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 are going to be placed on music cold. Thank you for your patience.
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Good morning, My name is less or not and I'll be your conference operator today I would like to welcome everyone to Kratos groups second quarter 2020, <unk> earnings Conference call. Today's call is being recorded [laughter]. This time I would like to turn the call over to Shane They know Investor relations.
Please go ahead.
Thank you the China 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 show course group issued a news release announcing her financial results. This morning.
Which are filed on or Edgar and SEDAR profile. This information as well as 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 reminds 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 at 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 in quarterly report on form 10-Q language 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.
Reconciliation 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 website the Kronos group Dot com.
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 think you in advance for your patience and understanding we will now make prepared remarks, and they will move to a question and answer session with that.
I'll pass it over to corners group CEO, Mike Ornstein.
Thank you Shannon 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 for word responsibly.
We cannot do that without recognizing the historical injustice, specifically tied to candidates prohibition that continues to this day.
As we continue to grow entering new end of all the 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 to establish 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 and that in an 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, Kogan 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.
Krona 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.
Well I'm going 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 boasts 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.
The Israeli government has taking several steps to optimize and expedite the patient access process for medical cannabis.
In 2016, the Israeli Ministry of Health published a medical cannabis information booklet in 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 this 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 candidate 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, Kronos group consolidated 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.
'cause it's gone from when all is one of the largest and most sophisticated for 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 our partners it could whats gone from 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 from an R&D analytic analytical sciences perspective.
We had two partnerships with top cannabis researcher Dr. Deeni Mary the skin care repair research, we're doing a technique on and through the analytical testing lab on cross 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 avenues 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 in 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.
Several potential purchasers continue to implement health and safety measures and reduce staff at onsite operations, including limited delivery time slots, which opposed logistical challenges and create a reduction in purchase order fulfillment.
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 involved 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 supplied cannabis more broadly available.
With over 100 stores out stores authorized to open as of July, Ontario seems to be committing to 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 overtime.
We know the adult use consumers and medical patients in Canada are looking for value. During this time and some of her peers have committed to a deep discount strategy as a way to provide this perceived value to the cut that consumers and to compete with the elicit market.
Kronos, we believed 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 aim to deliver a premium XTRAC for consumers with Precyse can have annoyed concentration levels and turpin profiles for consistent experience.
The premium candidates extracts are made using CEO to extraction processes and each product has a unique and aromatic blend which uses all natural chirpy enriched flavors.
All of our batteries in cartridges rigorously tested before sale and the continued received 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 the U.S. 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 U.S. hemp derive CBD business with oversight of sales marketing and operations.
Summer officially join Kronos in January of this year, but she has been part of the teams in 2018 and her role it altria.
While it Altria summer led the strategy and business development teams due diligence and the cannabis 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 lore Jones.
Summer is a proven and results oriented leader with 14 years of regulated consumer package goods experience.
We're confident in our U.S. 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 true value to our consumers are Lord Jones brand launched a new size format for our hero product the Lord Jones TBD body lotion.
Now available in a larger hundred mill bottle.
Our popular body lotion is twice the size, but available at the same price as our original 50 Mel size.
In conjunction with its introduction, we lowered the price of our original 50, no 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 felt 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 CBG at R&D scale at drone instrumentation, we have continued to optimize the process for downstream processing and scale of procedures and are very pleased with our results today.
With the progress we've made we remain on schedule to produce fermented can avenue lines 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 U.S. between May in 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 isn't 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're 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 it is attention turns to economic recovery.
Accelerating cannabis leg 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 will turn it over to Jerry to provide a discussion on this quarter's financial results and our remediation efforts.
Thanks, Mike.
Good morning, everyone.
Turning to our financial results the company reported consolidated net revenue in the second quarter of 2020 of $9.9 billion.
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 are U.S. attempt to ride 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 29 team.
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 left 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 the R&D expenses, mainly due to increased spending on research at the Kratos device Lab research and development Center and Upskilling activity at Kronos fermentation.
Additionally, within GE today, 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 authority related to our previously disclosed restatement of our 2019 interim finding.
Actual statements.
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 billion, 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 market in the second quarter 2019.
Gross profit for the rest of World segment was negative 3.5 million.
$7.6 million declines on the second quarter of 29 team.
The decrease year over year was primarily driven by a $3.1 billion inventory write down on dried Canada 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 will work to exclude the $3.1 billion inventory write down gross profit to 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 continue 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 setter and upscale and 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 this 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 colder than 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. hemp derive CBD products under the lower Jones brand, New brand development, and increasing 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 is 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.
This 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 aligned 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 in the implementation process to date.
