Cronos Group Inc.
Q2 2020 Earnings Call Transcript

Published: 6 Aug 2020

[Operator:]

Good morning. My name is Lashana and I will be your conference operator today. I would like to welcome everyone to Cronos Group’s Second Quarter 2020 Earnings Conference Call. Today’s call is being recorded. At this time, I would like to turn the call over to Shayne Laidlaw, Investor Relations. Please go ahead.

[Shayne Laidlaw:]

Thank you, Lashana, and thank you for joining us today to review Cronos Group’s second quarter 2020 financial and business performance. Today, I’m joined by our Chairman, President and CEO, Mike Gorenstein; our CFO, Jerry Barbato; and our EVP of Legal and Regulatory Affairs, Xiuming Shum.

[Mike Gorenstein:]

Thank you, Shayne, 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 at Cronos are dedicated to making a difference. As a leader in the cannabis industry, we are committed to using our voice to lead our industry forward responsibly. We cannot do that without recognizing the historical injustice specifically tied to cannabis prohibition that continues to this day. As we continue to grow entering new and evolving markets, we are committed to supporting meaningful and progressive social justice reform and legislation in markets such as the U.S.

[Jerry Barbato:]

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 million, 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 Redwood’s financial results, our U.S. hemp-derived CBD business that was acquired in September of last year. Revenue was partially offset by non-recurring 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 million decline from the second quarter of 2019. The decrease versus prior year was primarily driven by a $3.1 million inventory write-down on dried 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 adult-use sales and the lack of wholesale revenue. If we were to exclude the inventory write-down of $3.1 million, gross profit in the second quarter of 2020 would have been $0.1 million, representing a gross margin of 1%. We anticipate inventory write-downs to continue in the short term due to pricing pressures in the marketplace. Reported operating loss for the second quarter of 2020 was $34.8 million, 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 Cronos Device Labs Research and Development center, and upscaling activity at Cronos Fermentation. Additionally, within G&A, we had $3.5 million 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 financial statements. Our consolidated adjusted operating loss for the second quarter of 2020, which excludes the one-time review costs, was $31.3 million. Turning t our reporting segments. In the Rest of World segment, we reported net revenue in the second quarter of 2020 of $7.7 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 market in the second quarter of 2019. Gross profit for the Rest of World segment was negative $3.5 million, a $7.6 million decline from the second quarter of 2019. The decrease year-over-year was primarily driven by a $3.1 million inventory write-down on dried cannabis and cannabis extracts, primarily caused by pricing pressure in the Canadian market and the higher volume of adult-use sales and lack of wholesale revenue. If we were to exclude the $3.1 million inventory write-down, gross profit in the second quarter would have been negative $0.5 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 underutilization of certain manufacturing facilities that are being repurposed and the work that is underway to streamline our third-party biomass supply chain. We anticipate that these operational pressures will ease as our 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 Cronos Device Labs R&D scale center, and upscaling activities at Cronos 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 recorded $35 million of impairment charges on its reporting unit and $5 million of impairment charges on the Lord Jones brand. Due to the ongoing developments of the COVID-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 have 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 Lord Jones brand. 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 $0.6 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 premiums paid for our essential employees during the COVID-19 pandemic, as well as increased discounts and promotions in the direct-to-consumer channel to drive online sales growth in an effort to offset the negative impacts of retail channel customer closures, due to COVID-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-derived CBD products under the Lord Jones brand, new brand development and increase in headcount to support growth initiatives across a variety of functions. Overall, Cronos Group reported a decrease in net income from the prior year, primarily due to the non-cash impairment charges and the change in fair value of the financial derivative liability associated with Altria’s investment, which is described in more detail in the 10-Q. In the second quarter, the Company recorded a non-cash loss of $35.9 million related to the change in fair value of these financial derivative liabilities. Cronos continues to expect there may be significant reported earnings volatility, primarily driven by the fair value quarterly adjustments related to the movement for Cronos Group’s 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 Cronos Fermentation, the PEACE 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 disclose in our fourth quarter of 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 the material weaknesses, and have begun rigorous testing internally. The testing by our independent auditor is in process on certain controls and will progress on to testing the rest of the controls throughout the course of 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 U.S. 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 manual controls and realize efficiencies throughout our supply chain and operations. I continue to be encouraged by the work our teams are doing globally, both in our wholly-owned business and with our JV partners. With that, I’ll turn it over to Mike for closing remarks before Q&A.

