Tilray Inc. (TLRY) Q2 2020 Earnings Call Transcript

Tilray Inc.  (NASDAQ: TLRY) Q2 2020 earnings call dated Aug. 10, 2020

Corporate Participants:

Raphael Gross — Investor Relations

Brendan Kennedy — Chief Executive Officer

Michael Kruteck — Chief Financial Officer

Analysts:

Vivien Azer — Cowen & Company — Analyst

Rupesh Parikh — Oppenheimer — Analyst

Pablo Zuanic — Cantor Fitzgerald — Analyst

Aaron Grey — Alliance Global Partners — Analyst

Michael Lavery — Piper Jaffray — Analyst

Graeme Kreindler — Eight Capital — Analyst

Tamy Chen — BMO Capital Markets — Analyst

Andrew Carter — Stifel — Analyst

Presentation:

Operator

Greetings, and welcome to the Tilray Second Quarter 2020 Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Raphael Gross. Please go ahead.

Raphael Gross — Investor Relations

Good afternoon, and thank you for joining us on Tilray’s second quarter 2020 earnings conference call and webcast. On with me today are Brendan Kennedy, Chief Executive Officer; and Michael Kruteck, Chief Financial Officer. Before we begin, please remember that during the course of our discussion, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. These statements are based on management’s current expectations and beliefs and involve risks and uncertainties that could differ materially from actual events and those described in these forward-looking statements.

Please refer to Tilray’s reports filed from time-to-time with the United States Securities and Exchange Commission and Canadian Securities Regulators, along with the earnings press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements. Finally, please note on today’s call, management will refer to adjusted EBITDA and gross margin, excluding inventory valuation adjustments, which are non-GAAP financial measures. While the company believes that these non-GAAP measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today’s release for a reconciliation of each non-GAAP financial measure to the most comparable measure prepared in accordance with GAAP.

Now, I’d like to turn the call over to Brendan.

Brendan Kennedy — Chief Executive Officer

Good afternoon everyone, and thank you for joining us. I will begin with perspectives on key industry headwinds and opportunities followed by an update on our business performance and forward outlook. Then Michael will review our second quarter financial results. Beside COVID, we have seen continued demand in the industry. Indications suggest consumers have transitioned reasonably well ordering on the various provinces’ e-commerce platforms, which has helped maintain product demand. We see the demand has been partially driven by the introduction of value-added cannabis product offerings which are becoming more affordable and accessible as licensed producers in larger provinces such as Ontario continue to increase their distribution and point of sale. Additionally, many privately operated retailers have ramped up curbside pickup, online ordering and delivery services to consumer.

One potential longer term outcome of COVID is that consumers may have a heightened concern for quality and safety, while being more interested in obtaining product from licensed retailers and licensed producers rather than the illicit market. This may lead to a faster migration from the illicit market to the legal market, which would be a positive for the industry. Additionally, cannabis has been recognized as an essential business in Canada, Germany, Portugal, Australia and multiple U.S. states. By recognizing this industry as essential it stabilizes and furthers the taste for legalization around the world, first for medical cannabis followed by Adult Use.

As we’ve believed from the beginning, the steady increase in the number of legal cannabis market supports our thesis that there is a significant global growth opportunity. This recognition validates our thinking that cannabis is a mainstream product consumed like other consumer staples. Turning the page to what has changed for Tilray; beginning in January 2020, we successfully refocused our business, right-sized our cost structures and have narrowed our focus to three strategic priorities. First, International Medical, a segment in which we have a proven track record and a potential to be one of the winners. We expect meaningful growth to continue on a quarter-over-quarter basis. In fact, we anticipate it will exceed our revenue in Canada over the course of the next several years.

Second, Canadian Adult Use, less than a fifth of the illicit market have converted to the legal market. This continues to present a significant opportunity for our business as additional consumers convert to the legal market. We also believe increased numbers of licensed brick-and-mortar retail stores, greater product assortment based on the introduction of 2.0 product and lower pricing on dried flower, will continue to encourage consumers to move to the legal market and present growth opportunities for our business. Third, Manitoba Harvest hemp foods, which provides us with a hemp product platform in the United States and 19 other countries around the world. We also evaluating our business and reduced our cost structure.

Many of these measures have already had a positive impact on our P&L, and we expect to continue seeing benefit for the remainder of 2020 and into for future years. It is important to clarify, our cost reduction efforts began during the first quarter before and unrelated to COVID. We anticipated the need to modify our business structure. We made plans and took aggressive actions ahead of our peer set. Many of this necessary, but time consuming measures are behind us. Our cost reduction efforts included the following: right-sizing our resources, and significantly reducing our SG&A expenses. This included eliminating or reducing contractors and third-party vendors, evaluating marketing hedges across all brands to ensure we drive revenue in key areas of growth.

Most notably, we completed a difficult process of reducing our headcount by 70%. We closed High Park Gardens, which was a high cost growth facility in Ontario. We also undertook other effort to increase operating efficiencies, which will result in future additional cost saving. Additionally, we focused on investments on our high-performing facilities in order to maximize yield and leverage our existing footprint and manufacturing capabilities to serve the international medical markets, Adult Use market in Canada and the hemp foods markets globally. We also took significant effort to clean up our inventory and write-down our destroyed product such as byproduct that are no longer feasible for the market, or are seeing values decline due to market dynamics. Finally, we have reviewed our portfolio of investment and taking appropriate charges based on expectations for their current potential future value.

By completing these actions we have better aligned ourselves with market demand and have position Tilray to drive towards adjusted EBITDA breakeven or profitability by year-end and generate enhanced shareholder returns going forward. None of these actions were taken lightly and none of them were easy. However, they were the right actions to take in order to position our company as a nimbler and cost-efficient business poised to realize the benefits of growing consumer and patient demand for our products in current and future markets. While implementing these changes we also had several significant accomplishments. We brought international production on the line at our EU Campus in Portugal. We are now able to take advantage of Portugal’s warmer climate, which is amenable to year round cultivation and a lower cost of labor.

