Cronos Group Inc.
Q1 2021 Earnings Call Transcript

Published: 7 May 2021

[Operator:]

Good morning. My name is Paulie, and I will be your conference operator today. I would like to welcome everyone to the Cronos Group 2021 First Quarter 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, sir.

[Shayne Laidlaw:]

Thank you, Paulie, and thank you for joining us today to review Cronos Group's 2021 first quarter financial and business performance. Today, I am joined by our President and CEO, Kurt Schmidt; our CFO, Jerry Barbato; our Executive Chairman, Mike Gorenstein; and our EVP of Legal and Regulatory Affairs, Xiuming Shum.

[Kurt Schmidt:]

Thank you, Shayne. I want to open the call up by saying thank you to our global team for their continued and relentless effort to help Cronos become a leader in the markets we operate in. Despite not being quite at the end of the fight against COVID-19 and varying degrees of vaccine availability across the markets we operate, I'm hopeful we can find a path towards a more normal life in the near future. We are grateful to our team for their creativity and ingenuity and growing our business and pushing forward no matter the circumstances.

[Jerry Barbato:]

Thanks, Kurt, and good morning, everyone. Turning to our financial results. The company reported consolidated net revenue in the first quarter of 2021 of $12.6 million, a 50% increase from the prior year period. Revenue growth year-over-year was primarily driven by the growth in the adult-use Canadian cannabis market, sales in the Israeli medical market, and growth in our U.S. hemp-derived CBD business, partially offset by strategic price reductions on various adult-use cannabis products in Canada taken in the second half of 2020. Consolidated gross loss for the first quarter of 2021 was $3 million, a $3.5 million decrease in losses from the first quarter of 2020. The improvement versus prior year was primarily driven by an increase in net revenue and a decline in inventory write-downs in the Rest of World segment. Adjusted EBITDA loss for the first quarter of 2021 was $37.1 million, increasing marginally from the first quarter of 2020. The marginal increase in losses year-over-year was primarily driven by an increase in sales and marketing spend due to brand development in the U.S. segment and an increase in R&D driven by spending on product development and developing cannabinoid IP, partially offset by decreases in sale and marketing spend in the Rest of World segment, gross loss, and general and administrative expenses

[Kurt Schmidt:]

Thank you, Jerry. This quarter we continue to execute our strategy and grow despite the ongoing impacts of the pandemic and we're incredibly motivated to keep this momentum building throughout our organization. With a focus on supporting our regional strategies and supporting our R&D and innovation work on the brand level, we continue to push forward with innovative products and unique marketing campaigns. With that let's now open the line for questions.

[Operator:]

. And your first question comes from the line of Rahul Sarugaser with Raymond James.

[Rahul Sarugaser:]

So I guess my first question really is primarily around biosynthesis. Kurt, you highlighted that as a key milestone specifically the Health Canada license which of course was important. So I guess my first question is what do you mean by research scale of CBG, what scale are you looking to get to? And what cannabinoids can we expect to see next and timelines to seeing these cannabinoids incorporated into your commercial products?

[Kurt Schmidt:]

Yes. So thank you for the question. We're going to move from -- obviously, we're making a small R&D pilot scale. We're now moving into the Winnipeg facility to produce at scale, which will allow us to launch products into the Canadian market on our first molecule which is the CBG, correct as you said. So we are looking at the sequential nets -- As we've stated before, we have about 7 separate molecules that we're developing with Ginkgo and they will rollout sequentially over time as we move forward, CBG being the first. We also mentioned our focus will be on the rare cannabinoids to begin with because we feel that brings the most interesting part of the product line, the most differentiation and value-added products that we can bring to consumers. So we want to focus on those first versus the major cannabinoids of CBD and THC.

[Rahul Sarugaser:]

So I guess maybe my follow-on question then is given that Cronos is sort of as far as we know, the only cannabis-specific -- cannabis company with its own fermentation capabilities that is driving these products. So how do you see this as a competitive advantage somewhat as being unique to the sector but also translating that capability as you build out your U.S. sales infrastructure?

[Kurt Schmidt:]

Yes, couple things. One of them obviously by building up this capability at our Winnipeg facility, we're learning what it takes to produce these things that scale, to produce the cannabinoids at scale which is an important art. So that's the manufacturing expertise to go with the innovation expertise. Obviously, we've always used Canada as a development platform for a potential entry into the U.S. on some of these products. So that gives us that leg up as we want to enter the U.S. eventually, and so both on the CBD side and the adult-use side. So it's vitally important from that aspect. And, Mike, I don't know if you want -- you've been early on, on this one, whether you want to add some comments to this.