[Mike Gorenstein:]

Thank you, Jerry. Despite unprecedented shifts in the global economy and the way we live, Cronos has remained focused on delivering on our priorities, and we are well-positioned to weather the storm. We are constantly assessing our consumers’ shifting needs. Whether our 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 as 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 a crucial role as we continue to scale our business. Cronos has always been a company of people that thrive in new markets, embrace change, and welcome hard problems. And by staying flexible, we are positioned to opportunistically create value as the landscape continues to shift. With that, let’s now open the line for questions.

[Operator:]

Your first question comes from the line of Tamy Chen with BMO Capital Markets.

[Tamy Chen:]

Hi. Thanks. Good morning, everyone. First question is, Mike, I think, you said previously that with respect to your broader strategy, one part of it is the sort of letting or waiting the industry kind of sort out, both in Canada and even the U.S., before you embark on larger moves. So, I just wanted to get a sense, where are you on that? I mean, has the industry sort of started to develop or mature a bit more where you are looking at possibly making some larger moves the business?

[Mike Gorenstein:]

Sure. So, 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 brands are unique products with -- and their relationship with consumers. And what we would want to see before making any larger acquisitions is stickiness of market share and carve out of different consumer segments. We haven’t really seen that happen yet. And I think the volatility in market share is something that continues quarter-to-quarter. What’s really important for us from ROIC perspective is knowing that we’re able to get something that hits the consumer needs that we can take across borders and really be able to scale and build a moat 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 point in time to make an acquisition versus continue to just build out ourselves. And the U.S., I would say, it’s really more of a regulatory question at this point. I think, you do see a little bit more of uptick in consumer relationships with brands. But, watching and being proactive about how the regulatory environment develops, and I think with a lot of the different developments around COVID likely accelerating our view of when we see legalization, I think that brings us closer to when we would be making one or more moves in the U.S. But, still given the restrictions, it’s not something that will happen immediately.

[Tamy Chen:]

And my follow-up is on the Israeli market. So, following your comments there, I notice that a number of your competitors in Canada are now also moving to import into the Israeli medical market. It’s actually become what seems to be more of a net importer rather than I think previously associations where that they would be a net exporter. So, I’m just wondering, does that affect your Israeli strategy, given your production hub that’s’ there? 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 if you’re able to kind of quantify how many patients are right now, what the possible size of the opportunity could be down the road?

[Mike Gorenstein:]

So, I think, Israel is an exciting market. And while we did originally think of it as something that we be used as an export hub, we have been and continue to be pleasantly surprised by the rapid growth in the medical market. 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 an interesting dynamic that we haven’t really seen in other markets. I think, from competitiveness on cost and price, 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 to really supplement what we have there domestically right now. I think just the conditions and environment in Israel make it just more advantageous to produce. So, I expect, we’ll continue to see rapid growth. We -- I think it’s too early to be able to provide any specific numbers. But, I do use the analogy that Canada a few years ago, where 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 readings in the Israeli parliament over a legalized -- more full legalization bill, I think we look at our domestic footprint as something that will be essential and give us a big advantage when we see legalization. And again, a smaller population but -- and while still early from a structural perspective, being able to go direct from producer to a store without any wholesalers should make it easier 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 full legalization is also something that we’re very focused on.

[Operator:]

Your next question comes from the line of Rahul Sarugaser with Raymond James.

[Rahul Sarugaser:]

Good morning, Mike and Jerry. Thanks so much for taking my question. As you know, we focus a lot on biology program. So Jerry, you referred to some increasing costs from experimentation. It’d be great to get an update on where those costs are being attributed, how is the scale-up going? Mike, is the timeline associated September of next year, or still hold.