We have implemented all the controls we laid out last quarter to address our material weaknesses and thats begun rigorous testing internally.
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 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 Chronos has remained focus on delivering on our priorities and we are 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 is ever.
Our growing diversified portfolio of brands, which participate across geography is 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.
Kronos has always been accompany of people the thrive in new markets embrace change and welcome hard problems and by staying flexible we are positioned to opportunistically create value as a 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.
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 markets.
Hi, Thanks morning, everyone first question Oh, Mike. Thank you said previously is that with respect to your broader strategy. One part of it is there sort of lighting or waiting the industry. So it out both Canada and even the U.S. before you embark on large.
Sure.
So just wanted to get a sense, where where are you on.
Industrial sort of started to develop a mature that more where you are looking at possibly some large 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 were able to get something that hit the consumer need that we can take across borders and really be able to scale and build emote 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.
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 or 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 that it's.
Im 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 expectations, where that they would be next quarter. So I'm just wondering that affect your Israeli straight.
Energy, giving little our production, how black and dash and when you talk or 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 though thanks.
Sure. So I think you know Israel and is an exciting market and while we did originally think of it as something that would be used as an 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 top line perspective. It is not likely to have the same addressable market size, but I will note that.
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.
No I think.
From a of competitiveness on on coffee price, it's it's difficult to see a 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.
He 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 think it's too early to be able to provide any specific numbers, but I do you 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 and there's a shortage, but now that we've been through the first reading in the Israeli Parliament over.
Illegal life 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 with being able to.
Go direct from producer to a store without you know without any any wholesalers 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 a full legalization is also something that we're very focused on.
Thank you.
Your next question comes from the liner Robert Sarver, do Sir with Raymond James.
I'm wondering I'm, making Jerry thanks, so much for taking my question. You know you know we focus a lot.
Biology program. So Gerry you referred to some increasing cost that calls for integration with regards to get an update on on you know what were those costs are being attributed how's the scale up going like you know the timelines associated with September of next year still hold.
Sure.
Thanks, Good morning, So I think the scale up costs.
You know, there's some certainly capex in 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 it was used and still for pharmaceuticals.
You know under under eight for tax to converting it to be something that fits undersea 45 is where some of the cost lower and we've been doing a number of runs and what can you can you due to increased production.
So there are cost with with ER with that but I think it's been going well and the increasing cost is 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 the downstream processing cranes to be able to efficiently take the incremented snap 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 ads from fermentation or it can take an avenue I term extraction and they seem with the fit into the products. We have on the market today and into the products that we have in our development pipeline.
Great. Thanks, and one very quick follow up question pending as an expansion activities.
And as the regulatory environment starts to get clarify, particularly on CVB I mean, how do you see the constantly finding extrapolating the that that program.
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Yeah, It's certainly a focus of ours and I think it's not specific CBD.
There are other can advertise that.
We're we're again focused on and I think that similar to Canada, a 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 as well.
Horse focusing on the Canadian consumer, but also trying to get learnings on how we can then seamlessly bring those products and those processing into the U.S. So in other 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 you know.
There are certain things you can do in the U.S. market and certain things you can do in the Canadian market and once we're able to combine none of that it's a much more powerful combination so the Canadian market, the advantages being able to work with and specifically on the.
More controlled snap on one side, 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 that need can.
Tumor needs in the U.S. market.
Great. That's very helpful I'll 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.
No ROE were seen kind of the gross margin.
And I know you mentioned lower pricing. So I guess a couple of questions number one when you see kind of stability for the gross margins on this business and then you do third party for our cost where you got sucked 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.
So 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.
Comes 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 that I've, just got sales and that medical market, which will have some impacts on our margins.
Got it and then kind of stepping back into kind of thinking about the lower Jones business, it's been hit pretty hard, but specialty you taken kind of an impairment, 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 that trend business and does it grow in the second half towards 2020, just going to be a difficult year with all the challenges from cobot 19.
Yes, Thanks again to Andrew you know I think we were confident that team and the go forward business plans, but the external impacts are difficult to predict and that difficulty.
Led to us because you're 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 19th had that make it 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 it's very difficult first for us to predict what the rest of 2020 holds because as you see stores open.
In some states and locality, they're having to re close and that's what we what 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 the line upset the Rubin see I see.
Hi, This is stuff on for John Dunn 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 a through direct to consumer online rebuilds online retailers and then I just any update on on large on from the CBD strategy overall would be appreciated.
Yeah. Thanks for the question, Sir So you know 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.
No. 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 enough 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 some of my point.
