throbber
Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 1 of 72
`
`THE ROSEN LAW FIRM, P.A.
`Jonathan Horne (JH 7258)
`Laurence M. Rosen (LR 5733)
`275 Madison Avenue, 40th Floor
`New York, New York 10016
`Telephone: (212) 686-1060
`Fax: (212) 202-3827
`Email: jhorne@rosenlegal.com
`Email: lrosen@rosenlegal.com
`
`Lead Counsel for Plaintiffs and the putative Class
`
`UNITED STATES DISTRICT COURT
`SOUTHERN DISTRICT OF NEW YORK
`
`
`
`GANESH KASILINGAM, Individually and On
`Behalf of All Others Similarly Situated,
`
`
`Plaintiff,
`
`
`
`
`
`
`
`
`v.
`
`
`
`
`
`TILRAY, INC., BRENDAN KENNEDY,
`and MARK CASTANEDA,
`
`
` Defendants.
`
`
`
`
`CASE No.: 1:20-cv-03459-PAC
`
`SECOND AMENDED COMPLAINT
`FOR VIOLATIONS OF THE
`FEDERAL SECURITIES LAWS
`
`
`CLASS ACTION
`
`
`

`

`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 2 of 72
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`TABLE OF CONTENTS
`
`INTRODUCTION ................................................................................................................. 1
`
`JURISDICTION AND VENUE ............................................................................................ 5
`
`
`I.
`
`II.
`
`III. PARTIES ............................................................................................................................... 6
`
`IV.
`
`V. BACKGROUND ................................................................................................................... 8
`
`VI. DEFENDANTS OVERSTATE TILRAY’S MARGINS AND THE VALUE OF THE ABG
`AGREEMENT ....................................................................................................................... 9
`
`IMPORTANT NON-PARTIES ............................................................................................. 7
`
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`
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`A.
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`Investors Focused On Tilray’s Gross Margins ................................................................... 9
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`B. Defendants Overstated Tilray’s Gross Margins ................................................................ 11
`
`1. Defendants Understated Cost of Sales by Excluding Labor and Materials ................... 11
`
`2. Defendants Understated Cost of Sales By Recording Worthless Waste As Valuable
`Byproduct ....................................................................................................................... 13
`
`C. Defendants Misleadingly Characterize an Investor Relations Stunt As A Major
`Accomplishment ............................................................................................................... 16
`
`1.
`
`Tilray Agrees To Pay ABG $100 Million To Prop Up Its Share Price ......................... 16
`
`2.
`
`The ABG Agreement Appears to Be the Realization of Tilray’s Goals ........................ 18
`
`
`VII. FALSE STATEMENTS ...................................................................................................... 19
`
`VIII. LOSS CAUSATION ............................................................................................................ 34
`
`
`A. Defendants Renegotiate the ABG Agreement .................................................................. 34
`
`
`
`B. Defendants Impair the ABG Agreement By 86%, and Reduce the Value of Tilray’s
`Inventory by 44% .............................................................................................................. 35
`
`
`IX. ADDITIONAL FACTS FURTHER PROBATIVE OF SCIENTER .................................. 36
`
`
`A. Kennedy Admits that Tilray Did Not Follow GAAP ....................................................... 36
`
`
`
`
`
`
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`B. Tilray’s “Favorite Metric” Is Extracts Revenue ............................................................... 37
`
`C. But for COVID-19, Defendant Kennedy’s False Statements Would Have Given Him
`Control Over the World’s Largest Cannabis Company .................................................... 38
`
`i
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`