[Mike Gorenstein:]

Sure. Thanks and good morning. So, I think the scale-up costs and there is some significant 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’s some work that was needed to do to take the facility from when it was used and still for pharmaceuticals under Apotex to converting it to be something that sits under C-45 is where some of the costs are. And we’ve been doing a number of runs and we continue to increase production. So, there are costs with that. But, I think it’s been doing well and the increasing cost is a positive because it shows we’re continuing to ramp up and figure out downstream processing. So, there will be costs as we build out the downstream processing, trains to be able to efficiently take the fermented cannabinoids and make sure that they’re just fungible in our supply chain. So that in September, we’re in a position where we can take cannabinoid from fermentation or we can take cannabinoids from extraction, and they seamlessly fit into the products we have on the market today and in the products that we have in our development pipeline.

[Rahul Sarugaser:]

And one very quick follow-up question, clearly there is an expansion in activity, and as the regulatory environment starts to get clarified, particularly on CBD, how do you see potentially expanding or extrapolating that program into the U.S.?

[Mike Gorenstein:]

Yes. It’s certainly a focus of ours and I think it’s not specific to CBD. There are other cannabinoids that we’re again focused on. And I think that similar to Canada, we do plan to expand things. And when you look at our setup 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 bring those products and those processes into the U.S. So, the products we believe that will win in the Canadian market, I think, it just further advantages us for when we ultimately enter the U.S. market. And 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 those, I think, it’s a much more powerful combination. So, the Canadian market, the advantage is being able to work with and specifically on the more controlled cannabinoid side. So, it’s with THC, THCV being able to work with universities, being able to have the type of infrastructure that we do and do that research is 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 will be something that meet consumer needs in the U.S. market.

[Operator:]

Your next question comes from the line of Andrew Carter with Stifel.

[Andrew Carter:]

I wanted to ask about the business and specifically Canadian adult-use business. Two quarters in a row where we’ve seen kind of gross margin really deteriorate. And I know, you mentioned lower pricing. So, I guess, a couple of questions. Number one, when will you see kind of stability for the gross margins on this business? And then, so you do employ third-party for flower costs. Are you upside down on costs? Are you seeing flower costs east at all?

[Jerry Barbato:]

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 -- to both market dynamics and our strategy which we believe is 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. As the price of third-party flower comes down over time, our margins will improve. And then, 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, as Mike talked about in his remarks, we are ramping up Cronos Israel’s business and have just begun sales in that medical market, which will have some impacts on our margins.

[Andrew Carter:]

And then, kind of stepping back and to kind of thinking about the Lord Jones business, it’s been hit pretty hard but especially you taking kind of an impairment, which means you kind of reviewed the business. What are kind of your expectations of that business, if you could provide any kind of long-term targets for that business, and does it grow in the second half or is 2020 just going to be a difficult year with all the challenges from COVID-19?

[Jerry Barbato:]

I think, we’re confident in the team and the go-forward business plans. But, the external impacts are difficult to predict. And that difficulty led to us 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, COVID-19 pandemic has had a significant impact on many of our customers who have experienced temporary store closures and some of them permanently closed, which has negatively impacted sales and demand quite frankly in the segment. So, for right now, it’s very difficult for us to predict what the rest of 2020 holds. Because as you see stores open in some states and localities, they are having to reclose and that what we -- what you really can’t figure out is what’s 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 to the store and the interactions and the number of people allowed in stores.

[Operator:]

Your next question comes from Seth Rubin with CIBC.

[Seth Rubin:]

Hi. This is Seth on for John Zamparo. Thanks to my questions. So, I guess, sticking to Lord Jones, are there some signs you can offset the loss in brick and mortar through online channels, either through direct-to-consumer or online retailers? And then, I guess, any update on Lord Jones from the CBD strategy overall would be appreciated.

[Mike Gorenstein:]

So, while on the surface, it may seem a bit disappointing that our U.S. business was flat quarter-over-quarter. COVID obviously had a significant impact on our brick and mortar sales. But, I would say, 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, in spite of having such little revenue to those retail partners, and then as we look forward, I mean, we feel confident in the plans that business has to correct the trajectory of that business, and are very excited to see what Summer will do to lead the business forward.

[Seth Rubin:]

And just a quick follow-up if I can, just on your capital allocation strategy looking forward. Could we maybe expect any significant CapEx projects in the pipeline?