We're always evaluating opportunities, but I think from the brand portfolio that but 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 <unk> these on Laura.
Well certainly some moving pieces in the quarter in particular as we try to triangulate to normalized gross margin. So you know one the one hand, you have the price production on your core offering on but then as well as on increased promotion, but I would think yeah that which the deflation that you're seeing.
And in the 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 gross profit profile would have 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.
And that online channel Oh, you know, 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. It's 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 just a lot on that 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.
Yeah, I think certainly we've seen a we've seen pricing rapidly come down but that does take some time to actually flow through to what you're seeing on margins. If 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 we 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 mine or Pipers, Michael Lavery with Piper Sandler.
Good morning, Thank you.
You have your piece plus looking like it said the launch now in Arizona, California, Illinois, and Pennsylvania, I can you give a little sense of maybe how soon that's coming how come from out 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 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, and then a more mainstream skincare brand that would be where our attention as.
Bob again, though having everything ready for peace plus we will be opportunistic time wise to make sure that when we see there the right timing the right opportunity will move forward with it.
So theres, they're not have set schedule just yet.
There's there's not a set schedule I think it's more of a gain some timing of we want to make sure that we would 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 or Jones pretty well already but.
I just want to understand the thinking behind the breakdown in the sense that.
I think typically in a situation like that if it's considered transitory pressure than 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 the significant number of the company's customers.
You've experienced closures and pressures on their business.
Well, we did the analysis the the impairment was the logical thing to do.
Okay. Thank you very much.
Your next question.
[noise] MKM partners.
Your next question comes on line of Bill Kirk with M.K.M. partners.
There's no response from that line.
Your next question comes on line of met Bottomley Canaccord Genuity.
Good morning, everyone. Thanks for taking the question.
I'm wondering if I could get some no additional commentary on on your views on brand building, specifically you know what's happening into Canadian market here, where retail sales are obviously continuing to grow pretty healthily, whereas there are some dynamics with Watson inventory throughout this factor and how some of your peers are pricing so given the fact.
A lot of your comparable peers out there with similar market cap someone to larger name.
Have a higher penetration, what's your I guess mix or trade off between having I guess more of a measure opex burns them from a versus some of those appears versus brand building and even selling products today at a breakeven just to get product out there given that 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 will 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.
No 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 a broad advertising and you can be very restricted there still are ways that you can advertise but.
Building a brand isn't really specific just what your packaging look like and being able to put up billboards and.
You know our approach to value creation I'll, just I'll use the analogy of look at say the tobacco industry over 100 years ago, and if you go back and think about the early market you can see something probably pretty similar to where we are today with the Canadian flower market and industry participants and competing to figure out how to sell loose leaf tobacco.
But the biggest value creation, ultimately didn't come from who could outsell someone else and tobacco leaf.
It came from researching consumer needs and being able to develop a breakthrough consumer product like cigarette and so we believe the path of value creation for Cronto 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 and.
Canada being able to then take that product and also launch it and Israel and the U.S. and other markets as as full legalization comes online. So I think it's important we do have a product and market that we have the sales on manufacturing infrastructure to be able to continue having relationships or that were.
Already when we have differentiated products that come out and I think we've got the right.
Pieces in place with the work that we've been doing since Todd joined US as Chief Innovation Officer, and how we incorporate differentiation from American Avenue wise in different form factors all 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 need to provide some in its better to the consumer.
Well understood. That's helpful. And then just on the flip side is that.
Just looking at your balance sheet, which is one of the strongest sector are you sort of comfortable at the current operating burn that you're at in order to fund those interim losses as we look for sort of longer term brand building a more differentiated opportunities or is there a four to six month or four to six month quarter path, where you'd like.
You know did get that the 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 you know 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 costs, 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 granular with eight capital.
Hi, Good morning. Thank you for taking my questions here I, just wanted to get a bit of 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 extracts were down. So I was just wondering whether that flower increases.
Driven by the exports to international markets and wanting to get some more detail regarding the XTRAC side of things given the a 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 Q2 of 29 team we had a large wholesale shipment and I think you can't really look at.
The difference between extracts and flower, whether that's pre roles or even Kinks. Your oil is based on a quarter over quarter.
Basis, I think there's always going to be fluctuations in the mix.
Nathan and just just to add to that Bob 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 in 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 a operating company, where you'll see right.
Revenue come from the same way you would see the Canadian revenue and whether its imported ore 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 that just 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 declined the gross margin.
Profit figures actually increasing just wondering what's driving that 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.
[noise], Okay. Thank you very much.
[noise]. This concludes our question and answer session for today. Thank you for your participation you may now disconnect.
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