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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 3 of 72
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`1.
`
`Step 1: Defendant Kennedy Makes False Statements To Obtain Personal Control Over
`Tilray .............................................................................................................................. 38
`
`i.
`
`Kennedy and Two Close Associates Control Tilray While Owning Less Than A Third
`of Tilray’s Shares ........................................................................................................ 38
`
`ii. Kennedy Avoids Taxes While Securing Corporate Control Over Tilray ................... 40
`
`2.
`
`Step 2: Kennedy Uses His Control to Pursue a Merger That Would Have Him Head the
`World’s Largest Cannabis Company, Nearly Succeeds, But Fails Because of COVID-
`19.................................................................................................................................... 42
`
`i.
`
`Kennedy Nearly Succeeds In Making Himself CEO of the World’s Largest Cannabis
`Company ..................................................................................................................... 42
`
`ii. Kennedy’s Plan Comes to Naught Because of COVID-19 ........................................ 46
`
`iii. The Controlling Shareholders Lose Control ............................................................... 48
`
`iv. Kennedy Uses His Control Over Tilray’s Board of Directors To Push Through the
`Aphria Merger ............................................................................................................. 50
`
`v. Defendants Had to Complete the Share Exchange Before the Aphria Merger ........... 51
`
`D. Defendant Kennedy Sold $26,310,803.10 of Stock During the Class Period .................. 51
`
`E. Additional Self-Dealing .................................................................................................... 54
`
`F. Tilray Uses Its Stock As Currency For Acquisitions ........................................................ 55
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`G. The Volume of Trading In Tilray’s Stock Increases Suspiciously After the Share
`Exchange ........................................................................................................................... 56
`
`
`CLASS ACTION ALLEGATIONS ............................................................................................. 58
`
`APPLICABILITY OF PRESUMPTION OF RELIANCE (FRAUD ON THE MARKET) ........ 60
`
`CLAIMS FOR RELIEF ................................................................................................................ 62
`
`
`FIRST CLAIM ........................................................................................................................... 62
`
`
`
`
`
`SECOND CLAIM ...................................................................................................................... 65
`
`COUNT III ................................................................................................................................. 66
`
`
`PRAYER FOR RELIEF ............................................................................................................... 68
`
`DEMAND FOR TRIAL BY JURY .............................................................................................. 68
`
`
`ii
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`

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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 4 of 72
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`Lead Plaintiff Saul Kassin and Named Plaintiffs Craig Scoggin, Surinder Chandok, and
`
`Leslie Rose (“Plaintiffs”), individually and on behalf of all others similarly situated, for their
`
`Complaint against Defendants Tilray, Inc. and Brendan Kennedy, allege the following based on
`
`personal knowledge as to themselves and their own acts and information and belief as to all other
`
`matters.
`
`I.
`
`INTRODUCTION1
`
`1.
`
`This is a securities class action brought on behalf of all persons who purchased
`
`Tilray common stock on the NASDAQ from January 16, 2019 through March 2, 2020, both dates
`
`inclusive (“Class Period”), and who held such shares through at least one corrective disclosure.
`
`Excluded from the Class are (i) Defendants, (ii) officers and directors of Tilray and Privateer
`
`Holdings, Inc. (“Privateer”), and any subsidiaries thereof, (iii) the family members, heirs, assigns,
`
`and legal representatives of all persons set out in (i) and (ii), and (iv) all entities controlled by the
`
`persons set out in (i)-(ii).
`
`2.
`
`For years, Kennedy has been telling anyone who will listen that the current upstart
`
`cannabis companies – Tilray and its competitors – are in a struggle whose three or four winners
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`will dominate a $200 billion per year market. Kennedy wants to lead one of those companies and
`
`saw that the best way forward was to merge with another large company. But for that, he needed
`
`to personally control Tilray. To convince investors to give him personal control, Kennedy
`
`misstated financial metrics which overstated Tilray’s stability and suggested it was reaching its
`
`business goals – key factors for a company in an industry that has only existed for a few years.
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`Even as he was securing personal control, Kennedy was negotiating a merger with another
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`cannabis almost exactly Tilray’s size, Aphria Inc. The combined company would be the largest
`
`
`1 All emphases are added. All quotations from written sources with Canadian or UK spelling
`have been edited to American spelling.
`
`1
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`

