Q2 2020 Cronos Group Inc Earnings Call
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Ladies and gentlemen, this is the operator today's conference is scheduled to begin momentarily until that time. Your line is what it can be placed on music code. Thank you for your patience [noise].
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Good morning, My name is not show not in that will be our conference operator today.
I'd like to welcome everyone to Kratos groups second quarter 20 Twinning earnings Conference call. Today's call is being recorded [laughter]. This time I would like to turn the corner to Shane They know Investor Relations. Please go ahead.
Thank you this summer and thank you for joining us today to review Chronis group's second quarter 2020 financial and business performance today I'm joined by our Chairman President and CEO, Mike Ornstein, our CFO, Jerry Barbato, and our VP of legal and regulatory affairs, assuming some course group issued a news release announcing our financial results. This morning.
There are filed on our Edgar and SEDAR profile. This information as well the prepared remarks, we'll also be posted on our website under Investor Relations before I turn the call over to Mike I would like to remind you that her discussion. During this conference call will include forward looking statements that are based on assumptions that are subject to risks and uncertainties that could cause actual results to differ materially.
And those projected in the forward looking statements, including as a result with the factors described in the cautionary statement and risk factors included in the company's earnings release and regulatory filings, including the company's most recent annual report on form 10-K, B quarterly report on form 10-Q, I was any forward looking statements made during this call are qualified in their entirety.
In addition, during this call certain financial measures, maybe discuss that are not recognized under the U.S. generally accepted accounting principles referred to by the Securities and Exchange Commission as non-GAAP measures. We believe these non-GAAP measures assist management planning forecasting and evaluating business and financial performance, including allocating resources.
Conciliation of these non-GAAP measures to their closest reported GAAP measures are included in our earnings press release furnished to the FCC, which is available in the pressroom section of our web site. The Kronos group Dotcom. These non-GAAP measures may not be comparable to measures used by other issuers I'd also like to note that we are conducting our call today from our respective remote locations.
As such there may be Greek delays cross talk or minor technical issues. During this call. We thank you in advance for your patience and understanding.
I will now make prepared remarks, and that will move to a question and answer session with that I'll pass it over to corners group CEO Microlensing.
Thank you Jane and good morning, everyone.
To start the conversation I'd like to speak about two issues affecting everyone around the world today.
First I want to address the topic of racism and specifically, how we'd kronos are dedicated to making a difference.
As a leader in the cannabis industry, we're committed to using our voice to lead our industry Ford responsibly.
We cannot do that without recognizing the historical injustice, specifically tied to candidates prohibition that continue to this day.
As we continue to grow entering new involving markets, we're committed to supporting meaningful and progressive social Justice reform legislation in markets such as the U.S.
We believe this work starts in the inside out. So we have established a company to address how excuse me established a committee to address how we and the company can make an impact and the communities. We operate in both through our time and financial investment to fight racial injustice nx and equity within our industry.
We are fortunate to have a platform resources and influence and we will continue to use it to do our part to combat racial injustice and to change society for the better.
Secondly, cobot 19 has impacted markets industries and people globally, leading to material changes in the way, we live and the way we do business.
We've also seen the profound impact our products, having our consumers everyday lives and we continue to modify and monitor our distribution network to bring quality products to market. During this time.
Kona Scoop is found on the mission to improve People's lives by unlocking the full potential candidates and our company has always been at the forefront of providing safe access and high quality products to patients and consumers.
As you know my focus and the company's focus on creating long term shareholder value by developing disruptive intellectual property and building iconic brands.
I always encouraged long term thinking, especially in today's economy and environment.
Chris is truly building a business for the future our value will come from technology breakthroughs and branded sales that will help establish relationships with our consumers.
Moving to our operations in Israel and June 2020, following the successful shipment of bulk dried flower from Canada to Israel, We commenced sales of peace Naturals branded cannabis today is really medical market.
This is an important milestone for Kronos and we look forward to expanding our distribution and the piece naturals brand in the Israeli market.
The team at Kronos, Israel is also preparing to introduce new skews in adjacent categories, such as oils and pre rules, which will further establish our leadership position.
Allow me to take a moment to dive more into the Israeli market and how we've positioned ourselves the leader there.
Israel has a population of just over 9 million people and built one of the world's highest cannabis usage rate.
Unlike the North American cannabis markets, Israel has a much less competitive but listen market, given Israel stringent border controls and security infrastructure.
Israeli government has taking several steps to optimizing expedite the patient access process for medical cannabis.
In 2016, the Israeli Ministry of Health publish a medical cannabis information booklet and guide which includes the methodology intended for doctors to prescribe cannabis.
This is meant to guide and assist in customizing treatment with medical cannabis.
Many doctors in the Israeli health care systems have been trained and certified using his clinical methodology, which enabled them to provide treatment and issue patients licenses for possession and use of medical cannabis.