[Michael Gorenstein:]

Thank you. Yes, I'd just add, one of the things we're excited about now being able to start ramping up in Winnipeg is, our focus is on getting these products with the rare cannabinoids out early and quickly in Canada so that we can see how they perform, we can get learnings. So -- given the timeline we expect in the U.S., we'll be able to launch these products with a lot of information in the U.S. market as we're able to access it with expected federal permits ability coming in the near future.

[Rahul Sarugaser:]

Well, congrats on that progress.

[Operator:]

And your next question comes from the line of John Zamparo with CIBC.

[John Zamparo:]

I wanted to ask about gross margins and in particular, the cadence of gross margins over the next year or so in the Rest of World segment and really what's required to get these to a level closer with most of your peers. Is it just that there is a certain minimum threshold of sales you need to cover fixed costs or is there some element of forward purchasing commitments that needs to roll-off? Any color there would be appreciated.

[Jerry Barbato:]

Yes. Thanks, John. So we're still going to see fluctuations in gross margin as price and mix change from quarter to quarter. And the mix changes are reflective, not only of product mix but also of revenue mix between Canada and Israel. And as you stated in your question, our Q1 margins suffered a bit as revenue slowed sequentially, and we have a high fixed cost base into our Stayner facility, but we anticipate that these pressures will ease over time as our revenue base grows and our manufacturing and purchasing teams refine processes and prices stabilize both in the wholesale market and on the shelf.

[John Zamparo:]

And then my second question is on M&A and we've seen a pretty noticeable increase in M&A in the Canadian space. I'm curious if your view has changed at all here to the point where you would look at any Canadian assets and how should we think about the U.S. M&A strategy pre any steps towards legalization?

[Kurt Schmidt:]

Yes. Thanks, John, for that question. I'll have Mike jump in as well on this one. When it comes to Canada, we're going to use the same discipline we've had all along, which is first of all, we think we have between what we're doing on the innovation side and the brands we already have. We think we have a pretty good sense of portfolio. That doesn't mean that we wouldn't look at things, but we're going to use the same kind of discipline that we've done with everything in this area in the past. So right now, I feel pretty comfortable with what we have. When it comes to the U.S., again that's been Mike's focus. We've always looked at it is building out our own brands. We have our Canadian portfolio, we also have brands in the U.S. and will likely see a mixture of potential M&A but I'd like Mike to weigh in on this because this has been a lot of his focus for the past year.

[Michael Gorenstein:]

Thanks, Kurt, and thanks, John. Yes, that's exactly right. We feel that the U.S., we're closer to being able to directly operate and we feel comfortable that there are paths for us to be able to get optionality in the near term. So while we'll continue to look at every opportunity, it just keeps pushing us further toward the U.S. as far as where our focus is in capital allocation. But we're really looking at ways not only to get exposure to other brands that are performing but ways to set ourselves up so that our brands have the right assets to make sure that they're able to perform as we move actively on our own.

[Operator:]

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

[Andrew Carter:]

I wanted to ask about the edibles launch in Canadian market. Obviously, a market that provides federally legal template for testing in developing but how do balance in getting really an accurate consumer insight given the marketing restrictions as well as the package limitations? And also could you talk about what price point you're launching as well as forms and where you go beyond Spinach?

[Kurt Schmidt:]

Yes. Thanks for that, Andrew. Yes. First of all, we're excited about this kind of a launch because it's just not the product itself could compete, well, I believe with any confectionery products in the non-THC area. I mean this is really an innovative product that is really unique to the marketplace. So we think that is great. On the question of whether it's applicable. Not everything, but because obviously if you look at the states, the regulatory environment, generally speaking, is more like alcohol versus more like the pharma-regulatory environment in Canada. But there are things we learned, consumer acceptance, concept. We have incredible research capability and consumer insights and we apply those to the U.S. I mean we do the same things we do as looking at the Canadian consumers as we do in the U.S., so it's very, very applicable. And so that's part of the beauty of what we're doing. It allows us to test those ideas and concepts and be ready and to be quick. When -- as Mike talked about earlier, federal legalization comes about. So we think it's very applicable. Sure, you have to take in a little bit of dimensionality for the fact that the U.S. is going to be a bigger opportunity, it's not just the size of the market but stability of the market as well. But as far as the Canadian testing platform for the U.S., it's pretty important and we've already -- what we're already learning with our capabilities, how to apply those learnings into the U.S.

