Tilray Brands, Inc. - Interim / Quarterly Report 2022

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with the unaudited financial information and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and our Annual Report on Form 10-K for the fiscal year ended May 31, 2021 (“Annual Report”).

Company Overview

We are a leading global cannabis-lifestyle and consumer packaged goods company headquartered in Leamington and New York, with operations in Canada, the United States, Europe, Australia, and Latin America that is changing people’s lives for the better – one person at a time – by inspiring and empowering the worldwide community to live their very best life by providing them with products that meet the needs of their mind, body, and soul and invoke a sense of wellbeing. Tilray’s mission is to be the trusted partner for its patients and consumers by providing them with a cultivated experience and health and wellbeing through high-quality, differentiated brands and innovative products.

Our overall strategy is to leverage our scale, expertise and capabilities to drive market share in Canada and internationally, achieve industry-leading, profitable growth and build sustainable, long-term shareholder value. In order to ensure the long-term sustainable growth of our Company, we continue to focus on developing strong capabilities in consumer insights, drive category management leadership and assess growth opportunities with the introduction of innovative new products. In addition, we are relentlessly focused on managing our cost of goods and expenses in order to maintain our strong financial position.

Within Canada, we are focused on gaining market share in the Canadian cannabis industry by executing on our strategic priorities through entering new product categories that possess the most consumer demand, while leveraging our expertise to develop brands that are truly differentiated from our competitors and carefully curated to meet patient and consumer demand, investing in brand building and innovation activities and optimizing our production to continue to be the high-quality, low-cost producer we are today.

Internationally, we are focused on business activities that provide a return on investment in the near term without being capital intensive. We intend to continue to maximize the utilization of our existing assets and investments in connection with the development and execution of our international growth plans, while leveraging our cannabis expertise and well-established medical brands. Through our well positioned cultivation facilities in Portugal and Germany, we intend to fuel the demand for our EU GMP certified medical grade cannabis internationally. By building on this foundation, we strive to take a leadership position in the international cannabis industry.

Within the U.S., we are focused on leading the craft beer segment, including growing our SweetWater brand by expanding our distribution footprint, focusing on new product development and innovation and building brand awareness of, and equity in, our existing adult-use cannabis brands in the U.S. ahead of federal legalization of cannabis by leveraging the SweetWater manufacturing and distribution infrastructure. Further complementing this strategy, our Manitoba Harvest brand is a leading manufacturer of hemp-derived CBD and other cannabinoid products to promote the acceptance and mainstream usage of cannabis and hemp-based products ahead of federal legalization.

MedMen Transaction

On August 13, 2021, the Company and other investors formed Superhero Acquisition L.P., a Delaware limited partnership, (“SH Acquisition”). SH Acquisition was formed for the purpose of acquiring approximately $165.8 principal amount of senior secured convertible notes (the “MM Notes”) originally issued by MedMen Enterprises Inc. (“MedMen”) and certain warrants (the “MM Warrants”) to acquire Class B subordinate voting shares of MedMen (the “MedMen Shares”) issued in connection with the original issuance of the MM Notes. The MM Notes mature on August 17, 2028. Pursuant to an Assignment and Assumption Agreement dated as of August 17, 2021, SH Acquisition completed its acquisition (the “MM Transaction”) of the MM Notes and MM Warrants from certain funds affiliated with Gotham Green Partners.

The Company’s interest in SH Acquisition represents its right to 68% of the MM Notes and related MM Warrants held by SH Acquisition, which are convertible into approximately 21% of the MedMen Shares outstanding upon closing of the MM Transaction. The Company’s ability to convert the MM Notes and exercise the MM Warrants is dependent upon federal laws in the United States being amended to permit the general cultivation, distribution and possession of cannabis (a “Triggering Event”) or the Company’s waiver of the need for a Triggering Event and the receipt of any additional regulatory approvals. The total value of the MM Notes and MM Warrants was $170.9 million of which $117.8 million represents the ownership interest of Tilray, and $52.9 million represents the ownership interest of the unrelated minority owners.

As of August 31, 2021, MM Notes and MM Warrants are accounted for as debt and equity securities and recorded in long-term investments with an offsetting current liability for the outstanding consideration due. As partial consideration for the MM Notes and MM Warrants, on September 17, 2021, the Company issued 9,817,061 shares of its common stock. The balance of the consideration for the MM Notes and MM Warrants was paid in cash by the other partners of SH Acquisition.

Aphria – Tilray Business Combination

On April 30, 2021, upon consummation of the arrangement with Aphria Inc. (“Aphria”) pursuant to a plan of arrangement under the Business Corporations Act (Ontario) (the “Arrangement”), Aphria stockholders and Tilray stockholders owned approximately 61.2% and 38.8%, respectively, of the post-closing outstanding Tilray common stock resulting in the reverse acquisition of Tilray, whereby Tilray is the legal acquirer and Aphria is the acquirer for accounting purposes. Accordingly, as reported in our Annual Report and in this Form 10-Q, the assets and liabilities of Aphria are presented at their historical carrying values and the assets and liabilities of Tilray are recognized on the effective date of the business combination transaction and measured at fair value. The operating results for the comparable period, the three months ended August 31, 2020, are of those of Aphria. In conjunction with the reverse acquisition, the Company elected to adopt Aphria’s fiscal year of June 1 to May 31.