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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 5 of 72
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`cannabis company by revenues in the world, positioning it to become one of those three or four
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`market leaders. Kennedy offered Aphria a deal that was not particularly favorable to Tilray’s
`
`shareholders – but made Kennedy the combined company’s CEO. With personal control over
`
`Tilray, Kennedy could have delivered on the offer. But he never got a chance, because the
`
`discussions were culminating in early March 2020 and collapsed with COVID-19.
`
`3.
`
`In July 2018, Tilray held an IPO that left more than 80% of its shares in the hands
`
`of its controlling shareholder Privateer, a private equity fund which, by the beginning of the Class
`
`Period, only held Tilray shares. About half of the remaining shares were freely tradable; the other
`
`half, a mere 10% of its total shares, were subject to a lockup agreement.
`
`4.
`
`In January 2019, that lockup on the remaining 10% expired and the shares were
`
`freely tradeable. Adding only 10% of Tilray’s shares to its float caused its stock price to fall 17%
`
`in one day.
`
`5.
`
`To keep Tilray’s stock price from falling further and to secure additional benefits,
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`Defendants caused Tilray to enter into, and touted, a purported co-branding deal with one of the
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`world’s largest brand owners, Authentic Brands Group (“ABG”). Kennedy boasted that the deal
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`was a strategic masterstroke that followed long discussions between the two companies,
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`culminating in a month’s intense negotiations. He claimed that the deal was worth the more than
`
`$100 million Tilray had paid for it, and Tilray’s financial statements carried the ABG Agreement
`
`at the full consideration Tilray paid for it. He also told investors that ABG had vetted Tilray and,
`
`by conferring its seal of approval, showed Tilray had a great deal to offer leading brands.
`
`6.
`
`Not remotely. Kennedy and Tilray’s other representative had spent mere days
`
`negotiating, and conducting due diligence for, the ABG Agreement. According to one insider,
`
`Kennedy caused Tilray to enter into the ABG agreement for one main reason: to “prop up Tilray’s
`
`stock [price].” Tilray’s own branding experts protested that the deal offered far less to Tilray than
`
`2
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`