The Israeli medical candidates agency currently grants personal medical Canada's permits and prescriptions to patients to treat a variety of medical conditions.
And I'm like the Canadian medical candidates program patients fill prescriptions directly through pharmacies.
The medical patient count in Israel is expected to grow rapidly representing an excellent opportunity for our business to grow in this market.
The rapid growth in the Israeli medical market reminds us of the early days in Canada as medical market with demand outpacing supply and the stigma associated with the product quickly fading away.
Beyond the medical market in Israel, we are encouraged by the progress being made on further legalization of the potential adult use market, which provide more legal access to candidates in Israel.
There are currently to build being reviewed by the government and they're progressing through parliament quicker than many had anticipated.
As a reminder, krona screw consolidates the results and capture is 90% of the economics through our equity interest across the Kronos Israel entities.
With our manufacturing footprint established local team strong brand and product portfolio, you're very well positioned to succeed in the market.
Two boots gone Schmoll is one of the largest and most sophisticated lithium in Israel, producing exporting a variety of products to 35 countries throughout Europe and Asia.
For our Chronos, Israel facility, we work closely with a partner that could whats gone well and are able to leverage not only their agricultural expertise, but also their skilled labor pool with about 80 employees currently working on site and extensive infrastructure, including warehouse and utilities and much more.
I'm pleased to share that we are in full production and it had successful harvest.
Outside of Kronos, Israel's direct operations, we have further committed to the region and have a strong presence or an R&D analytic analytical sciences perspective.
We had two partnerships the top cannabis researcher Dr. DT Mary the skin care repair research, we are doing a technician and through the analytical testing lab on Kronos Israel's campus called cancel.
Under our agreement cancel is developing a commercial cannabis analytical testing business onsite across Israel.
In addition, we've created their own research hub Kronos device labs, which employs about 30 people and is focused on everything from understanding the effects of different can add benoit to creating next generation devices for cannabis products.
Turning to the Canadian market and the second quarter, we continue to supply the adult used market working with provinces and private retailers to meet demand during this time.
As Cobot 19 continues to impact global markets and global supply chain, we've seen an uptick in sales driven by consumer demand and the growth in retail outlets and key provinces.
Despite the strength, we have seen and the continued store openings and some provinces, we remain cautious knowing that the shock to the economy could potentially have negative impacts on our industry.
In Canada, we're now seeing most retailers open with limited capacity and social different thing guidelines.
The slowdown in disruption faced by retailers are in addition to quarantine measures and travel restrictions, which would impact the ability of consumers to readily access our products outside of online channels.
These restrictions will continue to change and evolve which creates uncertainty in forecasting consumer demand and sales velocity.
Despite the changing landscape throughout the second quarter, the alcohol and gaming Commission of Ontario continued to grant retail store authorizations with the objective of making the legal supply of cannabis more broadly available.
With over 100 stores out stores authorized to open as of July, Ontario seems to be committing of their plan of growing store count each month throughout 2020 and have a long runway for growth given the demand for new retail licenses.
In the Canadian 2.0 market, our adult use brands spinach, and Cove, and our direct to consumer medicinal cannabis brand piece naturals continued to expand distribution throughout the country in their respective channels.
We are proud of our uncompromising approach to quality, which is at the heart of everything we do.
As we continue to glean more consumer insights into the Canadian market, we look forward to producing new and differentiated products over time.
We know the adult use consumers and medical patients in Canada are looking for value. During this time and some of our peers have committed to a deep discount strategy as a weighted provides is perceived value to the cut that consumers and to compete with the elicit market.
At Kronos, we believe that the real essence of value revolves around the tradeoff between the benefits that consumer route seats from a product and the price he or she pays for it.
We pride ourselves on the quality of the product we bring to market.
For instance, our vaporizer devices aimed to deliver a premium extract for consumers with Precyse can avenue, a concentration levels and surfing profiles for consistent experience.
The premium cannabis extracts are made using CEO to extraction processes and each product has a unique and aromatic blend which is all natural turpin rich flavors.
All of our batteries and cartridges rigorously tested before sale and we continue to receive positive feedback on these innovative new products.
We believe our consumer benefit and pricing profile provided great value to consumers currently.
We will continue to look at ways to provide more value to the consumer whether through benefit or price on a regular basis as the industry evolves.
Moving to us I want to start off the discussion by welcoming summer freeing into her new role as general manager of our U.S segment.
Last month summer was named general manager of our US hemp derive CBD business with oversight of sales marketing and operations.
Summer officially joined Kronos in January of this year, which has been part of the teams in 2018 and her role at Altria.
While it Altria summer led the strategy and business development teams due diligence in the Canada space, which culminated in the strategic investment from Altria.
She has been responsible for leading our U.S sales efforts, including managing brand and retail partnerships for lower Jones.
Summer as a proven and results oriented leader with 14 years of regulated consumer packaged goods experience.
We're confident in our us brands and our strategic direction under summers leadership.