Prior to the completion of the Arrangement, our condensed consolidated financial statements were presented under International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board and in Canadian Dollars (C$). All prior periods have been recast and are shown in this Form 10-Q under GAAP and in United States Dollars ($).

The Coronavirus ("COVID-19") Pandemic, Its Impact on Us

We continuously address the effects of the COVID-19 pandemic, a discussion of which is available in sections entitled " Risk Factors " in Item 1A of Part I and “ The Coronavirus ("COVID-19") Pandemic, Its Impact on Us” in Item 7 of our Annual Report on Form 10-K for the fiscal year ended May 31, 2021.

During the first quarter of fiscal year 2022, our Canadian adult use cannabis business continued to be impacted by the COVID-19 pandemic in the buying patterns of the provincial boards which resulted in stagnant net revenue in June and July with an increase in August which we attributed to the increase in vaccination rates throughout Canada. While buying patterns of the provincial boards were stagnant, recent retail sales data suggests an uptick in consumer demand. Our Canadian medical cannabis business remained stagnant over the course of the quarter. Our international cannabis business continued to experience lower net revenue in Germany from situationspecific protective measures put in place throughout Germany. Our beer and alcohol business continued to deal with lower number of customers on-premise combined with declining off-premise business from the prior year. Recent increases in the Delta variant have hampered revenue growth in our main consumer facing markets. Our distribution business experienced slight improvement in the global supply chain disrupted by the COVID-19 pandemic resulting in a modest increase in net revenue.

Despite the introduction of COVID-19 vaccines, the pandemic remains highly volatile and continues to evolve. We cannot accurately predict the duration or extent of the impact of the COVID-19 virus, including the Delta and other variants and other areas that directly affect our business operations. We will continue to assess our operations and will continue to consider the guidance of local governments throughout the world. If economic conditions caused by the pandemic do not recover as currently estimated by management or market factors currently in place change, there could be a further impact on our results of operations, financial condition and cash flows from operations.

Use of Non-GAAP Measures

Throughout this Form 10-Q, we discuss non-GAAP financial measures, including reference to:

gross profit (excluding inventory valuation adjustments and purchase price allocation (“PPA”) step up),
cannabis gross profit and margin (excluding inventory valuation adjustments and PPA step-up),
beverage alcohol gross profit and margin (excluding inventory valuation adjustments and PPA step-up),
distribution gross profit and margin (excluding inventory valuation adjustments and PPA step-up),
wellness gross profit and margin (excluding inventory valuation adjustments and PPA step-up),
adjusted net income (loss),
free cash flow, and
adjusted EBITDA.

All these non-GAAP financial measures should be considered in addition, and not in lieu of, the financial measures calculated and presented in accordance with accounting principles generally accepted in the United States of America, (“GAAP”). These measures, which may be different than similarly titled measures used by other companies, are presented to help investors’ overall understanding of our financial performance and should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP.

Results of Operations

Our consolidated results, in thousands except for per share data, are as follows:

	For the three months August 31,	For the three months August 31,	Change	% Change


(in thousands of U.S. dollars)	2021	2020	2021 vs	. 2020
Net revenue	$ 168,023	$ 117,490	$ 50,533	43 %
Cost ofgoods sold	117,068	82,545	34,523	42 %
Grossprofit	50,955	34,945	16,010	46 %
Operatingexpenses:
General and administrative	49,487	25,972	23,515	91 %
Selling	7,432	5,817	1,615	28 %
Amortization	30,739	4,127	26,612	645 %
Marketingandpromotion	5,465	4,925	540	11 %
Research and development	785	120	665	554 %
Transaction costs	25,579	2,458	23,121	941 %
Total operatingexpenses	119,487	43,419	76,068	175 %
Operatingloss	(68,532 )	(8,474 )	(60,058 )	709 %
Finance expense,net	(10,170 )	(5,736 )	(4,434 )	77 %
Non-operating (expense)income,net	48,860	(13,359 )	62,219	(466 %)
Loss before income taxes	(29,842 )	(27,569 )	(2,273 )	8 %
Income taxes(recovery)	4,762	(5,825 )	10,587	(182 %)
Net loss	$ (34,604 )	$ (21,744 )	$ (12,860 )	59 %

Key Operating Metrics

We use the following key operating metrics to evaluate our business and operations, measure our performance, identify trends affecting our business, project our future performance, and make strategic decisions. Other companies, including companies in our industry, may calculate key operating metrics with similar names differently which may reduce their usefulness as comparative measures.