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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 6 of 72
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`what it had paid for it. And ABG hadn’t vetted Tilray; Tilray had driven a truck full of money to
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`ABG’s headquarters and demanded so little in return that ABG would have been crazy to refuse.
`
`7.
`
`Defendants did more to convince investors of Tilray’s stability. Young companies
`
`like Tilray are often judged by their gross margins, which essentially measures the portion of
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`revenues that are not spent producing and selling the goods sold. Companies easily achieve
`
`economies of scale on overhead, but it is far more difficult to reduce unit costs or increase their
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`sale price. Yet in the two quarters after its IPO, Tilray’s gross margins had fallen from 55% to
`
`31%, raising doubts about whether Tilray could survive in a fiercely competitive field. To allay
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`investor concerns, Tilray recognized more than $40 million of unsellable marijuana plant waste as
`
`valuable inventory. Defendants subtracted the $40 million from Tilray’s cost of sales, improving
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`its margins, and making it seem far more profitable and promising than it really was.
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`8.
`
`Kennedy made these false and misleading statements to secure personal voting
`
`control over Tilray. Kennedy and two long-time friends (“Controlling Shareholders”) control
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`Privateer through supervoting Privateer shares. In turn, Privateer owns most of Tilray’s ordinary
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`Class 2 shares, but it controls Tilray by holding all of its supervoting Class 1 shares, which
`
`collectively hold more votes than all the Class 2 shares put together. Thus, the Controlling
`
`Shareholders indirectly control Tilray.
`
`9.
`
`The Controlling Shareholders needed the votes of Privateer’s other shareholders to
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`secure personal control over Tilray. To avoid flooding the market with new freely tradable
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`Privateer shares, the Controlling Shareholders also had to get Privateer’s other shareholders to
`
`agree to a two-year lockup.
`
`10.
`
`The Controlling Shareholders were asking a lot. A two-year lockup of shares in a
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`volatile company in a nascent industry like Tilray is risky.
`
`3
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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 7 of 72
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`11.
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`It is to convince Privateer investors to agree to the lockup that Defendants
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`overstated Tilray’s stability and progress on its business plan.
`
`12.
`
`Kennedy succeeded: the other Privateer shareholders agreed to the Share Exchange.
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`But securing personal control over Tilray was only the first step in his scheme. For years, Kennedy
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`had told reporters and investors that the cannabis market was in its infancy and would reach sales
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`of $200 billion per year. Kennedy had told them, too, that just like in the beer industry, that $200
`
`billion market would be dominated by three or four giant companies.
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`13.
`
`Even as Kennedy pushed through the Share Exchange, he was negotiating a merger
`
`with Aphria, a cannabis company almost equal Tilray’s size. In a February 2020 draft Letter of
`
`Interest, Kennedy offered Aphria attractive terms meant to close the deal quickly. The offer barely
`
`attached any premium to Tilray shares, despite its historically higher valuation. But Kennedy
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`insisted on one term: he would be the combined company’s CEO.
`
`14.
`
`Having secured personal control over Tilray, and facing Aphria’s impending due
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`diligence that would reveal his duplicity, Kennedy disclosed the truth in January and March 2020.
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`In January, Defendants announced that Tilray had renegotiated the ABG deal. The new deal was
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`drastically smaller. Then in March 2020, Defendants wrote down 86% of the value of the ABG
`
`Agreement and 44% of Tilray’s total inventories. Both disclosures caused Tilray’s stock price to
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`fall, damaging investors. Months later, Defendant Kennedy would admit that Tilray had
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`deliberately recorded waste as inventory.
`
`15.
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`But like so many plans pursued in February 2020, Kennedy’s scheme did not come
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`to pass. Aphria dropped negotiations on March 18, when an anxious world did not know what the
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`next day would bring, let alone the next year. Aphria fared better through COVID-19 than Tilray.
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`When the deal finally closed in December 2020, Aphria was more than twice Tilray’s size. And
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`Kennedy even lost the personal control that gave him a negotiating edge. COVID-19 forced Tilray