Also at our Portugal facility, we received end-to-end good manufacturing practice certification in accordance with EU standards. Among other things, this allows us to manufacture Medical Cannabis Extracts in-house and export GMP produced finished medical cannabis products both dried flower and oil from Portugal throughout the European Union and to other international markets with legal medical cannabis regulations. To our knowledge, we are among the first in the cannabis industry to have successfully obtained a full EU GMP certification within the EU. We strengthened our balance sheet with the closing of a $60 million debt facility and an $85.3 million net equity offering. These two transactions provide us with sufficient capital to focus on our path to profitability.

We also released 30.5 million shares from the Privateer lock-up to reduce overhang and enables us to manage the increase to our public float in an orderly fashion. Turning to page, from what we had already accomplished to where we stand today; we are harvesting some of our first crops at scale from our facility in Portugal that can be shipped to other countries around the world. In Canada, we have integrated the Kindred sales force through acting as our business sales agent for all provinces and territories excluding Quebec. By leveraging the expertise and relationships we expect our distribution to grow in the adult use markets and the High Park’s diverse portfolio of brands such as CANACA, Chowie Wowie, and Marley Natural. We anticipate Kindred to expand the distribution and sales of both our existing product as well as our new 2.0 products for which we have been able to ramp up production and maintain significant — sufficient stock.

Notably, while we are aligning our production and product portfolio to address continued demand for high potency products, we’re also monitoring value consumer behavior closely and are contemplating further innovation for the batch to ensure our offerings meet consumer needs. While others have and will join us in this segment of the market we believe that cannabis like other CBD categories has room for several successful brands in each price segment and that few consumers are purely driven at this stage of industry evolution. Our current retail footprint estimate in Canada for 2020 is somewhere between 1,100 and 1,250 barring any unforeseen issues the COVID. This is towards the high end of our original estimate of between 800 and 1,200 and would be a positive catalyst for Tilray’s growth and the growth of the overall Adult-Use market in Canada.

Given industry dynamics and changing consumer behavior, we have reevaluated our supplier requirements and have taken steps to terminate or restructure supply contracts on favorable terms to Tilray. In all instances of resolving contracts we have eliminated any future purchase commitment. Due to increases in our own yields and productivity, we believe our Tilray facilities will be able to deliver most of our anticipated needs for the next 18 to 24 months and that any shortfall can be made up by purchases from third parties at attractive prices. We are set up for significant international success in growth in the coming quarters through the efforts of our dedicated and multi-disciplinary European team and our supply from our EU campus in Portugal. We will generate most of our near-term international sales growth in Germany.

We plan to continue the supply of flower and oil products from our facility in Portugal in enough volume to meet the market demand in a sustainable manner. We already have longstanding and strong relationships with pharmacies and cannabis distributors in the market and continue to build significant brand awareness among our patient population in Germany. We also expect to see continued growth in Australia, Latin America and other international locations. However, this growth will be up in much smaller starting base and currently exists in Germany. We see a significant opportunity in the medical market in France and continue to aggressively pursue potential market opening opportunities in other countries. In preparation, we have expanded our global Medical Advisory Board and are happy to welcome Dr. Anna Carballo who’s located in Portugal.

We continue to rely on the expertise and experience of our Medical Advisory Board as we work to further legitimize the medical cannabis industry based on research and data. Now turning to the second quarter, I am pleased to report strong financial results for our period ending June 30, 2020. Specifically compared to last year’s second quarter our cannabis revenues showed significant growth with International Medical up 349%. Canada Adult Use up 17%, Canada Medical increasing by 65% and our hemp products increased 2%. We also reported a meaningful improvement to our adjusted EBITDA. We recorded a loss of $12.3 million, which compares favorably to the adjusted EBITDA loss of $18.7 million in the first quarter of this year. With half of the year now complete, I am pleased to say that we just experienced our two best quarters in Tilray’s history despite changing industry dynamics and challenges brought on by COVID.

Now, I would like to discuss where we are heading. As we leverage the steps we have taken and direct our efforts on to our core businesses, we expect our next two quarters to be even better than the first two. Our goals to the back half of 2020 are to deliver additional revenue growth, better gross margins and breakeven or positive adjusted EBITDA in the fourth quarter. Absent any significant COVID-19 setbacks, we expect meaningful revenue growth in our International Medical market supported by additional growth from the Canadian Adult Use business. One of our objectives is for our revenue outside of Canada from International Medical and U.S. and international hemp foods to exceed Canadian revenue. We have seen significant growth in our International Medical during the first half of the year and expect that trend to accelerate in the back half of the year.

Our facility in Portugal will help support this growth internationally. During the next 36 months we hypothesize an additional 40 countries will legalize medical cannabis and four additional countries will take serious steps towards legalizing Adult Use cannabis, which will only add to our international opportunity. Certainly, the need for additional sources of government tax revenue may be a factor in this process. Many are speculating that the social unrest in the United States has furthered the case for legalization in cannabis reform nationwide. While we believe this is certainly true we also believe that reform at a federal level is largely dependent upon the election outcome in November.

Four states are voting on legalizing adult use cannabis Arizona, Montana, New Jersey and South Dakota. Three states are voting on medical cannabis legalization Mississippi, Nebraska and South Dakota. The inclusion of the medical measure on the ballot in Idaho is uncertain. In the meantime, we are focusing our U.S. strategy on building a portfolio of trusted CBD brand in states where we are legally permitted to do so, and we will address the Federal CBD market upon further clarity from the FDA. To conclude, we have positioned Tilray to be more efficient and successful in our key businesses global medical cannabis, Canadian Adult Use cannabis and global hemp product.

Given our footprint, we have a diversified source of revenue that has helped us maintain growth during the challenging time and positions us to achieve our ambitious goal to be one of the worldwide winners in our industry. We have strengthened our balance sheet and are squarely focused on our path to profitability. And we are pleased with what we have accomplished regarding our cost reduction. We will remain focused on building brands and creating products that resonate with our consumers and patients around the world enabling Tilray to become the most trusted cannabis and hemp company.