There are many opportunities we see on the horizon from introducing new product format under Lord Jones to launching new brands and targeting different retail channels and consumers.
Last quarter in response to market feedback and part of our evolving effort to provide through value to our consumers are lower Jones brand launched a new size format for our hero product the lower Jones CBD body lotion.
Now available in a larger 100 mental bottle our popular body lotion is twice the size, but available at the same price as our original 50 miles size.
In conjunction with this introduction, we lowered the price of our original 50 NOL size by 30%.
We think the new pricing structure provides a great entry point to attract trial consumers into the brand and convert them to repeat customers.
The support from our consumers during this quarter has been sell and we're excited to be bringing these new format sizes and products to our loyal lower Jones consumers.
We will be remiss not to mention the work, we're doing with Gingo and our joint venture natural era.
Following the successful fermentation of CVG at R&D scale at drone instrumentation, we've continued to optimize the process for downstream processing and scale up procedures and are very pleased with our results to date.
With the progress we've made we remain on schedule to produce fermented can avenue at commercial scale and September 2021.
And in Colombia, our joint venture Natura successfully completed three additional test exports attempt derived CBD extract to the us between May and July of this year for business development and R&D purposes.
Although this is not signify the started revenue for this business. They provide good learnings that set us up well for the future.
During this unprecedented times is very encouraging to see that we're making progress against our strategy across our global footprint.
The current environment doesn't make things easy for any industry, let alone one that is in a nascent stage of development, but I'm very proud of our employees and all that we have accomplished during this time.
From our production and manufacturing facilities to our continued R&D efforts, we are creating and launching new products and brands in different markets across the globe and we're committed to bringing high quality brands and products to our consumers.
There are few silver linings in this environment.
First given our strong balance sheet and decreased access to capital for industry competitors. We continue to feel that we are extremely well positioned to the opportunistic and how we create value for shareholders.
Second we believe that his attention turns to economic recovery.
Accelerating cannabis level legalization is a great solution to help create much needed jobs and tax revenue.
We can't always tell what the future holds we remain optimistic and ready to seize opportunities as they come our way.
With that I'll turn it over to Jerry to provide a discussion on this quarter's financial results and our remediation efforts.
Thanks, Mike and good morning, everyone.
Turning to our financial results the company reported consolidated net revenue in the second quarter of 2020 of $9.9 billion.
A 29% increase from the prior year period.
Revenue growth year over year was driven primarily by the continued growth in cannabis products in the adult use Canadian market.
And the inclusion of Redwoods financial results, our us hemp derive CBD business that was acquired in September of last year.
Revenue was partially offset by nonrecurring wholesale revenue in the Canadian market in the second quarter of 2019.
Consolidated gross profit for the second quarter of 2020 was negative $3 million a $7 billion decline from the second quarter of 2019.
The decrease versus prior year was primarily driven by a $3.1 billion inventory write down.
On dry cannabis and cannabis extracts within the rest of world segment caused by cannabis price compression in the Canadian market.
As well as an increase in cost of sales driven by a higher volume of adults you sale and the lack the wholesale revenue.
If we were to exclude the inventory write down of $3.1 billion gross profits in the second quarter of 2020 would have been point 1 million, representing a gross margin of 1%.
We anticipate inventory write downs to continue with a short term due to pricing pressures in the marketplace.
Reported operating loss for the second quarter of 2020 was $34.8 billion, representing an $18 million decline from the second quarter of 2019.
The loss was due to a combination of factors, including a decline in gross profit general and administrative expenses as a result of increased headcount.
Sales and marketing costs related to the development of new and existing brands and product lines.
And R&D expenses, mainly due to increased spending on research at the Kronos device Lab research and development Center and Upskilling activity at Kronos fermentation.
Additionally, within DNA, we had 3.5 billion dollars' worth of expenses driven by review costs and costs related to the company's responses to requests for information from various regulatory authorities related to our previously disclosed restatement of our 2019 interim findings.
So statement.
Our consolidated adjusted operating loss for the second quarter of 2020, which excludes the onetime review call was 31.3 million.
Turning to our reporting segment.
And the rest of World segment, we reported net revenue in the second quarter of 2000 $27.7 million, a 1% increase from the prior year period.
Revenue growth year over year was driven primarily by increased distribution of cannabis products in the Canadian market, including the launch of cannabis vaporizers in both the adult use and direct to consumer categories.
Partially offset by nonrecurring wholesale revenue in the Canadian markets in the second quarter of 2019.
Gross profit for the rest of World segment was negative 3.5 million.
A $7.6 million declines on the second quarter of 2019.
The decrease year over year was primarily driven by a $3.1 billion inventory write down on dry cannabis and cannabis extracts primarily caused by price compression in the Canadian market and the higher volume of adult U.S sales and left a wholesale revenue.
If we were to exclude the $3.1 billion inventory write down gross profit in the second quarter would have been negative point $5 million, representing a negative 6% gross margin.