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`4
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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 8 of 72
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`to sell almost 40 million shares and warrants at rock-bottom prices, triggering a provision in its
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`certificate of incorporation which automatically converted Class 1 supervoting shares into Class 2
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`ordinary shares when the former accounted for fewer than 10% of the total. With no Class 1 shares,
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`Kennedy and his friends no longer controlled Tilray.
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`16.
`
`Kennedy had more success chasing money than power. He made more than $26
`
`million net selling Tilray shares during the Class Period. He timed his sales well: he made most of
`
`his sales either within two weeks after he began making false statements or within about two
`
`months before the corrective disclosures. They also violated a pledge he had made not to sell Tilray
`
`shares.
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`17.
`
`Through his indirect control, Kennedy used Tilray as a piggybank. When he was
`
`short on cash, he had Tilray purchase a company Privateer owned 30% of, paying himself $2.4
`
`million, paying other Privateer investors nothing, and paying the company’s 70% owner a mere
`
`$3.2 million, and that in shares.
`
`18.
`
`Kennedy misled investors about Tilray. He sold tens of millions of dollars of Tilray
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`shares. He tried to make himself CEO of the world’s largest cannabis company and, but for
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`COVID-19, would have succeeded. The investors he misled did not fare nearly as well. At the
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`close of the Class Period, Tilray’s shares traded for about $5 – down more than 95% from their
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`Class Period highs.
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`II.
`
`JURISDICTION AND VENUE
`
`19.
`
`The claims asserted herein arise under and pursuant to Sections 10(b) and 20(a) of
`
`the Exchange Act (15 U.S.C. §§ 78j(b) and 78t(a)) and Rule 10b-5 promulgated thereunder by the
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`SEC (17 C.F.R. § 240.10b-5).
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`20.
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`This Court has jurisdiction over the subject matter of this action pursuant to 28
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`U.S.C. § 1331, and Section 27 of the Exchange Act (15 U.S.C. §78aa).
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`5
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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 9 of 72
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`21.
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`Venue is proper in this judicial district pursuant to 28 U.S.C. § 1391(b) and Section
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`27 of the Exchange Act (15 U.S.C. § 78aa(c)) as the alleged misstatements entered into and
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`subsequent damages were suffered in this judicial district.
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`22.
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`In connection with the acts, conduct and other wrongs alleged in this complaint,
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`Defendants, directly or indirectly, used the means and instrumentalities of interstate commerce,
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`including but not limited to, the United States mails, interstate telephone communications and the
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`facilities of a national securities exchange.
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`III.
`
`PARTIES
`
`23.
`
`Lead Plaintiff Saul Kassin, and Named Plaintiffs Craig Scoggin, Surinder Chandok,
`
`and Leslie Rose, as set forth in their PSLRA certification which were previously filed and are
`
`incorporated by reference, purchased Tilray shares at artificially inflated prices during the Class
`
`Period and were damaged thereby.
`
`24.
`
`Defendant Tilray produces and sells marijuana, hemp, and related products. Tilray
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`grows hemp and marijuana in both Canada and Portugal, where it built a large open-air marijuana
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`farm. Tilray has sold medical marijuana or made it available for clinical trials in Argentina,
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`Australia, Canada, Chile, Croatia, Cyprus, the Czech Republic, Germany, Israel, Ireland, New
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`Zealand, South Africa, Switzerland, the United States, and the United Kingdom. Tilray sells
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`marijuana for recreational use in Canada, and hemp and hemp-derived CBD products in the U.S.
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`and nineteen other countries.
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`25.
`
`Since July 2018, Tilray’s shares have traded on the NASDAQ under ticker TLRY.
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`As of the beginning of the Class Period, investment fund Privateer Holdings, Inc. held shares
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`accounting for approximately 82% of the economic interest in, and 93% of the voting power over,
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`Tilray. Tilray was thus a “controlled company” under NASDAQ rules.
`
`6
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`