[Mike Gorenstein:]

We’re always evaluating opportunities, but I think from the brand portfolio that we have, right now, we’re pretty comfortable with where we are from an infrastructure perspective. I think, outside of any acquisitions or further launches where we might want to backfill margin with CapEx, we’re pretty comfortable with where we are today. So, not much to be expected there.

[Operator:]

Your next question comes from the line of Vivien Azer with Cowen.

[Vivien Azer:]

I wanted to follow up please on Lord Jones as well. Certainly, some moving pieces in the quarter, in particular as we try to triangulate to normalized gross margins. So, on the one hand, you have the price reduction on your core offering, then as well as increased promotion. But, I would think that with the depletion that you’re seeing in the commodity market, there should be some kind of offset. So, is there any color you can offer if you kind of trying to normalize for all those puts and takes, distribution, price adjustments and commodity deflation, what the gross profit profile would have looked like?

[Jerry Barbato:]

Thank you, Vivian. So, yes, 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 COVID and our response to that pandemic. 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 costs. So, 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 COVID pandemic and the opening of retail stores. But, you’re absolutely right. I mean, some of our costs will be going down. So, the question is, is the offset by the premium pay? And from the revenue side, what happens with the retail environment?

[Vivien Azer:]

Understood. Maybe just as a follow-up on that a little bit more specifically. Can you contextualize what you’re seeing in terms of price deflation on the input for the Lord Jones product?

[Jerry Barbato:]

Yes. I think, certainly we’ve seen prices 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 accounting perspective, new product -- or sorry, new input would actually match the product that we’re selling, we do see it coming down. We think it could even come down further. But, it takes time for us to flush through the current CBD supply we have on hand.

[Operator:]

Your next question comes from the Michael Lavery with Piper Sandler.

[Michael Lavery:]

Your PEACE+ looking like it’s set to launch now in Arizona, California, Illinois and Pennsylvania, can you give a little sense of maybe how soon that’s coming, how broad of a launch it might be and why those states in particular?

[Mike Gorenstein:]

PEACE+ is still something that we’re monitoring the macro environment, whether it’s regulatory or just what’s happening with retail before aggressively expanding. And I think, when you look at our focus for the back half of the year, we’re really looking to different brands, so Lord Jones and then more mainstream skincare brand that would be where our attention is? Again, now having everything ready for PEACE+, we will be opportunistic time wise to make sure that when we see the right time and the right opportunity, we’ll move forward with it.

[Michael Lavery:]

So, is there not a set schedule to share?

[Mike Gorenstein:]

There’s not a set schedule. I think, it’s more of some timing, we want to make sure that we bring our brand to market first, and then having PEACE+ ready. We’ll start rolling it out after that.

[Michael Lavery:]

And just to follow up, I know, we’ve covered Lord 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. If there’s something beyond the COVID-19 pressure that you’re pointing to, has your thinking on the market changed, or is it more just a conservatism approach, or just kind of how you thought about that?

[Mike Gorenstein:]

It was a deep analysis that we looked at. And yes, there are some temporary pressures. And we haven’t 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 does COVID last? And then, how long does that impact on consumer behavior last? So, yes, I would say yes, we took a conservative approach. I just think with the COVID pandemic and a significant number of the company’s customers who’ve experienced closures and pressures on their business, when we did the analysis, the impairment, it was the logical thing to do.

[Operator:]

Your next question comes from the line of Bill Kirk with MKM Partners. Your next question comes from the line of Bill Kirk with MKM Partners. There’s no response from that line. Your next question comes from the line of Matt Bottomley with Canaccord Genuity.

[Matt Bottomley:]

Mike, just wondering if I could get some additional commentary on your views on brand building. Specifically, what’s happening in the Canadian market here where retail sales are obviously continuing to grow pretty healthily, whereas there is some dynamics with lessen inventory throughout this sector and how some of your peers are pricing. So, given the fact that a lot of your comparable peers out there with similar market cap, some of the larger names have a higher penetration, what’s your, I guess mix or tradeoff between having I guess more of a measured OpEx burn versus some of those peers, versus brand building and just even selling products today at a breakeven just to get product out there? Given that you can’t really advertise, and there’s not much differentiation, when you walk into these stores, maybe it’s not much of an issue. But just curious on how you think that’ll play out in the long-term as Cronos looks to build their own brands domestically?