As we work to create an efficient global supply chain for 2020 and beyond we anticipate that gross margins will continue to fluctuate.
This is due to the current under utilization of certain manufacturing facilities that are being re purpose and the work that is underway to streamline our third party biomass supply chain.
We anticipate that these operational pressures will ease as their manufacturing and purchasing teams continued to make progress in these areas.
Turning to our Canadian cannabis vaporizers as we have spoken about before we made the strategic decision with our launch to utilize contract manufacturers to increase speed to market at the onset of cannabis 2.0 legalization.
Further we believe that contract manufacturing allows us to be more flexible and responsive to trends in the marketplace.
While also aligning with our asset light model.
We continue to work with contract manufacturers to reduce costs, while continuing to provide quality products to our consumers.
Reported operating loss in the rest of World segment for the second quarter of 2020 was $22.1 million, representing a $5.4 million decline from the second quarter of 2019.
The loss was primarily driven by a decline in gross profit and higher R&D costs related to our spending on research at Kronos device Labs, R&D scalar center and Upskilling activities at Kronos fermentation.
Before getting into the U.S business operating results allow me to talk about the impairments. We took this quarter in the segment.
The company reported.
$35 million of impairment charges on as reporting unit and $5 million of impairment charges on the lower Jones brand.
Due to the ongoing developments of the cobot 19 pandemic.
Closures of the retail stores have been longer than expected and revenue growth has been slower than anticipated.
With slower growth the company's operating results in the U.S segment has been negatively affected by the global pandemic and the timeline of society getting back to normal is uncertain.
Based on the valuations the carrying value exceeded the fair value, resulting in an impairment on both the reporting unit and the lower Jones brands.
Turning to the U.S. segment reported net revenue in the second quarter of 2020 was 2.2 million.
Gross profit for the U.S. segment was point 6 million, representing a gross margin of 27%.
We believe the decline in gross margins within the U.S. segment. This quarter were transitory in nature, driven by premium paid for our essential employees. During the cobot 19 pandemic as well as increased discounts and promotions in the direct to consumer channel. So drive online sales growth in an effort to offset the negative impact of retail.
Channel customer closures due to covert 19.
Reported operating loss in the U.S segment for the second quarter of 2020 was $5.6 million. The loss was primarily driven by a decrease in gross profit.
Sales and marketing costs incurred in relation to the development and launch of new U.S. attempt derive CBD products under the lower Jones brand, New brand development and increase in headcount to support growth initiatives across a variety of functions.
Overall Kronos group reported a decrease in net income from the prior year.
Primarily due to the noncash impairment charges and the change in fair value of the financial derivative liability associated with L. Three's investment, which is described in more detail in the 10-Q.
In the second quarter. The company recorded a noncash loss of $35.9 billion related to the change in fair value of these financial derivative liabilities.
Kronos continues to expect there may be significant reported earnings volatility.
Primarily driven by the fair value quarterly adjustments related to the movement of Kronos group stock price.
Turning to the balance sheet. The company ended the quarter with approximately $1.3 billion in cash and short term investments, which held relatively flat from the first quarter of 2020.
Capital expenditures for the quarter were $8.6 million.
Spending includes investments related to Kronos fermentation the piece Naturals campus, our Israeli facility and our new ERP system, which I will talk more about shortly.
We remain committed to deploying capital in a disciplined manner and only in ways that align with our strategic priorities.
Now I would like to provide an update on our remediation efforts in relation to the material weaknesses that we disclosed in our fourth quarter up 2019 filings.
We as a company are committed to instituting best practices for financial reporting.
Our management with oversight from the audit Committee continues to work diligently to phase in our plan and we have made substantial progress and the implementation process to date.
We have implemented all the controls we laid out last quarter to address our material weaknesses and have begun rigorous testing internally.
The testing buyer independent auditor is in process on certain controls and will progress on the testing the rest of the controls throughout the course 2020.
Lastly to improve our efficiency as an organization, we successfully implemented an ERP system across our Canadian businesses, which went live in July.
We have also commenced work to broaden the reach of our ERP system to our us business, which is expected to be launched in the first half of 2021.
The new ERP system will be a meaningful component of the internal control over financial reporting and enable us to reduce our reliance on an annual controls and realize efficiencies throughout our supply chain and operations.
I continue to be encouraged by the work our teams are doing globally, both at our wholly owned business and with our JV partners.
With that I'll turn it over to Mike for closing remarks before culinary.
Thank you Gerry.
Despite unprecedented shifts in the global economy, and the way we live Kronos has remained focus on delivering on our priorities and we're well positioned to weather the storm.
We are constantly assessing our consumers shifting needs whether consumers are seeking positivity self care or wellness, we remain committed to providing quality products with the level of consistency and quality that consumers have come to expect from our brands.
Our strategy, which is built on multiple growth engines is vital as ever.