[Michael Gorenstein:]

And second, just to add. Sorry, Andrew, just to add to that. I think one thing here that is really important to bring back up, it's really helpful for us from a learnings perspective to be able to have product format. So that when we introduced rare cannabinoids and differentiated products, those learnings we think are applicable from a formulation perspective, what type of feedback on, and so it might not be on all the brand elements and the marketing plan but on the actual product itself and having a breakthrough product. We think we'll still be able to get that information.

[Andrew Carter:]

Thanks. Second question, I wanted to build about kind of on gross margin but overall, can you kind of give -- provide a sense of your expectations for when the global supply chain, when all the tailwinds will kick in and be fully supporting the business needs i.e. when will GrowCo fully enabled -- fully on scale to enable the Canadian business, as well as domestic Israel fully supporting that business?

[Kurt Schmidt:]

Yes, this is Kurt. I'll kick it off and Jerry may have some things to add. But as far as GrowCo, again we've had the philosophy that the biomass will become more commoditized and the large ag growers are going to be the key players in here. So we're really pleased to see this partnership with GrowCo and Mucci, how it's developing. The project is running -- up and running with the necessary licenses now and receiving -- we've just received the processing license means that we can now sell to the wholesale market and you're going to see it becoming operational in stages throughout the first half of this year and that includes harvesting. We're not going to discuss any of the KPIs associated with it but we're in the early innings but I will say we are pleased with the development and what Mucci brings to this endeavor. So it's -- we are on track and we're feeling good about it.

[Jerry Barbato:]

Yes. Just to add a little bit to that. You're right, Israel, we're really happy with how it performed in Q1. The Cronos Israel team has achieved quite a bit in such a short amount of time. And I think as that medical market expands and then obviously we had headwinds that Kurt mentioned in the prepared remarks, the trends we're seeing during COVID in Canada with consumers, either in lockdown are generally less mobile is that their preferences have shifted and you've seen the provinces order less and de-load their inventory. And I think those all have impacts on margin because as you pointed out, you need to continue to grow that revenue base to absorb those fixed costs.

[Operator:]

. Your next question comes from the line of Heather Balsky with Bank of America.

[Heather Balsky:]

I guess, for starters, focusing on the CBG products launching. How are you thinking about your current market strategy, especially the learning curve for the customers and the budtenders about the product? And also as you launch the product, how are you thinking about eventually educating U.S. consumers in a less restrictive environment?

[Kurt Schmidt:]

Yes. Well, that's all part of the learning in Canada is going to be, is the launch of this product and how do we -- how we discuss it with the retail sector. So that all is in the planning of the works and lot of that will be transferable the U.S., some of it won't because the U.S. has a different marketing environment. And so, right now, we feel like we're getting all those plans set and as we said before, it's going to be the third quarter of this year. And we're working along with getting the product ready, we're working with the marketing program as well.

[Heather Balsky:]

And as the second question, separately, you talked about the store pickup that you expect it to improve if the weather improves. I'm just curious, have seen that occur as it moves until late April and early May and the weather is warmed up a bit?

[Kurt Schmidt:]

Yes, I think we are seeing some signs of that. Of course, if you're speaking of Canada and that will continue. I also look at the U.S. and Israel are the markets which are farther down the line. So you see the impacts, a big impact of the vaccine, so I think that's a critical piece too. As you see the vaccines rollout in the U.S., the Northeast, for example, in California have been hit harder, had been more restrictive, more like Canada situation. But we're seeing the bricks and mortars open up, once the bricks and mortar's open up, people start coming back out. The weather is additive to that because obviously, the cold weather has an influence. All those factors coming together, probably the most important one as we move forward is vaccination, that is a key. And when the vaccination starts penetrating the market like it is in the Northeast now, where everyone can be vaccinated regardless of age now, there is no restrictions. And you're seeing that, you start to see sporting events open up, bricks and mortars open up, and you're starting to see things getting relatively back to normal and progressing. So still going to take a while but I am confident. Again, we track the vaccine rate is an important statistic for us and I think that's an important one as we go forward, particularly with Canada.

[Operator:]

And at this time, there are no further audio questions. Are there any closing remarks?

[Kurt Schmidt:]

No, there isn't.

[Operator:]

And thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.