[Mike Gorenstein:]

Sure. Thanks and good morning. So, that’s a great question. And, I think, first, I’ll say, when you think of brand building, we’re thinking on a global scale. And I think that while you can’t do 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 to what your packaging looks like and being able to put up billboards. And our approach to value-creation, I’ll use analogy of look at, say, the tobacco industry over 100 years ago. And if you go back and think about the early market, you could see something probably pretty similar to where we are today with the Canadian flower market, and industry participants 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 in tobacco leaf. It came from researching consumer needs and being able to develop a breakthrough consumer product, like cigarettes. And we believe the path to value creation for Cronos is similar. So, it’s continuing to focus on what that breakthrough product is, being able to bring it to market, and not only being able to bring that product to market in Canada but being able to then take that product and also launch it in Israel and the U.S. and other markets as full legalization comes on line. So, I think it’s important that we do have product in market that we have the sales and manufacturing infrastructure to be able to continue having relationships, so that we’re ready when we have differentiating products to 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 rare cannabinoids and different form factors in the products. But, I believe that building a brand off of essentially flower which is commoditized and given the restrictions and regulations in Canada, will be difficult. But, there’s still an opportunity from product differentiation. And that’s really what we need to be able to do. Until we have a product that’s different, I think consumers will be continuing to switch between brands and we need to provide something that’s better to consumer.

[Matt Bottomley:]

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 at, in order to fund those interim losses as we look for sort of longer term brand building at more differentiated opportunities or is there four to six months -- or four to six months quarter past wherever you’d like to obviously get that breakeven or above?

[Mike Gorenstein:]

Given the way that we’re set up and what we look at as end markets versus where we are today, the focus really is on what is a longer term return on invested capital versus when can we be cash flow positive. And I think that we are set up with a 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. 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 aren’t something that is providing a good return on the investments we make. But still, if anything that we see opportunistically -- or fits our strategic plan that we can make investments into, we’re going to continue to make.

[Operator:]

Your final question comes from the line of Graeme Kreindler with Eight Capital.

[Graeme Kreindler:]

I just wanted to get a bit more color regarding the change in the different segments on the Rest of World revenue quarter-over-quarter. I saw flower revenues more than doubled in the quarter while the extracts were down. So, I was just wondering whether that flower increase was driven by the exports to international markets, and wanted to get some more detail regarding the extract side of things, given the launch of vapes. Just want to get some more detail regarding what we’re seeing in that variance and what’s included in that broader category?

[Jerry Barbato:]

So, I think what you’re seeing, so at least Q2 of 2020 versus Q2 of 2019 is, while our revenue is relatively flat, we sold all of our products in the second quarter in the Canadian marketplace, either in the rec or medical channel, whereas in Q2 of 2019, 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-rolls, or even tincture oil and vapes on a quarter-over-quarter basis. I think there’s always going to be fluctuations in the mix.

[Mike Gorenstein:]

And just to add to that, I just want to point out a difference that if you’re comparing us to peers, because we have our own distribution in Israeli entity, when we export from Canada to Israel, that’s not something that shows up in revenue upon the export. It’s once the product -- branded product is 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 export in Israel and more of just Israel as operating company, where you’ll see revenue come from the same way you would see the Canadian revenue. And whether it’s imported or produced in Canada is really just a supply chain issue.

[Graeme Kreindler:]

And then, just one quick follow-up. I appreciate the commentary prior with regards to the USA segment, and its fluctuations in gross margin. Now, when looking at the adjusted operating loss over a quarter-over-quarter basis, that actually improved by about 15%. So, I was hoping to get a bit more detail with respect to the flat revenues, a decline in gross margin but profit figures actually increasing. Just wondering what’s driving that.

[Jerry Barbato:]

Yes. I think a majority of that is just related to 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.

[Operator:]

This concludes our question-and-answer session for today. Thank you for your participation. You may now disconnect.