Our growing diversified portfolio of brands, which participate across geographies channels and categories provide us with many ways to fuel our global business.
And our asset light model will continue to play crucial role as we continue to scale our business.
Chronos has always been accompany if people the thrive in new markets embrace change and welcome hard problems and by staying flexible where physicians to opportunistically create value as the landscape continues to shift.
With that let's now open the lines for questions.
Ladies and gentlemen at this time, if you would like to ask a question. Please press star followed by the number one on your telephone keypad. If you would like to withdraw your question Chris Pankey. Please be advised that you're only allowed to ask one question and one follow up question.
Your first question comes from the line of Tammy can with BMO capital market.
Hi, Thanks, good morning, everyone.
First question Oh, Mike. Thank you said previously that arm with respect to your broader strategy, one part of any sort of lighting or waiting to be industry sort out both Canada and even the U.S. before you embark on larger loans.
So just wanted to get a sense, where where are you on.
Industrial sort of started to develop our mature that more way are looking at possibly making some larger business.
Sure So would you know.
When we look at say, Canada for example, and I'll answer the Canada and the U.S. separately I think what we're really looking for is where our where our brands are unique products with.
In their relationship with consumers and what we would want to see before making any any larger acquisitions is stickiness of of market share and and carve out of different consumer segments.
We haven't really seen that happened yet and I think the volatility in market share is something that.
Continues quarter to quarter.
What's really important for us from a the ROI see perspective is knowing that we're able to get something that hit to consumer need that we can take across borders and really be able to scale and build a mode with consumers and I think it's still early in the product and brand launches that it's hard for us to find something that.
It would be better for us.
At least at this at this point in time to make an acquisition versus continue to just build out ourselves.
In the U.S. I would say this.
It's really more of a regulatory.
Question at this point I think you do see a little bit more up uptick in consumer relationship with brands.
But watching and being proactive about how the regulatory environment.
Develops and I think with a lot of the of the different developments around co bid likely accelerating our view when.
We see legalization I think that now that brings us closer to when we would be making a one or more moves in the U.S., but still given the restriction to its.
The not something that will happen immediately.
Got it okay and my follow up on the Israeli market. So following a common stock.
I noticed that a number of your competitors in Canada are now also moving to input into the Israeli medical market. Its actual becomes what seems to be more than net importer, rather than I think previously for patients where that they would be next quarter. So I'm just wondering that aspect Youre Israeli show.
Energy, giving rule, our production, how black and there and when you talk when think about the opportunity in Israel the size of the market and obviously the population is smaller than Canada. So I don't know able to kind of quantify how many patients are right now what the possible size.
Opportunity could be down the though thanks.
Yeah.
Sure. So I think is really is an exciting market and while we did originally think of it as something that would be using export hub, we were been and continue to be pleasantly surprised by just the rapid growth in the medical market.
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It is a smaller population in Canada. So I think from a topline perspective. It is not likely to have the same addressable market size, but I will note that.
There you just don't have the same type of competition from the illicit market and that is the interesting dynamic that we haven't really seen in other markets.
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No I think.
From a competitiveness on oncology price, it's it's difficult to see Canadian exports in the long term as being something that will.
Continue to supply the Israeli market for us it's using our Canadian production is really supplement what we have their domestically right now maybe just the conditions and environment Israel make you make it just more advantageous to produce.
So I expect we'll continue to see a rapid growth. We I think it's too early to be able to provide any specific numbers, but I do use the analogy to Canada.
A few years ago.
Were you know if you go back we're seeing a lot of growth in the medical market in there the shortage, but now that we've been through the first reading in the Israeli Parliament over.
Illegal acts more full legalization Bill I think we look at our domestic footprint and something that will be essential and give us the big advantage when you see legalization and again smaller population but.
And while still early from a structural perspective like being able to go direct from.
Producer to a store without.
You know without any any wholesaler should make it easier to add to to scale and from a margin perspective, we would expect to be more attractive.
So I think the medical market is one aspect and preparing for.
For full legalization is also something that we're very focused on.
Thank you.
Your next question comes from the liner ROE start reducer with Raymond James.
I'm wondering on making Jerry thanks, so much for taking my question as you know.
We focus a lot on like Biology program. So Gerry you referred to some increasing cost that caused presentation. You did we get an update on on what were those costs being attributed how's the scale up going like you know the timeline associated with it September of next year still hold.
Sure.
Thanks, and good morning, So I think the scale up costs.
Yeah, Theres, some certainly between capex and different infrastructure.
Making sure that we have commercial fermentation infrastructure ready having the different.
Security packages. These are all planned capex, but there is some work that was needed to do to take the facility from when I was used and still for pharmaceuticals.
You know under under eight the tax to converting it to be something that fits undersea 45 is where some of the costs are and we've been doing a number of.
Ron maybe can you due to increased production.
So there are costs with with with that but I think it's been going well on the increasing cost as a positive because.