With that, I’d like to turn things over to our CFO, Michael Kruteck to review our financials.

Michael Kruteck — Chief Financial Officer

Thank you, Brendan and thanks to everyone joining us on our call and webcast this afternoon. Please note all the financial information we are discussing today was prepared in accordance with U.S. GAAP and is in U.S. dollars unless otherwise indicated. Second quarter revenues grew $4.5 million or 10% to approximately $50.4 million or CAD69.4 million compared to the same quarter last year. We experienced growth across all product channels excluding Bulk and realized significant ongoing improvement in our International Medical channel. Cannabis segment revenues increased 16% to $30.2 million or CAD41.5 million compared to $26 million or CAD34 million for the same period last year. The increase was driven by 17% growth in Adult Use to $17.6 million, 65% growth in Canada Medical to $3.8 million and 349% growth in International Medical to $8.3 million.

Bulk contributed $402,000 in sales compared to $6.7 million in the year-ago quarter. As previously indicated, we expect continued growth in both the adult use and medical sales channels for the remainder of 2020 and a decline in bulk sales as we focus on higher margin opportunities. We will take advantage of bulk sales on an opportunistic basis and in cases where it helps us rebalance inventory levels in certain products. The adult use growth was partially due to the launch of our Cannabis 2.0 products in December 2019. 2.0 products now account for approximately 22% of adult use sales and are expected to continue to contribute to the channel growth as we launch new form factors in the coming months. Adult use represented 58% of cannabis revenue in the second quarter of both 2019 and 2020. Canada Medical represented 13% of cannabis revenue in this year’s second quarter versus 9% in the year ago period.

And International Medical represented 28% of cannabis revenue in the second quarter of 2020 compared to 7% in the year ago period. As expected, bulk fell to 1% of cannabis revenue from 26% last year as we focus on opportunities to sell Tilray products to end users. Hemp segment revenue increased 1.6% to $20.3 million or CAD28 million compared to $19.9 million or CAD26.1 million for the same period last year. Until there is more clarity from the FDA on CBD in the U.S., we view the hemp segment, which is primarily our Manitoba Harvest business as a business that is likely to deliver modest top line growth. Segment revenue mix during the second quarter was 60% cannabis and 40% hemp compared to 57% cannabis and 43% hemp in the second quarter last year.

We expect to see a continued shift to higher percentage of cannabis in the coming quarters. On a sequential basis revenue decreased 3.2% from the $52.1 million achieved in our first quarter. This was driven by a 15.8% decrease in adult use sales, a 5.3% decrease in Canada Medical sales and a 5.1% decrease in hemp sales, all of which were partially offset by a 43.2% increase in international medical sales and a minimal contribution from bulk sales. In general, our quarter-over-quarter decline in adult use sales and Canada Medical was largely attributable to pantry loading we experienced in the month of March. This was one of the few measurable impacts to our business that we attribute to COVID. While April continued to exceed sales levels in January and February we saw a drop off in May and June, and were unable to offset the entire impact of the accelerated sales experienced during the March period. This was partially due to changes in purchasing behavior by the Canadian provinces, temporary store closures in Ontario, the shift to curbside pickup or delivery and the limited number of retail locations added during the quarter.

We estimate the March increase was responsible for approximately 14% incremental sales. During the quarter we also completed the transition to our outsource sales team Kindred, which resulted in a brief period of limited retail sales coverage. Early indications point to increased sales in the adult use channel as Kindred expands our business with existing accounts and establishes new points of distribution for our portfolio of products. Total kilogram equivalents sold increased 105% to 11,430 kilogram from5,588 kilogram in the prior year second quarter. This was largely driven by a one-time bulk transaction related to the settlement of a supply contract. Our average net selling price per gram of cannabis in the second quarter was $2.64, a 43% decrease or $1.97 from the $4.61 during the same period in 2019 and a 50% sequential decrease from the $5.28 during the first quarter of this year.

However, the $2.64 during the second quarter of 2020 was impacted by a one-time bulk transaction associated with the termination of a supply contract. Excluding the one-time transaction average net selling price increased to $5.03 from the same period in 2019. The increase was primarily due to continued growth of our International Medical business, a shift in sales to higher potency and higher-priced products and the continued growth of 2.0 products in Canada. Going forward, we expect our average selling price per gram to remain stable or increased over time as sales of International Medical cannabis continue to make up a larger percentage of our sales mix. Our average cost per gram sold of cannabis in the second quarter was $2.06 per gram a roughly 47% decrease from $3.86 during the same period in 2019 and $3.97 during the first quarter this year.

The decrease was impacted by the same one time bulk transactions associated with the termination of a supply contract. Excluding the one-time transaction net cost per gram decreased to $3.42. The year-over-year decrease is primarily a result of reduced cost structures at our facilities due to our cost cutting efforts, better throughput and cost absorption at our High Park Holdings processing facility and partially due to the availability of low-cost product available from third parties. Nevertheless, the closure of High Park Gardens, a high cost facility and increased grow volumes in Portugal where we have had limited cost absorption we expect to see cost per gram reduced over time as the full benefit of our cost reductions is realized.

We may see fluctuations as our facility in Portugal continues to ramp production and the percentage of third-party purchases varies in relation to our own product quantities. Gross margin for the second quarter including asset write-downs, and one-time charges, was negative 10.7% compared to 27% in the same period last year and 21% during the first quarter of 2020. During the second quarter this year, we wrote down $18.6 million of inventory, some of which was associated with the closure of High Park Gardens and some of which was the result of an exhaustive review of all products in stock, cannabis and hemp and a thorough evaluation of their potential use or demand in the market. This number also includes approximately $5 million associated with the write-off of a deposit for purchases from a supplier.