measures.
		For the three months ended August 31,
(in thousands ofU.S. dollars)		2021		2020
Net cannabis revenue	$	70,449	$	51,202
Net beverage alcohol revenue		15,461		—
Distribution revenue		67,186		66,288
Wellness revenue		14,927		—
Cannabis cost of sales		40,190		25,775
Beverage alcohol cost of sales		6,662		—
Distribution cost of sales		59,290		56,770
Wellness cost of sales		10,925		—
Grossprofit(excludinginventoryvaluation adjustments and step-up)		50,955		34,945
Cannabisgross margin(excludinginventoryvaluation adjustments and step-up)		43 %		50 %
Beveragegross margin(excludinginventoryvaluation adjustments and step-up)		57 %		NA
Distributiongross margin(excludinginventoryvaluation adjustments and step-up)		12 %		14 %
Wellnessgross margin(excludinginventoryvaluation adjustments and step-up)		27 %		NA
Adjusted EBITDA		12,697		8,070
Cash and cash equivalents		376,297		306,717
Workingcapital		317,789		482,368
Free cash flow		(109,543 )		(70,055 )
Adjusted free cash flow		(61,153 )		(70,055 )

NA=These reporting segments did not exist in the prior year first quarter. The related acquisitions occurred thereafter.

Segment Reporting

Management updated our reporting segments during the period. While the Company reported “business under development” as a fifth operating segment in its previous Annual Report, management determined that this no longer met the definition of an operating segment. The Company will continually review its operations and reporting structure in order to disclose its operating segments. Our reporting segments revenue is primarily comprised of revenues from our cannabis, distribution, beverage alcohol operations, and wellness, as follows:

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For the three months ended
August 31, Change
(in thousands of U.S. dollars) 2021 2020 2021 vs. 2020
Cannabis business $ 70,449 $ 51,202 $ 19,247 38%
Distribution business 67,186 66,288 898 1%
Beverage alcohol business 15,461 — 15,461 100%
Wellness business 14,927 — 14,927 100%
Total net revenue $ 168,023 $ 117,490 $ 50,532 43%
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Our geographic revenue is, as follows:

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For the three months ended
August 31, Change
(in thousands of U.S. dollars) 2021 2020 2021 vs. 2020
North America $ 90,543 $ 51,192 $ 39,351 77%
EMEA 76,009 65,077 10,932 17%
Latin America 1,471 1,221 250 20%
Total net revenue $ 168,023 $ 117,490 $ 50,533 43%
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Our geographic capital assets are, as follows:

(in thousands of U.S. dollars)	August 31, 2021	May 31, 2021	Change	Change
North America	$ 477,278	$ 504,575	$ (27,297 ) (5 %)
EMEA	139,958	140,838	(880 ) (1 %)
Latin America	4,103	5,285	(1,182	) (22 %)
Total capital assets	$ 621,339	$ 650,698	$ (29,359 ) (5 %)

Cannabis revenue

Cannabis revenue based on market channel is, as follows:

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For the three months ended
August 31, Change
(in thousands of US dollars) 2021 2020 2021 vs. 2020
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Revenue from medical cannabisproducts	$ 8,374	$ 6,380	$ 1,994 31 %	$ 1,994 31 %
Revenue from adult-use cannabisproducts	69,593	56,948	12,645 22 %
Revenue from wholesale cannabisproducts	1,700	3,792	(2,092 ) (55 %)
Revenue from international cannabisproducts	10,266	—	10,266 100 %
Total cannabis revenue	89,933	67,120	$ 22,812 34 %
Excise taxes	(19,484 )	(15,918 )	(3,566	) 22 %
Total cannabis net revenue	$ 70,449	$ 51,202	$ 19,247 38 %

Revenue from medical cannabis products: Revenue from medical cannabis products for the three months ended August 31, 2021 was $8.4 million as compared to $6.4 million in the prior year same period, representing an increase of 31%. This increase in revenue from medical cannabis products is primarily driven by the contributions of legacy Tilray’s medical cannabis business resulting from the business combination of April 30, 2021, along with a modest increase in average gross retail selling price to medical patients as compared to the first quarter of 2021. This increase was offset by lower number of existing patient renewals and lower number of new patients, in both independent and clinic patients.

Revenue from adult-use cannabis products: Revenue from adult-use cannabis products for the three months ended August 31, 2021 was $69.6 million as compared to $56.9 million in the prior year same period, or an increase of 22%. This increase in revenue from adult-use cannabis products is primarily driven by the contributions of legacy Tilray’s adult-use cannabis business resulting from

the business combination of April 30, 2021, and numerous additional retail sales promotional programs, innovations, social media visibility and efforts to increase new accounts. During the early portions of the first quarter of fiscal 2022, consistently with our immediately preceding fourth quarter of fiscal 2021, we continued to experience stagnant replenishment rates and ordering by the provincial boards as a response to the lockdown measures related to the COVID-19 pandemic and the shift in the retail cannabis demand to price based brands during COVID. The decline is primarily due to shifting consumer trends to large-format and price compression in the market, magnified by consumer behavior during the lockdowns to a much heavier focus on price and potency. We also experienced additional declines in average gross selling price to the adult-use market and changes in the point-of-sale experience of our retail customers due to high turnover of budtenders at retailers. We continue to expand our product offerings to accommodate the changes in our adult-use customers and completed our first shipments to Nunavut. Tilray has presence in all Canadian provinces and territories.