The shows we're continuing to ramp up and figure out downstream processing. So there will be costs as we build out the downstream processing cranes to be able to efficiently take me incrementally NAV and always make sure that they're just fungible and our supply chain so that.
You know in September we're we're in a position where we can take an avenue trades from fermentation or we can take an avenue rights from extraction and they seamlessly fit into the products. We have on the market today and into the products that we have in our development pipeline.
Great and thanks, and one very quick follow up question pending as an expansion activities and U.S. and and as the regulatory environment starts to get clarify, particularly on CVB I mean, how do you see potentially expanding extrapolating the that that program into the U.S.
Yeah, It's certainly a focus of ours and I think it's not specific CBD you know there other can abnormal that.
We're we're again focused on and I think that similar to Canada.
We do plan to expand things and when you look at our set up in the Canadian market a lot of what we're doing is.
Of course, focusing on the Canadian consumer, but also trying to get learnings on how we can then seamlessly, bringing those products and those processing into the U.S. So.
The products, we believe that will will win in the Canadian market I think it just further advantages asked for when we ultimately enter the U.S. market and.
There are certain things you can do in the U.S. market in certain things you can do in the Canadian market and once we're able to combine that doesn't mean, it's a much more powerful combination so the Canadian market, the advantages being able to work with and specifically on the.
More controlled can avenue inside so it THC TV being able to work with universities being able to have the type of infrastructure that we do and do that research very very important of course, the largest consumer market being in the U.S.. We are still doing our consumer research in the U.S. and focusing on developing products that ultimately well be something in need can.
Tumor needs in the U.S. market.
Great. That's very helpful. All sought out there.
Your next question comes from the line of Andrew Carter with Stifel.
Hey, Thanks, good morning.
The rest of world business Canadian adults business.
Cores in a row were seen kind of the gross margin really deteriorate and I know you mentioned lower pricing. So I guess a couple of questions number one when we see kind of stability for the gross margins on this business and then you do third party for our cost are you upside down on costs are you seeing power cost at all thanks, I'll stop there on the personal.
Great Good morning, Andrew.
So we're not going to provide guidance going forward on margins, but as we said in our prepared remarks.
Margins in the rest of World segment will continue to fluctuate over the next.
You are both market dynamics, and our strategy, which we believe a setting us up for long term success.
I think we're confident on our asset light model, but with that asset light model. We're experiencing some margin pressure today, you know as the price of third party flower.
I was down overtime, our margins will improve.
And then you know just in the market in general we're seeing continued pricing pressure across the Canadian market, where producers are lowering their prices and offering larger format size offerings.
And then you know as Mike talked about in his remarks, we are ramping up Kronos, Israel's business and up just pick on sales and that medical market, which will have some impacts on our margins.
Got it and then kind of setting a swing back into kind of thinking about the lower Jones business, it's been hit pretty hard, but specialty you taking kind of impairments, which means you kind of review the business what are kind of your expectations of that business can if you could provide any kind of long term targets for the current business and.
Does it grow in the second half was 2020, just going to be a difficult year with all the challenges from cobot 19.
Yes, Thanks again to Andrew I.
I think we were.
Confident the team and the go forward business plans, but the external impacts are difficult to predict and that difficulty.
Led to us Bridget projecting out this business and I can tell you that at the onset of 2020, we were very excited about the prospects for meaningful growth in the U.S. business.
But the but cobot 19 pandemic at that.
A significant impact on many of our customers who have experience.
Temporary store closures and some of the permanently close which has negatively impacted sales and demand quite frankly in the segment. So you know for right now with very difficult efforts for us to predict what the rest of 2020 holds because as you see stores open.
In some states and localities, they're having to re close and that's what we will you really can't figure out is what the impact on the consumer in the short run just because the store may open back up you're not going to get the same foot traffic through the store and the interactions the number of people a lot in stores.
Hi, Thanks, I'll pass it on.
Your next question comes from nine to upset the Rubin with C.I.B.C.
Hi, This is Seth on for Jonathan borrow Thanks for taking my question, So you're sticking to Lord Jones or there's some signs you can offset the loss in brick and mortar through online channels either through direct to consumer online retails are online retailers. On then I have any update on on Lord Jones from the CBD strategy overall would be appreciated.
Yeah, Thanks for the questions.
So.
While on the surface it may seem a bit disappointing that our U.S. business was flat quarter over quarter.
You know cobot has obviously had a significant impact on our brick and mortar sales, but I would say.
We did we did fairly well in the second quarter, having very little sales to our retail partners and focusing on our direct to consumer now with that we had a lot of price promotions and discounts to drive those sales, but quarter over quarter. You know in spite of having such little revenue to those retail partners and then as we look.
Forward I mean, we feel confident in the in the plans the business as the projected to correct. The trajectory of that business and are very excited to see what several were due to lead the business or work.
Okay, great. Thanks, and just a quick follow up if I if I can just on your capital allocation strategy looking forward.