During the same period last year and the first quarter of 2020 we wrote down inventory valued at $200,000 and $4 million respectively. Based on the actions taken during the first half of 2020 we do not expect to incur additional material inventory adjustments in the foreseeable future. Gross margin for the second quarter excluding inventory valuation adjustments was 26%, which represented a 100 basis point decrease from the year-ago period and a 300 basis point decrease from the first quarter of 2020. The decrease was partially due to introductory shipments made at lower margins in our International Medical business and as previously indicated a one-time bulk transaction associated with the settlement of a supply contract. Excluding the one-time transaction gross margins excluding inventory adjustments was 32%, a 500 basis point increase from last year and a 300 basis point increase versus prior quarter.

Gross margin for cannabis excluding inventory valuations and adjustments decreased to 10% from 14% in the year-ago quarter and from 20% in the first quarter of 2020. Excluding the one-time bulk transaction previously mentioned cannabis margins were 20%, 600 basis points higher than prior year and flat to Q1 2020. Gross margins for hemp excluding inventory valuations and adjustments was 50% compared to 51% in the year-ago quarter and increased from 41% in the first quarter of 2020. The increase from Q1 is largely due to the timing of discount programs offered to our largest customer. Please recall, starting in 2020 we made the decision to stop attributing any cost value to byproduct at our High Park and Portugal facilities. This decision should reduce our need to make future inventory adjustments.

However, this decision has had the impact of increasing our cost per gram on the flower and derivative products that do have value. Moving to expenses, total operating expenses including non-cash impairment charges of $28.4 million were $70.4 million in Q2, a $25.2 million increase compared to the prior year quarter. Excluding impairments and write-downs second quarter operating expenses totaled $42 million and represented a $3.2 million decrease from the prior year second quarter and a reduction of more than $9 million from the first quarter of this year. The savings is even more significant if we compare Q2 to the annualized run rate of Q4 2019 and amounts to a $13 million reduction. This is demonstrative of the meaningful impact we have seen from the cost reductions Brendan mentioned earlier.

The details of the $28.4 million non-cash impairment charges incurred during Q2 includes $25.1 million related to the closing of High Park Gardens. This consisted of $13.6 million for land and buildings, $10.2 million for its cultivation license, and $1.3 million for foreign currency translation adjustments. Included in the non-cash charges was $3.3 million related to our separation from Smith & Sinclair. There were no asset impairments in the second quarter of last year. During the first quarter of this year, we had $29.8 million related to impairments. In relation to inventory adjustments, we do not currently envision additional material impairments. The expense reductions implemented have taken place across all aspects of our business and include headcount reductions of over 400 people as well as cost controls in all departments.

We are now focused on investing dollars in areas that will generate the highest expected return across the business. We do not believe we had cut costs or headcount to the extent they will have an adverse impact on our ability to meaningfully grow our business across all categories in 2020 and 2021. As Brendan indicated our efforts to reduce our cost structure were not prompted by the COVID situation. Our plans to right size the business were and are independent of any COVID impacts in the market. While these changes were difficult, we feel we have completed the majority of these measures and are in a good position to focus our outlook on future growth. Net loss for the second quarter, including inventory adjustments and impaired charges was $81.7 million or $0.65 per share compared to a net loss of $36.3 million or $0.37 per share in the second quarter of 2019.

The increased net loss was primarily due to the impact of the change in fair value of warrant liability and the impairment of assets. Excluding inventory adjustments and impairment charges net loss was $34.7 million, a $1.4 million improvement compared to Q2 2019 and a $116 million improvement versus Q1 2020. Adjusted EBITDA loss for the quarter was $12.3 million compared to a loss of $18.7 million in the second quarter last year. The improvement in the year-over-year adjusted EBITDA loss was due to higher revenues and lower operating expenses. On a sequential basis and despite moderately lower revenues attributable to COVID-19 our adjusted EBITDA loss reflected a 34% improvement from the $18.7 million loss in the first quarter of 2020 as we implemented our cost reductions and operational efficiencies.

This significant momentum reflects our commitment to achieving positive or breakeven adjusted EBITDA at the end of Q4 by continuing to grow revenues, improve margins and operate our business efficiently. Turning to the balance sheet, we ended the second quarter with cash and cash equivalents of approximately $137 million, a reduction of $37 million from the $174 million at the end of the first quarter of 2020. Due to restrictions associated with the warrants we issued in March of this year we had very limited access to our at-the-market or ATM offering program during Q1 and Q2. Given our existing cash balances, future access to the ATM program and increased efficiencies in our business we believe we have sufficient capital and access to future capital to manage our operations and execute our plans for the remainder of 2020 and into 2021.

We anticipate our cash flow needs for the remainder of the year to be approximately $45 million to $55 million, which primarily consist of operating cash needs of $15 million to $20 million plus interest in principal payments of approximately $15 million and capex of approximately $60 million. These numbers assume no meaningful additional impacts due to COVID and the remaining capex assumes completion of Phase 2 in Portugal during 2020. We did experience some COVID-related construction delays in Portugal during April and May, but are still expecting completion this year. However, if we experience future construction delays later this year due to COVID-19 they may impact our total capex spend for the year. It’s important to note that during the quarter and subsequent to the quarter we aggressively reduced our future purchase commitments.

This reduction is the result of renegotiating and/or terminating several legacy supply contracts with out-of-market terms. While some solutions required certain cash payments, given existing market dynamics and projections of future available supply and pricing the final outcomes were favorable to Tilray. As Brendan outlined at the beginning of the call, we are focused on our path to profitability. We made significant changes to our business during Q1 and Q2 to strengthen our position as a leaner and more efficient leader in the cannabis and hemp industries. These actions while difficult and time-consuming, are largely behind us, which will now allow us to focus on future growth. We are now keenly focused on growing our revenue.