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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 10 of 72
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`26.
`
`Defendant Brendan Kennedy has served as Tilray’s President and Chief Executive
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`Officer, and a member of its Board, since January 2018, and Chief Executive Officer of Tilray’s
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`Canadian subsidiary since 2018. Kennedy also served as Privateer’s Executive Chairman from its
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`founding in 2011 through its dissolution in December 2019. Kennedy has worked exclusively in
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`the cannabis field since 2011. Until Privateer’s dissolution, Kennedy and two of his longtime
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`friends held a majority of Privateer’s voting power which, in turn, held a majority voting interest
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`in Tilray. Thus, Kennedy and his friends held indirect voting control over Tilray.
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`IV.
`
`IMPORTANT NON-PARTIES
`
`27.
`
`Former Employee 1 (“FE 1”) worked as a Senior R&D Manager at Privateer from
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`April 2017 to November 2018. In November 2018, FE 1 and other Privateer were transferred to
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`Tilray. FE 1’s new title was Senior Program Manager, but FE 1’s responsibilities did not change.
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`FE 1 worked for Tilray until March 2020. FE 1 reported to Engineering Manager Brent Harrison,
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`who reported to Drew Reynolds, Executive Vice President of Operations Expansion, who reported
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`to Kennedy.
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`28.
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`Former Employee 2 (“FE 2”) served as Tilray’s Senior Manager of Purchasing in
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`Toronto from October 2019 through May 2020. FE 2 reported to Steve Hatami, a Tilray Vice
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`President, who reported to Greg Christopher, Tilray’s Executive Vice President of Operations,
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`who reported to Kennedy. FE 2’s responsibilities included procurement for Tilray’s four Canadian
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`facilities.
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`29.
`
`Former Employee 3 (“FE 3”) served as a Tilray Vice President between February
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`2018 and October 2019. FE 3’s duties included overseeing Tilray’s business development outside
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`of Canada. FE 3 was “heavily involved with strategic initiatives.”
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`30.
`
`In 2011, Kennedy, Michael Blue and Christian Groh (“Controlling Shareholders”)
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`founded Privateer Holdings, Inc. to invest in the then-illegal cannabis industry. In 2014, the three
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`7
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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 11 of 72
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`launched Tilray’s predecessor as a Privateer subsidiary, alongside a number of other cannabis-
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`related companies. By the beginning of the Class Period (January 2019), Privateer had disposed
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`of substantially all of its assets except Tilray shares.
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`31.
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`Between 2011 and 2017, Privateer raised hundreds of millions of dollars from
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`outside investors. To secure these investments, the Controlling Shareholders relinquished about
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`two-thirds of their economic interest in Privateer, while retaining majority voting control through
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`supervoting Privateer shares.
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`V.
`
`BACKGROUND
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`32. Marijuana, hemp, and their derivates all come from the same plant: cannabis sativa.
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`Marijuana and hemp are not distinct plants but rather legal categories. By definition, cannabis
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`sativa that contains (by weight) less than 0.3% THC is hemp; cannabis sativa that contains more
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`than 0.3% is marijuana. This Complaint uses “marijuana” and “hemp” to refer to each legal
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`category seperately, and “cannabis” to refer to both collectively.
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`33.
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`In December 2018, the U.S. Farm Bill removed hemp from the list of controlled
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`substances, but not marijuana.
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`34.
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`The different legal treatment creates a vast gulf between hemp and marijuana.
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`While the federal prohibition against marijuana is rarely enforced, it remains a controlled
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`substance. Because of that federal prohibition, companies that sell products made from marijuana
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`plants in the U.S. even in states that have legalized their sale face substantial obstacles obtaining
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`bank loans or other services from large banks or, like Tilray, listing on a national securities
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`exchange. For that reason, Tilray cannot violate federal law to sell marijuana products in states
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`where it is legal, even though as a practical matter it would not face prosecution.
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`8
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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 12 of 72
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`35.
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`THC is concentrated in the marijuana plant’s flowers and buds. Because marijuana
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`plants are grown for their THC, producers typically use the marijuana plant’s flower and buds to
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`make sellable products for medical or recreational uses.
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`36.
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`Cannabis plants also have leaves, stalks, twigs, and stems. These byproducts of the
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`cannabis plant are called “trim” in the industry. Marijuana plant trim is generally considered waste.
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`It contains too little THC to be smoked, is federally prohibited in the U.S., and until December
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`2019, could not lawfully be used in edibles, foods, beverages, or other products in Canada.
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`37.
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`Cannabis plants also contain cannabidiol, commonly known as CBD. Producers
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`can use industrial processes to make CBD oil, which can then be added to foods, topical lotions
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`and oils, and other products. Many consumers believe that CBD has positive medical benefits.
`
`38.
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`Producers derive CBD from hemp plants. CBD can be extracted from hemp plant’s
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`stems and seeds, in addition to its flower. Producers can in theory derive CBD from marijuana
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`plants, but marijuana has less CBD and is federally prohibited in the U.S. Tilray did not use any
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`part of its marijuana plants to make adult use CBD. According to FE 2, Tilray produced its CBD
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`oils from hemp sourced from a Canadian company, B.C. Hemp.
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`39.
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`The sole significant regulatory obstacle to the use of hemp-derived CBD is that its
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`addition to an FDA-regulated product may, in the FDA’s view, adulterate the product.
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`VI. DEFENDANTS OVERSTATE TILRAY’S MARGINS AND THE VALUE OF THE
`
`ABG AGREEMENT
`
`A.
`
`Investors Focused On Tilray’s Gross Margins
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`40.
`
`Gross margins, a critical metric for small but growing company like Tilray, measure
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`how much money a company makes on each product it sells. Gross margin is defined as net
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`revenue minus cost of sales divided by net revenue.
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`9
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`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 13 of 72
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`41.
`
`Cost of sales is an accounting measure that includes all the costs directly related to
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`manufacturing and selling products but excludes all other costs, such as indirect overhead and sales
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`and marketing costs. The two main components of cost of sales are materials and labor.
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`42.
`
`Gross margins are relatively sticky or static. Unlike overhead, cost of sales tend to
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`grow proportionally with revenues.2 Put another way, there are few economies of scale in cost of
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`sales, but there are many economies of scale in general overhead because it is largely composed
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`of fixed costs.
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`43.
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`Defendants recognized that investors closely monitored Tilray’s gross margins.
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`Non-Defendant Tilray CFO Castaneda consistently ended the prepared remarks portion of earnings
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`calls by calling attention to two key metrics that, he said, made Tilray an attractive investment.
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`One was his claim that Tilray would reach and sustain gross margins of more than 50% over the
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`long term.
`
`44.
`
`The last reported results in Tilray’s IPO were those for Q1 2018. In that quarter,
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`Tilray’s gross margins were 55%. Tilray’s gross margins fell to 46% in Q2 2018, the first quarter
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`it announced after its July 2018 IPO, and to a mere 31% in Q3 2018, the last quarter before the
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`Class Period.
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`45.
`
`Tilray’s low gross margins drew analyst concern. In a March 8, 2019 report, a
`
`Jefferies analyst initiated coverage of Tilray at a rating of Underperform – the only such rating
`
`Jefferies had issued in the past 12 months. The Jefferies analyst gave Tilray the poor rating in part
`
`because its cost of sales “appears [to be] one of the least efficient” of similar companies, behind
`
`peers Canopy and Aurora.
`
`
`2 Ryan Caldbeck, 5 reasons gross margin is so important to investors & brands, June 12, 2013,
`available
`at
`https://www.newhope.com/managing-your-business/5-reasons-gross-margin-so-
`important-investors-brands; Villi Iltchev, Why Gross Margins Matter, November 21, 2019,
`available at https://twosigmaventures.com/blog/article/why-gross-margins-matter/
`
`10
`
`