Can you maybe expect any any significant capex projects and the pipeline.
Yeah.
We're always evaluating opportunities, but I think from the brand portfolio that that we have right now we're pretty comfortable with where we are from a infrastructure perspective and I.
I think outside of any any acquisitions or or further launches, where we might want to backfill margin with a with capex, we're pretty comfortable where we are today, so not much to the expected there.
Thanks.
Your next question comes from the line Vivian Vivien Azer with Cowen.
Hi, good morning.
I wanted to you on <unk> please on Laura.
Well certainly some moving pieces in the quarter in particular as we try to triangulate to normalized gross margins. So I want to one hand, you have the price production on your core offering on that then as well as on increased promotion, but I would think you know that went to the deflation that you're seeing.
Okay and in that commodity market are there should be some kind of offset so is there any color you can offer if we kind of im trying to normalize for all the puts and takes distribution price adjustment and commodity deflation. The gross profit profile it looked like thanks.
Yeah. Thank you. Thank you Vivian so yeah the margins in the U.S. were impacted by both components, both the revenue and the cost of goods sold in the quarter, both due to covert and our response to that endemic.
If you start with the net revenue impact, we increased discounts and promotions to our consumers in that online channel.
We posted a lot of those 30% discounts.
And then on the cost side, we paid our essential employees premium pay which drove up our cogs, so but both of those components negatively impacted margins in the quarter.
I think it's hard to predict when our margins will get back to some sort of normality based on the the cobot pandemic and the opening of retail stores, but you're absolutely right. I mean, some of our costs will be going down is the question is is that offset by the premium pay and from the revenue side, what happens with with the retail environment.
I understood maybe is that a lot on that a little bit more specifically can you contextualize, what you're seeing in terms of price deflation on the input for them were John's product. Thanks.
Yes, I think certainly we've seen a we've seen pricing rapidly come down but that does take some time and actually flow through to what you're seeing on margins and have you think of when.
From an accounting perspective, new product or new input would actually.
Matched the.
The products that we're selling we do see it coming down lead we think it could even come down further.
But it takes time for us to flush through the current at current CBD supply we have on hand.
Understood. Thank you there.
Your next question comes from the line of Pipers, Michael Lavery with Piper Sandler.
Good morning, Thank you.
You have your piece plus looking like it's set to launch now in Arizona, California, Illinois, and Pennsylvania, I can you give a little sense of maybe how soon that's coming how come for all of a launch it may be and why those states in particular.
Sure Thanks, and good morning.
Piece plus is still something that we're we're monitoring the macro environment, whether you know regulatory or just what's happening with with retail before I think aggressively expanding and I think when you look at our focus for the back half of the year, we're really looking to a different brand. So.
Our Jones amount not more mainstream skincare brand that would be where our attention as again no having everything ready for peace plus we will be opportunistic time wise to make sure that when we see either the right time in the right opportunity will move forward with it.
So theres, they're not have said scheduled to ship.
There's there's not a set schedule.
I think it's more of a kings and timing of we want to make sure that we bring our other brown the market first and then having piece plus ready, we'll we'll start rolling it out after that.
Okay, and just to follow up I know, we've covered more jones pretty well already but.
I just want to understand the thinking behind the write down in the sense that.
I think typically in a situation like that if it's considered transitory pressure.
Then you wouldn't have to take the write down.
Is there something beyond the could maintain pressure that you're you're pointing to has your thinking on the market changed or is it more just.
Conservatism approach or just kind of how you thought about that.
Yeah. Thank you.
It was a deep analysis that we thought we looked at and yeah. There are some temporary pressures.
And we Havent met expectations from the original model.
And what we don't know and it's difficult to predict for US is hey, what how long. This cobot last and then how long does that impact on consumer behavior last so yeah I would say yeah. We did we took a conservative approach I. Just think you know with coal that the cobot pandemic and a significant number of the company's customers.
Who have experienced closures and pressures on their business.
When we did the analysis the the impairment was the logical thing to do.
Okay. Thank you very much.
Your next question.
Bill.
Okay and partners.
Your next question comes on line of Bill Kirk with M pay him partners.
There's no response from that line.
Your next question comes from the line of met Bottomley Canaccord Genuity.
Good morning, everyone. Thanks for taking the question, Mike I'm wondering if I could get them.
Additional commentary on on your views on on brand building, specifically, what's happening in the Canadian market here, where retail sales are obviously continuing to grow pretty healthily, whereas there are some dynamics with what the inventory throughout this factor in and how some of your peers are pricing. So given the fact that a lot of you're comparing.
Here is out there with similar market cap some of the larger name I have a higher penetration, what's your I guess mix or trade off between having I guess more of a measured opex burns them from a versus some of those peers versus brand building and even selling products today at a breakeven just to get product out there given.