In particular, we expect to see meaningful growth in International Medical where we already have the proven track record, additional growth in adult use from our existing 2.0 Product and new form factors and from leveraging our Kindred sales force and by expanding the presence of hemp products at existing and new brick-and-mortar and online retail outlets. As we increased sales we are now positioned to realize the benefits of our new cost structure. Looking ahead, we remain focused on achieving significant revenue growth and a level of profitability that supports our growth initiatives.

We believe the cannabis industry is still in its early stages and that meaningful revenue opportunities exist and will continue to surface as additional countries legalize medical and/or adult use cannabis. We also believe there will be revenue opportunities for CBD in the U.S. once the FDA provides more clarity on nationwide regulations. We fully expect Tilray to have a substantial and profitable presence in our existing and future markets for cannabis and hemp and we believe we have taken significant actions to position Tilray to achieve this goal and be recognized as the most trusted cannabis and hemp company.

Brendan and I are now available to take your questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Vivien Azer with Cowen. Please go ahead.

Vivien Azer — Cowen & Company — Analyst

Hi, good evening. Thank you.

Brendan Kennedy — Chief Executive Officer

Hi Vivien.

Vivien Azer — Cowen & Company — Analyst

Hi. So my first question is a high level one on your production strategy; so Brendan, you called out a couple of things. So you’re setting down High Park Garden, high cost. That makes sense. But then you noted that you’re — it seems like there might be a lack of external supply that’s high quality and at the same time you’re making these bulk sales and terminating supply agreements. So I’m just trying to piece all this together. Like you obviously want to avoid cultivating internally at too high a cost, but what gives you confidence that there is actually adequate supply to supplement that, in particular given what you’re doing with your supply agreements? Thanks.

Brendan Kennedy — Chief Executive Officer

Yes, so when we look at our facility in Portugal and our facility in Enniskillen, Ontario what we’ve seen over the last six months is that our yields in — from Enniskillen have increased significantly based on some improvements that we made to the facility, really starting about a year ago and those improvements were completed in Q1. And so we’re seeing two things at that facility; significantly higher yield as well as significantly higher potency from that facility. And so that gives us confidence that our internal cannabis supply from three different facilities in the Nanaimo, Enniskillen and Portugal will enable us to meet the demand that we see over the course of the next year.

Vivien Azer — Cowen & Company — Analyst

Okay, that’s helpful. Thank you for that. Moving to the adult use market in Canada obviously, COVID, very challenging operating backdrop for you guys in the industry as a whole. But I am curious about how big of an impact COVID really was because obviously, it’s still early in reporting season but some of your peers did actually break out also adult use revenues. We didn’t see the same kind of softness in their work as many COVID-specific call outs at least thus far for Canadian cannabis earnings. So I guess the question is, how do you feel about your positioning in the value and deep value, the segments? Do you feel like you won your fair share of that segment? Thanks.

Brendan Kennedy — Chief Executive Officer

I think it’s yet to be determined. I think it’s a segment that we saw emerging really starting in August of 2019. And we were one of the first to enter that segment. Yeah, I think that there’s still a lack of brand loyalty within certainly — within that segment in cannabis. But I think it’s probably early to determine what our eventual market share will be. In terms of COVID, I think the — the biggest impact of COVID was the pantry loading we saw really across and adult use and Canadian Medical at the end of Q1 where you saw online ordering at the OCS and we saw online ordering within our medical patients increase significantly in March. And that led to some high inventories at places like the OCS at the end of March and some of those provinces have worked through that inventory in Q2.

Vivien Azer — Cowen & Company — Analyst

Perfect. That’s helpful. Thank you. I’m going to squeeze one last one in. Clearly the bright spot on the quarter was International Medical, very impressive that in six months time you guys have been able to double your revenue base and obviously led by Germany, I really appreciated your comment Brendan about over the coming years Germany actually surpassing Canada. I mean, from a population standpoint alone, like that makes a ton of sense. But I’m curious what you’re seeing kind of in the last three months, maybe it’s six months. I know one of the problems that the German market was having was that under supply was starting to be a limiting factor in terms of doctors really embracing prescribing cannabis. So have you started to see that evolve or are we still like getting the medical community comfortable with a more robust supply chain in Germany? Thanks.

Brendan Kennedy — Chief Executive Officer

Yeah, I think there have been significant — well, I’ll step back in terms of how you frame the question. I think one of the things that’s important to note is that in the first two quarters of this year our International Medical exceeded our International Medical revenue for all of last year. And we expect that trend — that significant growth on International Medical to continue in Q3 and into Q4. And so that’s a trend that we think is really positive and we’re doing everything to ensure that — I think we can to ensure that we continue to significantly grow that International revenue. There had been some supply issues in Germany. One of the legacy suppliers has been unable to supply product over the course of — part of Q1 and into Q2 and so that’s a big opportunity for us.

We are starting to see both the number of — well, I shouldn’t say starting, we are continuing to see the number of patients who have prescriptions increased and we’re continuing to see the number of doctors who are writing prescriptions increased, although it’s still off a relatively small base and that just takes time. It takes time to educate patients. It takes time to educate physicians in the emerging medical market. We’ve seen the same thing in Canada four years ago. We saw the same thing in Australia over the last two to three years. And so we know how to do it, we know how to educate physicians. We know how to educate pharmacists and we know how to educate patients and so that’s just a process that we’re marching through.

Vivien Azer — Cowen & Company — Analyst

That’s great. Thank you so much.

Brendan Kennedy — Chief Executive Officer

Thanks Vivien.

Operator

Our next question comes from Rupesh Parikh with Oppenheimer. Please go ahead.

Rupesh Parikh — Oppenheimer — Analyst

Good afternoon. Thanks for taking my questions. So I wanted to ask a question just on gross margins. So you broke out separately the cannabis and hemp margins I believe for the first time, so I just wanted to understand how you guys are thinking about both going forward?

