you a little bit more color.

[Operator:]

Thank you. Our next question comes from Tamy Chen with BMO Capital Markets. Your line is open.

[Tamy Chen:]

Thanks. I just have one question. I don't think we have a cash flow statement right now. So, I think you ended the quarter with just under $100 million, which is similar to the end of Q3. So, I just wanted to kind of understand the -- obviously we can see where the cash burn is, but just where the sources came from, particularly the ATM. I'm wondering how much did you raise on that during the fourth quarter? Thanks.

[Brendan Kennedy:]

Yes. So, we raised about $70 million in the fourth quarter.

[Operator:]

Thank you. Our next question comes from Graeme Kreindler with Eight Capital. Your line is open.

[Graeme Kreindler:]

I wanted to ask about the inventory price adjustments. I know, there was some commentary regarding what it related to earlier in the call, but I was wondering if -- the price adjustments take in this quarter, do you see that as pretty complete at this point or you still taking ongoing assessments of the inventory balances and we could potentially see some other sizable adjustments in the future, given their shorter term outlook on in terms of what you're expecting on the market dynamics? Thank you.

[Brendan Kennedy:]

When we look at price adjustments and reserves for returns, I think if you look at us versus some of the others, it's relatively on the smaller side. This quarter was around $4 million. And most of that has just been reserves for -- potential reserves based on what the inventories are out in at the provinces. So, we have done some price discounting that’s has been mostly on the oil type products or T ships type products. As opposed to taking returns, we discounted the products that was sell through and not take return and some of the returns we're receiving from some of the products, relatively small dollars, compared to, again what we've seen in the industry.

[Graeme Kreindler:]

Okay, thanks. And then just wanted to shift gears, with respect to the international medical revenue, and I understood the variance there. You mentioned you had a bulk sale in the previous quarter, a lot going on in the assets in Portugal right now. But, as we think about that ramp, and the expectation of more than doubling that medical revenue, just trying to balance the discussions in terms of the amount of demand that various companies are expecting in the international market, versus when are we going to see continued proof of that demand increasing quarter-over-quarter, expecting pretty sizable gains on that revenue line and what point of the year would you expect in 2020, when we can really start to see that acceleration.

[Brendan Kennedy:]

We expect to see that acceleration really in earnest in the second half of the year. Actually, if we had more supply, more high quality supply, we'd be able to sell it. Every time we send flower to Germany, it sells on a couple of days. So, it's been more of a supply problem than a demand problem for us. So, that's been the challenge. So, we just need some -- we need more high quality supply, which we expect to produce -- have more capacity coming from Portugal.

[Operator:]

Thank you. Our next question comes from Andrew Carter with Stifel. Your line is open.

[Andrew Carter:]

Yes, thanks. So, I wanted to kind of drill in a little bit on the cannabis 2.0 products. We're obviously seeing a lot of out of stocks. So, first question is, are you seeing more of a normalized ordering pattern versus what you saw kind of in the 1.0 market? And kind of give us an idea where your supply chain is at this point? Are those products incremental to gross margin or do you still have some fixed costs absorption to go? That would be helpful. Thanks.

[Brendan Kennedy:]

Maybe I'll start and Mark will finish. We saw a different ordering pattern in December than we did a year ago, October. A year ago, October, all of the provinces were placing very large orders to build out their supply chain and keep product in their distribution centers. This time around, there were much smaller orders but what happened was we had reorders essentially as soon as our initial product showed up into those distribution centers. So, it's almost as if they were testing to see who could actually make this stuff and who would actually ship it. And so, the orders for those 2.0 products, they're just -- they're coming faster than what we saw a year and a half ago. And it's not normalized. It's nowhere close to being normalized. Because as soon as we shipped the 2.0 products to the provinces and put them on shelves, they disappear within a number of -- matter of days. And so, it's a good thing but we're trying to increase our manufacturing capacity rapidly, so that we can ensure that that we capture market share and capture shelf space.

[Mark Castaneda:]

And from a costing standpoint, we've put our plan in place and kind of built some inventory. We thought we'd be in great shape to have -- we're building a 300% or 400% of our plan, but it's filled out a lot faster and the reorders came a lot faster. So, we were probably more conservative this time around as well as the provinces being more conservative versus the first time. And from a cost absorption standpoint, we're really inefficient today just because now we're trying to scramble to catch up and just push as much through as possible. We're putting new lines in or an additional line in I think our chocolate side. And we'll get more efficient as those start to stabilize. We're not just rushing everything out.

[Brendan Kennedy:]

And now that we know what demand is and we're seeing orders and reorders and increasing our capacity, we will further automate those different manufacturing lines. We did a conservative approach in terms of the equipment we ordered the packaging that we ordered. And so, you'll see more efficiencies throughout our supply chain, which will drive down our COGS.

[Operator:]

Thank you. And our next question comes from Scott Fortune with Roth Capital Partners. Your line is open.

[Scott Fortune:]

Thanks for taking questions. Most of the questions have been answered, but real quick, are you seeing any hardware issues on the vape side, coming from the coronavirus and China suppliers, or how's your supply side of things from the 2.0 side of things?

[Brendan Kennedy:]

Yes. That's one of the areas where there is some impact. It’s really on the branded hardware. One of the things we did that turned out to be smart but maybe not intentional was we ordered significant inventory of the vape hardware that was unbranded, so that we could put whatever brands were doing well. We could put that branding on the hardware. And so, we do have some inventory that's unbranded that we can now brand in our facilities. And that gives us a little bit of sort of pressure relief valve as we're waiting for additional hardware to come to us from various international sources.

[Operator:]

Thank you. And I'm showing no further questions at this time. I'd like to turn the call back to Brendan Kennedy for any closing remarks.

[Brendan Kennedy:]

Thanks. I can't complete this call without saying few words about Mark Castaneda. Back in March of 2018, we recruited Mark out of 18 days of retirement to be our CFO. In July of 2018, Mark completed his fourth IPO, when he helped make Tilray the first cannabis company to complete an IPO on a major U.S. stock exchange. Over the past 20 years, I estimate that Mark has participated in between 70 to 80 quarterly earnings calls. Mark, I've enjoyed making history with you and look forward to continuing to work with you in your new strategic development role. And thank you for your hard work and dedication to Tilray. I want to thank our dedicated employees and team members for all of their hard work, improving patient and consumer lives through the power of cannabis and hemp. And we appreciate everyone's questions and participation on today's call. Have a great evening. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.