Matt you can't really advertising, there's not much differentiation when you walk into the stores, maybe not much of an issue, but just curious on how you think that'll play out in the long term as promises to build their own brand domestically.
Sure. Thanks, and good morning, So that's a great question and you know I think.
First of all they'll say when we think of brand building, we're thinking on a on a global scale and I think that while you can't do.
Broad advertising and used to be very restricted there still are ways you can advertise but.
Building a brand isn't really specific just what your packaging look like and being able to put a billboards and.
You know our approach to value creation I'll, just I'll use the analogy if look at say the tobacco industry over 100 years ago, and if you go back and think about the early market you can see some probably pretty similar to where we are today with the Canadian flatter market and industry participants in competing to figure out how to sell loose leaf tobacco.
But the biggest value creation, ultimately didnt come from who could outsell somewhere else in tobacco leaf.
Came from research and consumer needs and being able to develop a breakthrough consumer product like cigarette and so we believe the path to value creation for Cronto. It's a similar so it's continuing to focus on what that breakthrough product is being able to bring it to market and not only do you want to bring that product to market and in Canada.
Being able to then take that product and also launch it and Israel and the U.S. and in other markets as as full legalization comes online so and I think it's important that we do have a product in market that we have the sales on manufacturing infrastructure to be able to continue having relationships or that we're ready.
When we have differentiated products that come out and I think we've got the right.
Pieces in place with the work that we had been doing since our Todd joined US as Chief Innovation Officer, and how we incorporate differentiation from American Avenue wise in different form factors are in the products, but I believe that building a brand off of a essentially.
Flower, which is commoditizing given the restrictions in and regulations in Canada will be difficult, but there's still an opportunity from product differentiation and that's really what we what we need to be able to do until until we have a product. It's different I think consumers will be continuing to switch.
Between brands and we.
We need to provide something it's better to the consumer.
Well understood. That's helpful. And then just on the flip side of that.
Just looking at your balance sheet, which is one of the strongest in the sector are you sort of comfortable at the current operating burn that you're not in order to fund those interim losses as you look for some longer term brand building a more differentiated opportunities or is there a four to six month or 46 month quarter back where you'd like.
You know to get back to breakeven or above.
Yeah. We're you know given I think the way that we're set up and what we look at as end markets versus where were today. The focus really is on what is a little longer term return on invested capital versus when can we.
B B cash flow positive and I think that we are set up with the balance sheet, where we can absorb that but we're really making investments to be able to develop and bring those breakthrough products to market, where we think the most value comes from.
You know that doesn't mean that we aren't always focused on cost, but our focus is on making sure that we can reduce and get rid of costs that are something that is providing a good return on on the investments we make.
But still it anything that we see opportunistically or not it fits our strategic plan that we can make investments into we're going to continue to make.
Great. Thank the wrong.
Your final question comes on line of Graham Greener with eight capital.
Yes, hi, good morning. Thank you for taking my questions here I, just wanted to get a beta a bit more color regarding the change in a different segments on the rest of world revenue quarter over quarter I saw flower revenues that more than doubled in the quarter, while the xtracs were down so I was just wondering.
Whether that flower increase was driven by the exports to international markets and wanting to get some more detail regarding the XTRAC side of things given the the launch of based side just wanted to get some more detail regarding now and what we're seeing that variance was included in that broader category. Thank you.
Yes, so I think what you're seeing at least Q2 of 2020 versus Q2 of 29 team is.
While our revenue was relatively flat we.
Sold all of our products in the second quarter in the Canadian marketplace.
Either in the rack or medical channel, whereas in Q.
Q2 of 29 team, we had a large wholesale shipment and I think you feel you can't really look at the difference between extracts and flower, whether that's pre roles or even kings. Your oil is based on a quarter over quarter.
Basis, I think theres always going to be fluctuations in the mix.
Nathan and just just to add to that.
I just want to point out a difference that if you're if you're comparing us to peers, because we have our own distribution and an Israeli entity when we export from from Canada to Israel, that's not something that shows up in revenue upon the export it's once the.
Once the product a it the branded products actually sold through in Israel. That's when you would be seeing the revenue realized so there's a bit of a delay, but I would think of less of like us export in Israel and more of just Israel as they operating company, where you'll see revenue come from the same way you would see the Canadian revenue and whether it's important.
Or produced in Canada is really just a supply chain issue.
Okay understood I appreciate that color and then just one quick follow up.
I appreciate the commentary prior with regard to the USA segment and its fluctuations in gross margin there when looking at the adjusted operating loss over a quarter over quarter basis that after that actually improved by about 15%. So I would I was hoping to get a bit more detail with respect to read a flat revenues decline their gross margin.
Profit figures actually increasing just wondering what's driving thank you.
Yeah, I think a majority of that is just related to the timing issues of when.
We're spending our money. So we had a heavy Q1 and a lighter Q2, so I would really chalk it up to that I think it's difficult to look at quarter over quarter in that business.
Okay. Thank you very much.
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