Brendan Kennedy — Chief Executive Officer

Hey, thanks Rupesh. So on the gross margins for cannabis, I think we do continue to see expansion of the gross margins as we see the International Medical make up a higher percentage of our cannabis actual sales. And when we talk about the hemp, I think that we’ll probably see that fluctuate depending upon what kind of discounts and other things that we offer to customers in that particular space, but we do see that between — go up 40% and 50% consistent margin moving forward for hemp and that’s exclusive of any kind of real CBD activity in that particular space, but — and on the — so I think that’s the two pieces of it.

Rupesh Parikh — Oppenheimer — Analyst

Okay. In cannabis, what’s the expectation for that going forward?

Brendan Kennedy — Chief Executive Officer

Cannabis, I don’t — we necessarily have an expectation. I mean, we’re kind of seeing how fast we get growth out of the International Medical market. We’re trying to monitor what’s going on relative to pricing. Again, we think we’ll probably see a couple of 100 basis point expansion in that — a couple of 100 basis point expansion in that on a quarter-over-quarter basis is what we’re looking at for total margins inclusive of that.

Rupesh Parikh — Oppenheimer — Analyst

Okay, great. And then on the Canadian rec side, you guys really expect it to remain in the back half of the year? I mean how do you think about the improvement driven by flower versus 2.0? Do you expect Cannabis 2.0 to have a bigger impact or flower? Just any thoughts in terms of how you guys are thinking about that growth in the back half of the year?

Michael Kruteck — Chief Financial Officer

So generally, and Brendan, I don’t know if you’ve got some things on this, but generally speaking, I think that we’re seeing good growth coming out of the 2.0 products. We did see good quarter-over-quarter growth on a sequential basis. In our vapes in particular, we saw roughly 12% growth on that. And so, I’d say that we continue to see solid growth in that. We do see good growth in the packaged flower although it’s just — I think it’s moderating relative to the 2.0.

Brendan Kennedy — Chief Executive Officer

Hi Rupesh, I’d just add that we do have a number of 2.0 products in our pipeline that we anticipate launching here in Q3 and into Q4. And so we had we had built a 2.0 product portfolio, starting, gosh, two years ago and so there are a number of product where we thought we would see more competition at this point and we don’t, and so we have a number of products that we’ll launch in really in the coming weeks.

Rupesh Parikh — Oppenheimer — Analyst

Great. Thank you for all the color.

Operator

Next question comes from Pablo Zuanic with Cantor Fitzgerald. Please go ahead.

Pablo Zuanic — Cantor Fitzgerald — Analyst

Thank you and hello everyone. Just wanted to follow-up on the international front — the concern that Germany is developing so slowly and then we hear a lot of companies talking about supply in that market. So is there a reason that that market will actually be oversupplied in the next six to 12 months. On that and along those lines if you can talk about — you’re going to ship from Portugal, lower cost than say shipping from Germany from Denmark or producing in Germany or shipping from Canada. But how much of that advantage are you able to retain in terms of profit margins? And if cost in Portugal is so much lower why won’t you be able to have much higher share? Just trying to connect all those dots there; potentially oversupply, how does that play out for you compared to other companies? Thanks.

Brendan Kennedy — Chief Executive Officer

So when we looked at the patients — we you look at patient counts in Germany and we look at the growth of patients in Germany compared to medical patient count in Australia and in Canada back in 2014, ’15 the curve, the adoption curve in Germany is actually accelerated compared to Canada and in Australia. And so we do expect to see continued patient growth there, obviously much higher, 2.4 times the population. So eventually it will be a much larger medical market. We have seen a number of competitors either seize European operations or significantly cut back European operations and so that leaves us optimistic about our opportunity to capture market share within Germany.

Pablo Zuanic — Cantor Fitzgerald — Analyst

If I can have a follow-up there? Just on the EBITDA target being positive or breakeven by the fourth quarter what type of sales increase would you need to see or are you — to breakeven or do you still plan further cost cuts? And on a separate topic, I think you mentioned and I know you’re shifting to a broker or a third-party distributor to sell in Canada. If you could give more color on that and whether there will be any disruption or how does it help your business? Thanks.

Brendan Kennedy — Chief Executive Officer

Maybe I’ll take the second part of that question first. So, we integrated a sales broker called Kindred. And so we’re using their sales force who are acting as our exclusive agents for all provinces and territories except for Quebec. And so we made that transition in the middle of Q2 and so we’ve — obviously spend a lot of time educating and ramping up that sales force and what that does is it gives us much broader reach in Canada. So prior to that transition we had about 18 people on that sales on our own internal sales team and Kindred has at least probably two sales staff. And so that will not only increase the frequency at which we interact with the various provincial distributors and individual retailers, but also increase the scope. So the number of retailers that we can interact with on a daily, weekly, monthly basis and so that transition did take place in the middle of Q2 and we do expect that to drive revenue growth within the adult use market in the second half of the year.

Pablo Zuanic — Cantor Fitzgerald — Analyst

Michael, on the EBITDA question?

Michael Kruteck — Chief Financial Officer

Yeah. So I’d say, to the point that Brendan is making about the distribution in the Canada adult use market is that we do see growth in that market. I’d say that it’s not exceptional growth but it’s certainly solid growth coming from Canada Direct. Where we see the accelerated growth coming is from the International Medical and I think we’ve been pretty consistent about saying that we expect that to be a pretty significant growth opportunity for us as we move forward. I hesitate to put numbers out there right now in terms of what kind of percentages we’re talking about. We’re working towards all the things that we need to get to EBITDA positive or breakeven and that’s inclusive of the cost cuts that we’ve got. We should see some benefit as we move into the back half of this year foreseeing the full impact of the cost cuts that we have implemented and not necessarily just a partial amount of those as we did in Q1 and Q2. So I think that we’ve got some moving parts that if we — if our revenue expectations are not necessarily met, I think that we’ve got some avenues that we would look to go down and try to still make that happen, or if we see the revenues start trending to what we think they should, is that we’ve got an opportunity to maybe make some additional investments in the company elsewhere.

Pablo Zuanic — Cantor Fitzgerald — Analyst

Got it. Thank you.