Wholesale cannabis revenue: Revenue from wholesale cannabis products for the three months ended August 31, 2021 was $1.7 million as compared to $3.8 million in the prior year same period, representing a decrease of (55%). The Company continues to believe that wholesale cannabis revenue will remain subject to quarter-to-quarter variability and is based on opportunistic sales.

International cannabis revenue: Revenue from international cannabis products for the three months ended August 31, 2021 was $10.3 million. The increase is due to the contributions of legacy Tilray’s larger international cannabis business.

Distribution revenue

Revenue from Distribution operations for the three months ended August 31, 2021 was $67.2 million as compared to $66.3 million in the prior year same period, representing a slight increase on a period over period year basis. Included in distribution revenue is $65.0 million of revenue from CC Pharma, and $2.2 million of revenue from other distribution companies for the three months ended August 31, 2021 versus $64.3 million and $2.0 million, respectively, in the prior year same period. The slight increase in distribution revenue was primarily the result of increases in the value of the Euro compared to the US dollar during the first quarter of fiscal 2022 as compared to the first quarter of fiscal 2021. This increase was partially offset by the negative impact of an isolated weather event in Densborn, Germany. Specifically, heavy flooding impacted CC Pharma and forced a business closure for approximately five days leading to a decrease in net revenue in the quarter of almost $5.0 million. Additionally, COVID-19 situation-specific protective measures put in place throughout Germany, continue to result in insufficient supply from other European Union countries, fewer workdays from lockdown periods, and limitations on elective medical procedures and lower frequency in-person visits to physicians and pharmacies.

Beverage alcohol revenue

Revenue from our Beverage operations for the three months ended August 31, 2021 was $15.5 million from SweetWater which was acquired on November 25, 2020. SweetWater operates on-premises, wholesale, and specialty sales. Revenues were negatively impacted from reduction in keg demand from the on-premises channel, which have higher profit margins than products intended for offpremises consumption. During the first quarter of 2022, our beverage operations began operating our new brewing facility in Colorado, released an extensive new line of innovative products, including seltzers and vodkas sodas, as well as a new beer offering developed in collaboration with our Canadian cannabis Broken Coast brand.

Wellness revenue

Included in Wellness revenue is $14.9 million from Manitoba Harvest, for the three months ended August 31, 2021. Manitoba Harvest was part of the assets acquired in the Arrangement. There are no comparable revenues in the prior year being presented.

Gross profit, gross margin and adjusted gross margin for our reporting segments

Our gross profit and gross margin for the three months ended August 31, 2021 and 2020, is as follows:

(in thousands of U.S. dollars)	For the three months ended	For the three months ended	Change % Change	Change % Change
	August 31,
Cannabis	2021	2020	2021 vs. 2020
Revenue	$ 89,933	$ 67,120	$ 22,813 34 %
Excise taxes	(19,484 )	(15,918 )	(3,566	) 22 %
Net revenue	70,449	51,202	19,247 38 %
Cost ofgoods sold	40,190	25,775	14,415 56 %
Grossprofit	30,258	25,427	4,831 19 %
Gross margin	43 %	50 %	25 % (7 %)

Adjustedgrossprofit(1)	30,258	25,427	4,831 25 %
Adjusted gross margin(1)	43 %	50 %	25 % (7 %)
Distribution
Revenue	$ 67,186	$ 66,288	$ 898 1 %
Excise taxes	—	—	—	(0%)
Net revenue	67,186	66,288	898 1 %
Cost ofgoods sold	59,290	56,770	2,520 4 %
Grossprofit	7,896	9,518	(1,622	) (17 %)
Gross margin	12 %	14 %	(181	%) (3 %)

Adjustedgrossprofit(1)	7,896	9,518	(1,622	) (17 %)
Adjusted gross margin(1)	12 %	14 %	(181 %) (3 %)
Beverage alcohol
Revenue	$ 16,483	$ —	$ 16,483 100 %
Excise taxes	(1,022 )	—	(1,022	) 100 %
Net revenue	15,461	—	15,461 100 %
Cost ofgoods sold	6,662	—	6,662 100 %
Grossprofit	8,799	—	8,799 100 %
Gross margin	57 %	— %	57 % 100 %

Adjustedgrossprofit(1)	8,799	—	8,799 100 %
Adjusted gross margin(1)	57 %	— %	57 % 100 %
Wellness
Revenue	$ 14,927	$ —	$ 14,927 100 %
Excise taxes	—	—	—	100 %
Net revenue	14,927	—	14,927 100 %
Cost ofgoods sold	10,925	—	10,925 100 %
Grossprofit	4,002	—	4,002 100 %
Gross margin	27 %	— %	27 % 100 %

Adjustedgrossprofit(1)	4,002	—	4,002 100 %
Adjusted gross margin(1)	27 %	— %	27 % 100 %
Total
Revenue	$ 188,529	$ 133,408	$ 55,121 41 %
Excise taxes	(20,506 )	(15,918 )	(4,588	) 29 %
Net revenue	168,023	117,490	50,533 43 %
Cost ofgoods sold	117,068	82,545	34,523 42 %
Grossprofit	50,955	34,945	16,010 46 %
Gross margin	30 %	30 %	32 % 107 %

Adjustedgrossprofit(1)	50,955	34,945	16,010 46 %
Adjusted gross margin(1)	30 %	30 %	32 % 107 %

(1) Gross profit (excluding inventory valuation adjustments) and gross margin percentage (excluding inventory valuation adjustments) are non-GAAP financial measures.