`

`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 14 of 72
`
`46.
`
`Understanding that Tilray’s poor gross margins disturbed investors, during the
`
`Class period, Defendants deceived investors by both overstating inventory and understating labor
`
`costs (both inputs to cost of sales) – thus overstating gross margins.
`
`B.
`
`Defendants Overstated Tilray’s Gross Margins
`
`1.
`
`47.
`
`Defendants Understated Cost of Sales by Excluding Labor and Materials
`
`FE 1 had a variety of responsibilities at Tilray. In 2018 through a portion of 2019,
`
`FE 1’s work focused on high-level planning. FE 1 developed processes to account for Tilray’s cost
`
`of sales. FE 1’s responsibility was to take particular products and, for each product, determine and
`
`price the various materials and labor that went into making the product. The resulting report, called
`
`a Bill of Materials, allowed Tilray to determine its cost of sales for particular products and, thereby,
`
`its overall cost of sales.
`
`48.
`
`In 2019, as the Bills of Materials were developed for each product, FE 1’s role
`
`shifted to developing and supervising Tilray’s processes that ensured that Tilray employees would
`
`accurately enter costs of materials and labor into Tilray’s system.
`
`49.
`
`According to FE 1, Tilray consistently understated the costs of the labor incurred
`
`in creating its products. FE 1 reports that Tilray’s Technology Manager, Ontario Operations, who
`
`oversaw data entry in connection with the Bills of Materials, costs of sales, and inventory
`
`accounting, gave his employees improper instructions on entering data. Though FE 1 was “very
`
`vocal” about the incorrect directions, neither the Technology Manager nor anyone else at Tilray
`
`corrected the directions.
`
`50.
`
`These directions were frequently obviously wrong. For example, FE 1 observed a
`
`Toronto-based employee responsible for cost accounting exclude the costs of labor from costs of
`
`sales. FE 1 then corrected the employee. Confronted, the employee rationalized that the amount
`
`must have been small because it consisted of a few seconds for each labor step. FE 1 responded to
`
`11
`
`

`

`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 15 of 72
`
`the employee that these costs were significant; while any individual employee might spend only a
`
`few seconds on each product, because Tilray produced product on an assembly line, the labor of
`
`many employees would be required for each finished product. In fact, FE 1 told the employee,
`
`Tilray had about a dozen employees working full time on a manufacturing line making that
`
`particular product, not to mention all the other employees involved in the process of manufacturing
`
`it. FE 1 said that aggregated labor costs were a “true and direct cost” that must be included in the
`
`cost of finished products. But, acting on instructions from the Technology Manager, the employee
`
`continued to exclude labor costs.
`
`51.
`
`FE 1’s concerns that Tilray was not including costs of labor were particularly acute
`
`when it came to pre-rolled marijuana cigarettes, called “pre-rolls”. According to FE 1, beginning
`
`in the last quarter of 2018, Tilray started accumulating millions of pre-rolls. Pre-rolls are “super
`
`labor-intensive” and “sell cheap”. Because they cost a lot in labor but sell at a low price, excluding
`
`labor costs substantially overstates the pre-rolls’ profitability. FE 1 is certain that Tilray artificially
`
`lowered the pre-roll’s cost of sales because FE 1 used Tilray’s software to look up cost of sales for
`
`the pre-rolls. FE 1 then saw that the labor costs Tilray reported were substantially lower than those
`
`FE 1 had established.
`
`52.
`
`Yet the flawed Bills of Materials FE 1 helped create were the foundation of Tilray’s
`
`financial reporting. According to FE 1, to prepare financial statements, Tilray first exported
`
`financial information from the specialized software in which FE 1 stored it into an Excel
`
`spreadsheet. Tilray then used the Excel spreadsheet as the starting point to generate financial
`
`statements. Thus, the errors in the Bills of Materials would carry over into the financial statements.
`
`53.
`
`According to FE 1, the costs that had not been correctly entered as costs of sales
`
`were instead improperly recorded as general and administrative expenses (indirect overhead) to
`
`12
`
`

`

`Case 1:20-cv-03459-PAC Document 95 Filed 12/03/21 Page 16 of 72
`
`make the financial statements balance. Classified as overhead, the costs would not be worrying.
`
`Investors would assume the costs would not grow proportionally with revenues.
`
`54.
`
`FE 1 raised internal alarms about Tilray’s inaccurate financial statements. FE 1 told
`
`FE 1’s boss Steve Hatami that because the Bills of Materials did not include all costs, using them
`
`to generate financial statements would un

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