Operator

Next question comes from Aaron Grey with Alliance Global Partners.

Aaron Grey — Alliance Global Partners — Analyst

Hi, good evening, and thanks for the question. So my first question comes along lines with Manitoba. I know it seems like it’s kind of your third in terms of rank order for top-line opportunities. But the last quarter you talked about increased demand from Costco and Amazon. So just would like to get some more color in terms of how that business has been evolving, kind of how you see that growth opportunity over the next six to 12 months? Thanks.

Brendan Kennedy — Chief Executive Officer

Yeah. So Manitoba Harvest, I think that we see that as a kind of a top line moderate growth story, it’s despite the distribution that we might get, that’s just a larger business right now that’s fairly well-established that takes other significant distribution to really change the growth profile. So I’d say that we just see that as kind of a stable growth type of a business going forward, kind of in the range where it’s been.

Aaron Grey — Alliance Global Partners — Analyst

All right, great. Thank you. And then just one more from me then. Just in terms of the ASP and I guess it goes as well to the gross margin profile, that’s kind of been asked about earlier. As we look for the additional sales from International, I know you said — in this quarter it was kind of impacted from some introductory shipments at lower cost. So kind of how quickly can we see that kind of evolving kind of juxtaposed against kind of potentially lower value offerings at the Canadian adult use market side? It seems like with the expense growth you’re expecting to continue more on the International side that there should be a nice lift. But how do we kind of think about that as like — continues to evolve and you potentially do use some third parties as well on the Canadian side, just to kind of think about the puts and takes there on the gross margin? That’d be helpful. Thanks.

Michael Kruteck — Chief Financial Officer

Sure. So let me talk about average selling price. So in Europe and the International Medical we’re seeing average selling price inclusive of all the markets in which we sell in and it’s probably the $9 range or so, $9 to $10 range. And I think that we see that — there may be some pricing pressure on that as we kind of move into the year. Germany, just as there is some more market entrants trying to gain some share as well as we start to introduce some new product offerings, they’re lower THC potency. On the Canada rec, I’d say that we have seen — actually we’ve been pretty consistent with our pricing.

We haven’t really been driving pricing down, like a lot of other people have. We’ve been trying to manage the margin and pricing question there, as well as the product offerings. And when I look at kind of the sales by potency, we’ve seen a pretty significant I guess growth of sales of higher potency for us in the marketplace to the tune of, I mean we’re roughly — in terms of high and mid potency, we’re in the 30% for high potency, 48% for mid potency and probably 12% in the low potency right now. So we’re trying to manage that margin equation in Canada so that we can do that as a profitable business as opposed to just a market share and a revenue business.

Aaron Grey — Alliance Global Partners — Analyst

All right, great. Thank you. That’s helpful.

Operator

Next question comes from Michael Lavery with Piper Sandler. Please limit yourself to two questions.

Michael Lavery — Piper Jaffray — Analyst

Thank you very much. Just wanted to follow-up a little bit on the EBITDA piece and the positive to — breakeven a positive. I know you touched on some of the thinking around the revenue piece of that, but can you give some color on what are the keepings to watch, how much are the cost pretty well set versus the — if all just — driving the revenue, making sure you drive the revenues the right way. Are there some other flex factors? What’s most important for you when you’re watching that and how confident are you in being able to hit that by the end of the year?

Brendan Kennedy — Chief Executive Officer

Sure. Thanks. That’s a good question. So when we look at the cost reductions, those are pretty well set at this point. There may be some marginal additional things that we do just to optimize the business in certain areas. But in general, when I look at all the cost areas we’ve taken roughly 32% out of our cost structure and that’s everywhere from employee cost to sales and marketing, professional fees, public relations, and it’s across the board. And so, when I look at that in terms of how it breaks down, we’ve actually — if you compare it to a run rate of Q4 last year, we’ve achieved $15 million of that and we see the rest of that dropping to the bottom line in Q3 and Q4 timeframe. So that’s roughly, I mean we’ve roughly reduced our SG&A spend somewhere in the range of $50 million a quarter to $30 million to sub $30 million a quarter. And so, I’d say that that’s pretty well set and what we would be looking for is the top line growth to leverage those costs now.

Michael Lavery — Piper Jaffray — Analyst

Okay. That’s really helpful. And just a follow-up on Europe, I know you said it would outpace other segments and be a growth driver. I guess just maybe to help us not get carried away in our modeling; any other color you can give? Is there introductory pricing we should watch out for either to new customers or channels or countries besides Germany or anything just to help give a sense of how to frame a little more precisely what the back half looks like?

Brendan Kennedy — Chief Executive Officer

Yeah, so I don’t think we have more of the introductory to pricing type of thing coming our way. We’re more focused on the actual pricing into normal market channels at this point and we’ll continue along those lines. So I’d say that, like I said, I hesitate to just give out kind of a number. I think that we’ve talked about previously, something in the $40 million to $45 million, $50 million range for that business. And I still think that that’s kind of where our eyes are headed. And we’d like to see try to make that happen.

Michael Lavery — Piper Jaffray — Analyst

Okay, thank you very much.

Operator

Next question comes from Graeme Kreindler with Eight Capital. Please limit yourself to two questions.

Graeme Kreindler — Eight Capital — Analyst

Yeah, hi, good afternoon. I had a question. Brendan, I’d be curious your thought — you mentioned in the prepared remarks about the U.S. CBD market and specifically with the hemp business, how the real meaningful growth will, it really comes from getting some regulatory change, particularly from the FDA. So I was wondering as it relates to the upcoming election and there’s a lot of eyes on what that might do on the THC side; is there anything that you’d potentially could see as meaningful coming out of that with respect to unlocking incremental value from the CBD side? Thanks. The upcoming election and there’s a lot of eyes on what that might do on the THC side; is there anything that you’d potentially could see as meaningful coming out of that with respect to unlocking incremental value from the CBD side? Thanks.