Cannabis gross margin: Gross margin of 43% decreased in during the three months ended August 31, 2021 versus the prior year same period reflects the addition of sales of Tilray brands that have higher costs to produce than our legacy brands.

Significant efforts have been taken to reduce the company’s cultivation costs at its Legacy Tilray facilities, including announcing the shutdown of both the Enniskillen and Nanaimo facilities. In the interim and until the inventory cultivated at these facilities work their way through inventory, we expect to report lower gross margins than once all inventory is cultivated at Legacy Aphria facilities. During the period, imposing Legacy Aphria’s actual gross margins in the quarter over the higher costs at Legacy Tilray facilities, would have resulted in an increase in gross profit recorded of $4.9 million and resulted in a normalized adjusted gross margin of 33%.

Distribution gross margin: Gross margin of 12% remained fairly consistent with the same period in fiscal 2021.

Beverage alcohol gross margin: Gross margin of 57% is in line with our expectations but a slight decrease from the prior quarter. We did not operate in this segment during the first quarter of the prior year. We note that COVID-19 disrupted our product sales mix, resulting in lower than traditional gross margins for SweetWater.

Wellness gross margin: Gross margin of 27% is in line with our expectations and consistent with the preceding fiscal quarter. We acquired the wellness business in the Arrangement and did not operate in this segment during the first quarter of the prior year.

Operating expenses

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For the three months ended
August 31, Change
(in thousands of US dollars) 2021 2020 2021 vs. 2020
General and administrative $ 49,487 $ 25,972 $ 23,515 91%
Selling 7,432 5,817 1,615 28%
Amortization 30,739 4,127 26,612 645%
Marketing and promotion 5,465 4,925 540 11%
Research and development 785 120 665 554%
Transaction costs 25,579 2,458 23,121 941%
Total operating expenses $ 119,487 $ 43,419 $ 76,068
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Operating expenses are comprised of general and administrative, share-based compensation, selling, amortization, marketing and promotion, research and development, and transaction costs. These costs increased by $76.1 million to $119.5 million from $43.4 million as compared to prior year same period. This was primarily due to reporting full quarters of operating expenses for SweetWater and Tilray, including non-cash amortization charges associated with definite life intangible assets acquired and generally and administrative expenses. The remaining increase is from transaction costs related to non-recurring expenses associated with our current acquisitions and evaluation of future potential acquisition, and one-time litigation costs.

General and administrative costs

During the three months ended August 31, 2021, increased by $23.5 million to $49.5 million from $26.0 million as compared to prior year same period. This increase was primarily related to i) office and general; ii) salaries and wages, including executive compensation; iii) stock-based compensation expense; and iv) insurance. These increased expenses resulted from reporting full quarters of operating expenses for SweetWater and Tilray.

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For the three months ended
August 31, Change
(in thousands of US dollars) 2021 2020 2021 vs. 2020
Executive compensation $ 3,090 $ 2,250 $ 840 37%
Office and general 12,769 4,421 8,348 189%
Salaries and wages 15,311 9,343 5,968 64%
Stock-based compensation 9,417 2,850 6,567 230%
Insurance 4,632 3,206 1,425 44%
Professional fees 2,713 2,935 (222) (8%)
Travel and accommodation 790 727 63 9%
Rent 766 240 527 220%
Total general and administrative costs $ 49,487 $ 25,972 $ 23,515
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Office and general increased primarily due to reporting SweetWater and Tilray for the full quarter and the additional one-time costs associated with the upcoming closure of our Nanaimo facility. As noted above, salaries and wages increased primarily due to reporting SweetWater and Tilray for the full quarter. The Company’s headcount increased to approximately 2,100 employees as a result of the Arrangement compared to 900 employees as of August 31, 2020.

The Company recognized stock-based compensation expense of $9.4 million for the three months ended August 31, 2021 compared to $2.9 million for the same period in the prior year. The increase is primarily due to increased number of employees and the accelerated vesting of certain of our stock-based compensation awards tied to the Arrangement. Stock options are valued using the Black-Scholes valuation model and represents a non-cash expense, restricted share units (“RSUs”) are valued based on the graded

vesting and the grant date fair value. The Company issued 2,326,387 RSUs in the three months ended August 31, 2021 which included 1,345,158 performance RSUs as compared to 512,206 RSUs in the same period of the prior year.