Brendan Kennedy — Chief Executive Officer

That’s a good question. Yeah, oddly, I’ll say at this point it seems like there’s a good chance in the U.S. that we may have some clarity on THC before CBD or perhaps they have — perhaps they’d come concurrently. But I have — I’m taking myself out of the business of trying to predict anything having to do with timing and the FDA and so I don’t really have a great answer for your question other than I remain extremely optimistic about THC and clarity between the federal government and state governments related to THC in the coming 18 months.

Graeme Kreindler — Eight Capital — Analyst

Okay, alright, appreciate that. And as a quick follow-up, just with respect to the hemp business there and as you’re navigating the environment now with the lock-downs and the reopening. Is there any color you can provide with respect to how much of the sales mix; why is it e-commerce versus how much was in-store or how that’s deviated from historical? Just be curious to get any additional color in that respect. Thanks.

Brendan Kennedy — Chief Executive Officer

I don’t, I don’t.

Michael Kruteck — Chief Financial Officer

Sorry, go ahead Brendan.

Brendan Kennedy — Chief Executive Officer

I was just going to say that we’ve seen — in terms of Manitoba Harvest we’ve seen really strong business with both Amazon and the Costco and we saw that in Q1 and we saw that continue into Q2.

Michael Kruteck — Chief Financial Officer

I don’t have the details on the split so my apologies for that. I don’t have that data in front of me at least. I can certainly get it for you.

Graeme Kreindler — Eight Capital — Analyst

Okay. I can follow-up after offline. Thank you.

Operator

Next question comes from Tamy Chen with BMO Capital Markets. Again, please limit yourself to two questions.

Tamy Chen — BMO Capital Markets — Analyst

Thanks for the question. I just wanted to go back to Canada rec for a second. So just wondering if you can just give bit more detail as to how you intend to resume growth in that segment because this quarter it was a sequential decline, anyways? And right now in that market it appears the only way to grow share, even if it’s short-lived before someone else competes on price, is to get more competitive in that our hard value segment. So it seems that you’re trying to manage to not go aggressively there. So I just want to understand how you’re thinking about how to manage your trajectory and your performance in that segment in the face of this apparent trend in the industry?

Brendan Kennedy — Chief Executive Officer

We’ve seen — we expect to see increases in distribution through our relationship with Kindred, which gives us greater reach and a greater frequency interacting with the respective provincial buyers and retailers. And we’ve seen healthy growth in 2.0 product revenue growth and we expect with the additional 2.0 skews that we’re launching, it’s somewhere between half a dozen and a dozen. We expect to see continued growth in adult use. We expect to see growth in the adult use in Q3 and Q4.

Tamy Chen — BMO Capital Markets — Analyst

Okay. And specifically on the 2.0 product launches. As far as I — I missed this, I don’t think I saw it in the press release or heard earlier on the call, but I was wondering if you’re able to give additional color on the timing for THC beverages for you? When that might be coming to market? It seems like there is good demand in that category. Thanks.

Brendan Kennedy — Chief Executive Officer

There is good demand. The team at Food and Beverage would be better equipped to answer that question. So I would point to Jorn [Phonetic] to answer it. I know they’re working on it and they’re optimistic about their ability to produce those products.

Tamy Chen — BMO Capital Markets — Analyst

Okay, thank you.

Operator

Next question comes from Andrew Carter with Stifel. Please limit yourself to two questions.

Andrew Carter — Stifel — Analyst

Thanks. I’ll keep my question to one. I guess in — here you’re reiterating positive EBITDA guidance. In the quarter it’s — all the EBITDA improvement was driven by lower SG&A. It was actually lower or it was actually worse, you can consider low SG&A. So I’m just guessing, with the gross margin seemingly it’s not on track for improvement — if I heard Michael correctly earlier in the call you’re not even looking for that much of an improvement from the 10% level. I guess what provides you the incremental confidence of getting there to adjusted EBITDA. And can you give us kind of a revenue target for the year to get you there? Thanks.

Michael Lavery — Piper Jaffray — Analyst

Yeah. So I think that I did indicate that there would be improvement on the margins 100 basis points to a couple of 100 basis points. And then in terms of revenue target, I don’t think that we’re going to give that kind of specific guidance right now just due to a lot of moving issues in the marketplace. We’ve got a plan in place that we think delivers what we need to come at the EBITDA breakeven or positive and we’re working towards that. But I just don’t think that it’s prudent right now to be giving specific revenue target guidance.

Andrew Carter — Stifel — Analyst

And just I guess, a clarification I did hear the 100 basis points to 200 basis points, but is that off the 10% adjusted gross margin for the Cannabis business or is that for the overall gross margin for the Tilray business?

Michael Kruteck — Chief Financial Officer

Well, I mean, I think it’s largely driven by cannabis. It’s not necessarily going to be driven by Manitoba Harvest. I think we indicated that the Manitoba Harvest business margins would be in that 40% to 50%. So it’s going to fluctuate there based upon on how we approach the marketplace for discounts there. So I think that when we talking — and that’s where it’s been historically in last couple of quarters. So I think when we look at the business in cannabis is that we see some improved margins there from the growth on the International side of things, we see the growth in margins relative to Canada adult rec based upon 2.0 products and the mix of products that we continue to sell. And I think we just — and I’d say that the Q2 margin was quite low based upon some — that one time bulk transaction that we indicated and so that won’t be replicated. And so I think that we’ve got some improvement that we’ll see in the back half of the year.

Andrew Carter — Stifel — Analyst

Okay, thanks.

Operator

I would like to turn the floor over to Brendan for closing comments.

Brendan Kennedy — Chief Executive Officer

Great. Let me end our discussion tonight by expressing my appreciation to the entire Tilray team for obviously due to improved the lives of our customers through the power of hemp and cannabis. Thank you all for your interest in our company, your participation on tonight’s call and your thoughtful questions. Have a good evening.

Operator

[Operator Closing Remarks]