Selling costs

For the three months ended August 31, 2021, the Company incurred selling costs of $7.4 million or 4.4% of revenue as compared to $5.8 million and 4.9% of revenue in the prior year same period. These costs relate to third-party distributor commissions, shipping costs, Health Canada cannabis fees, and patient acquisition and maintenance costs. Patient acquisition and ongoing patient maintenance costs include funding to individual clinics to assist with additional costs incurred by clinics resulting from the education of patients using the Company’s products.

Amortization

The Company incurred non-production related amortization charges of $30.7 million for the three months ended August 31, 2021 compared to $4.1 million in the prior year same period. The increase is largely associated with the amortization on the acquired definite life intangible assets from the SweetWater acquisition and Tilray.

Marketing and promotion cost

For the three months ended August 31, 2021, the Company incurred marketing and promotion costs of $5.5 million as compared to $4.9 million in the prior year same period. The slight increase is primarily due to increased marketing and promotion programming that had been deferred with the COVID-19 pandemic.

Research and development

Research and development costs were $0.8 million during the three months ended August 31, 2021 compared to $0.1 million in the prior year same period. These relate to external costs associated with the development of new products. Although the Company spends a significant amount on research and development, the majority of these costs remain in costs of sales, as the Company does not reclassify research and development costs related to the cost of products consumed in research and development activities.

Transaction costs

Transaction costs were $25.6 million during the three months ended August 31, 2021 compared to $2.5 million in the prior year same period. This increase is associated with the solicitation of shareholder votes supporting an increase in the number of authorized common stock shares, transaction closing costs related to the Arrangement, our investment in the MM Notes and MM Warrants, the evaluation of other potential acquisitions and one-time litigation costs.

Non-operating (expense) income, net

Non-operating (expense) income is comprised of:

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For the three months ended
August 31, Change
(in thousands of US dollars) 2021 2020 2021 vs. 2020
Change in fair value of convertible debenture $ 39,370 $ 340 $ 39,030 11,479%
Change in fair value of warrant liability 17,535 — 17,535 100%
Foreign exchange loss (5,724) (16,331) 10,607 (65%)
Loss on long-term investments (1,675) (1,120) (555) 50%
Gain from equity investees 1,356 — 1,356 100%
Other non-operating (losses) gains, net (2,002) 3,752 (5,754) (153%)
Total non-operating income (expense) $ 48,860 $ (13,359) $ 62,219
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For the three months ended August 31, 2021 and 2020, the Company recognized a change in fair value of its APHA 24 convertible debentures of $39.4 million and $0.3 million, respectively, driven primarily by the decrease in the Company’s share price and the decrease in the trading price of the convertible debentures. Additionally, the Company recognized a change in fair value of its warrants of resulting in a gain of $17.5 million acquired as part of the Arrangement, also as a result of the decrease in our share price. Furthermore, the Company recognized a loss of $5.7 million and $16.3 million, respectively, resulting from the changes in foreign exchange rates during the period, and prior year period, largely associated with the strengthening of the US dollar against the Canadian dollar. The remaining other losses relate to changes in fair value in the Company’s convertible notes receivable and long-term investments.

Net loss, Adjusted net loss and EBITDA

For the three months ended August 31,	Change
2021 2020	2021 vs. 2020
Net loss $ (34,604 ) $ (21,744 ) $ (12,860 ) 59 %
Adjusted net loss $ (33,254 ) $ (445 ) $ (32,809 ) 7,373 %
Adjusted EBITDA $ 12,697 $ 8,053 $ 4,644 58 %

Adjusted net loss

Adjusted net loss represents a non-GAAP financial measure that does not have any standardized meaning prescribed under GAAP and may not be comparable to similar measures presented by other companies. Adjusted net income is calculated as net (loss) income plus (minus) the unrealized loss (gain) on convertible debentures, a non-cash item, share-based compensation, foreign exchange (loss) gain, all non-cash items, and transaction costs, costs which will not necessarily continue in future periods depending on the frequency of additional M&A considered by the Company. It represents a measure management uses in evaluating operating results. The increase in adjusted net loss is primarily driven by higher net loss stemming from higher amortization costs associated with the definite lived assets acquired during the year, the additional general and administrative costs associated with Tilray for the full quarter and increased non-cash unrealized loss on changes to the fair value of our convertible debentures.

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Year ended May 31, Change
Adjusted net loss reconciliation: 2021 2020 2021 vs. 2020
Net loss $ (34,604) $ (21,744) $ (12,860) 59%
Unrealized gain on convertible debentures (39,370) (340) (39,030) 100%
Foreign exchange loss 5,724 16,331 (10,607) (65%)
Stock-based compensation 9,417 2,850 6,567 230%
Transaction costs 25,579 2,458 23,121 941%
Adjusted net loss $ (33,254) $ (445) $ (32,809)
Adjusted net loss per share - basic and diluted $ (0.07) $ (0.00)
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Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure that does not have any standardized meaning prescribed by GAAP and may not be comparable to similar measures presented by other companies. The Company calculates adjusted EBITDA as net (loss) income, plus (minus) income taxes (recovery), plus (minus) finance (income) expense, net, plus (minus) non-operating (income) loss, net, plus amortization, plus stock-based compensation, plus transaction costs and certain one-time non-operating expenses, as determined by management. Adjusted EBITDA increased primarily from favorable effects of new lines of business, offset by the inclusion of legacy Tilray’s cannabis business, while we work to achieve our synergies plan, as follows:

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For the three months ended
August 31, Change
Adjusted EBITDA reconciliation: 2021 2020 2021 vs. 2020
Net (loss) income $ (34,604) $ (21,744) $ (12,860) 59%
Income taxes 4,762 (5,825) 10,587 (182%)
Finance expense, net 10,170 5,736 4,434 77%
Non-operating expense (income), net (48,860) 13,359 (62,219) (466%)
Amortization 39,333 10,979 28,354 258%
Stock-based compensation 9,417 2,850 6,567 230%
Facility start-up and closure costs 6,200 — 6,200 100%
Lease expense 700 240 460 192%
Transaction costs 25,579 2,458 23,121 941%
Adjusted EBITDA $ 12,697 $ 8,053 $ 4,644
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Adjusted EBITDA should not be considered in isolation from, or as a substitute for, net loss. There are a number of limitations related to the use of Adjusted EBITDA as compared to net loss, the closest comparable GAAP measure. Adjusted EBITDA excludes:

Current and deferred income tax expenses and recoveries, which could be a significant recurring expense or recovery in our business in the future and reduce or increase cash available to us.
Interest expense and loss on disposal of property and equipment to reflect ongoing operating activities;
Non-cash foreign exchange gains or losses, which accounts for the effect of both realized and unrealized foreign exchange transactions. Unrealized gains or losses represent foreign exchange revaluation of foreign denominated monetary assets and liabilities;
Non-cash change in fair value of warrant liability;
Non-cash amortization and amortization expenses and, although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future;
Stock-based compensation expenses, which has been, and will continue to be for the foreseeable future, a significant recurring expense in our business and an important part of our compensation strategy;
Non-cash inventory valuation adjustments;
Non-cash loss from equity method investments;
Costs incurred to start up new facilities and/or to close facilities in Nanaimo, Canada and Enniskillen, Canada;
Lease expense; and
Transaction costs associated with current and future business acquisitions.

Liquidity and Capital Resources

The following table sets forth the major components of our statements of cash flows for the periods presented:

		For the three	months	ended
		August	31,
		2021		2020
Net cash used in operatingactivities	$	(93,227 )	$	(56,100 )
Net cash used in investingactivities	$	(8,620 )	$	(13,698 )
Net cash(used in) provided byfinancingactivities	$	(8,028 )	$	6,737
Effect on cash of foreign currencytranslation	$	(2,294 )	$	9,132
Cash and cash equivalents,beginningofperiod	$	488,466	$	360,646
Cash and cash equivalents,end ofperiod	$	376,297	$	306,717
Decrease in cash and cash equivalents	$	(112,169 )	$	(53,929 )

Cash flows from operating activities

The changes in net cash used in operating activities during the three months ended August 31, 2021 compared to the prior year same period is primarily related to payments associated with the Arrangement, income taxes at Aphria Diamond and accounts receivable increases associated with increased sales in the quarter. This net cash used in operating activities was positively impacted reductions in inventory.

Cash flows from investing activities

The change in net cash used in investing activities in the first quarter of 2022 as compared to the first quarter of 2021 is primarily due to proceeds from the disposal of redundant production equipment at our Aphria One facility.

Cash flows from financing activities

Cash provided by financing activities in the first quarter of 2022 as compared to the first quarter of 2021 is primarily due to an early payment on SweetWater’s term loan facility.

Free cash flow and adjusted free cash flow

Free cash flow and adjusted free cash flow are non-GAAP measures. Free cash flow is comprised of two GAAP measures deducted from each other which are net cash flow used in operating activities less investments in capital and intangible assets. Adjusted free cash flow removes the cash impact of acquisitions from free cash flow. Our free cash flow and adjusted free cash flow were, as follows:

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For the three months ended
August 31, Change
Free cash flow 2021 2020 2021 vs. 2020
Net cash used in operating activities $ (93,227) $ (56,100) $ (37,127) 66%
Less: investments in capital and intangible assets (16,316) (13,955) (2,361) 17%
Free cash flow $ (109,543) $ (70,055) $ (39,488)
Cash expended related to acquisitions 48,390 — 48,390 100%
Adjusted free cash flow $ (61,153) $ (70,055) $ 8,902
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Contractual obligations

Purchase and other commitments

The Company has payments for long-term debt, convertible debentures, ABG finance liability, material purchase commitments and construction commitments, as follows:

	Total	2022 (remaining nine months)	2023	2024	2025	2026	Thereafter
Long-term debt repayment	$ 198,253	$ 32,981	$ 78,820	$ 80,838	$ 2,157	$ 2,516	$ 941
Convertible notes, principal and interest	571,989	13,893	13,893	284,803	259,400	—
							—

ABG finance liability	6,000	1,500	1,500	1,500	1,500	—	—
Materialpurchase obligations	29,523	24,222	4,185	937	179	—	—
Construction commitments	2,012	2,012	—	—	—	—	—
Total	$ 807,776	$ 74,608	$ 98,398	$ 368,077	$ 263,236	$ 2,516	$ 941

Lease obligations

We lease various facilities, under non-cancelable finance and operating leases, which expire at various dates through September 2040:

	Three months ending August 31,	Three months ending August 31,
	Operating leases	Finance leases
2022(remainingnine months)	$ 3,832	$ 1,672
2023	4,437	7,088
2024	3,840	2,061
2025	3,321	2,122
2026	3,472	2,186
Thereafter	8,522	39,586
Total minimum leasepayments	$ 27,423	$ 54,715
Imputed interest	(5,778 )	(19,167 )
Obligations recognized	$ 21,645	$ 35,548

Except as disclosed elsewhere in this Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations , there have been no material changes with respect to the contractual obligations of the Company during the three months ended August 31, 2021.

Off-Balance Sheet Financing

As of August 31, 2021, the Company has no off-balance sheet financing.

Contingencies

In the normal course of business, we may receive inquiries or become involved in legal disputes regarding various litigation matters. In the opinion of management, any potential liabilities resulting from such claims would not have a material adverse effect on our consolidated financial statements.

Recently Issued Accounting Pronouncements

A description of recently issued accounting pronouncements that may potentially impact our financial position and results of operations is disclosed in “Part I, Item 1. Note 2 – Basis of presentation and summary of significant accounting policies” to our financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

(a) Credit risk

Credit risk is the risk of financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligations. The maximum credit exposure at August 31, 2021, is the carrying amount of cash and cash equivalents, accounts receivable, prepaids and other current assets, promissory notes receivable and convertible notes receivable. All cash and cash equivalents are placed with major financial institutions in Canada, Australia, Portugal, Germany, Colombia, Argentina and the United States. To date, the Company has not experienced any losses on its cash deposits. Accounts receivable are unsecured, and the Company does not require collateral from its customers.

(b) Liquidity risk

At August 31, 2021, the Company’s financial liabilities consist of bank indebtedness and accounts payable and accrued liabilities, which have contractual maturity dates within one-year, long-term debt, and convertible debentures which have contractual maturities over the next five years.

The Company maintains a debt service charge covenant on certain loans secured by its Aphria One facilities that is measured at year-end only. The Company maintains debt service charge and leverage covenants on certain loans secured by its Aphria Diamond facilities and 420 that are measured quarterly. The Company believes that it has sufficient operating room with respect to its financial covenants for the next fiscal year and does not anticipate being in breach of any of its financial covenants.

The Company manages its liquidity risk by reviewing its capital requirements on an ongoing basis. Based on the Company’s working capital position at August 31, 2021, management regards liquidity risk to be low.

(c) Currency rate risk

At August 31, 2021, a portion of the Company’s financial assets and liabilities held in Canadian dollars and Euros consist of cash and cash equivalents, convertible notes receivable, and long-term investments. The Company’s objective in managing its foreign currency risk is to minimize its net exposure to foreign currency cash flows by transacting, to the greatest extent possible, with third parties in the functional currency. The Company is exposed to currency rate risk in other comprehensive income, relating to foreign subsidiaries which operate in a foreign currency. The Company does not currently use foreign exchange contracts to hedge its exposure of its foreign currency cash flows as management has determined that this risk is not significant at this point in time.

(d) Interest rate price risk

The Company’s exposure to changes in interest rates relates primarily to the Company’s outstanding debt. The Company manages interest rate risk by restricting the type of investments and varying the terms of maturity and issuers of marketable securities. Varying the terms to maturity reduces the sensitivity of the portfolio to the impact of interest rate fluctuations.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, and summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. An evaluation of the effectiveness of the design and operation of

our disclosure controls and procedures as of the end of the period covered by this Quarterly Report was made under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer.

Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of August 31, 2021, our disclosure controls and procedures (a) are effective to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is timely recorded, processed, summarized and reported and (b) include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Consistent with guidance issued by the SEC, the scope of management’s assessment of the effectiveness of our disclosure controls and procedures did not include the internal controls over financial reporting of SweetWater, which we acquired on November 22, 2021, and the internal controls over financial reporting of legacy Tilray, which we acquired on April 30, 2021. SweetWater and legacy Tilray represented 1.1% and 7.7% of our consolidated assets and 9.2% and 24.1% of our consolidated revenues as of and for the quarter ended August 31, 2021, respectively.

Changes in Internal Control over Financial Reporting

There have been no changes in our “internal control over financial reporting” (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this Quarterly Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. As mentioned above, the Company acquired SweetWater and legacy Tilray on November 22, 2020 and April 30, 2021, respectively. The Company is in the process of reviewing the internal control structure of SweetWater and legacy Tilray and, if necessary, will make appropriate changes as it integrates them into the Company’s overall internal control over financial reporting process.