Cronos Group Inc.
Q4 2020 Earnings Call Transcript

Published: 26 Feb 2021

[Operator:]

Good morning. My name is Ursula, and I will be your conference operator today. I would like to welcome everyone to the Cronos Group’s 2020 Fourth Quarter and Full Year 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, Ursula, and thank you for joining us today to review Cronos Group’s 2020 fourth quarter and full year financial and business performance. Today, I’m 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. Cronos Group issued a news release announcing its financial results this morning, which are filed on our EDGAR and SEDAR profiles. This information, as well as the prepared remarks will also be posted on our website under Investor Relations.

[Kurt Schmidt:]

Thank you, Shayne. As we turn the page to 2021 and reflect on 2020 the accomplishments the Cronos team achieved, especially given the complex operating environment were impressive. I'm incredibly excited to see what we can accomplish in 2021 and beyond. I'm going to take this moment to recognize and thank our global team for persevering through the challenges the world faced in 2020 and continue to face in 2021. I'm going to start this morning's call by reflecting on a few highlights from 2020 and to discuss our strategy to win in 2021. Since joining Cronos six months ago, I made it my focus to help accelerate growth and plan for our future strategy. With the help of Mike and our passionate team and leadership team, we've honed in on the areas we want to concentrate on as an organization. In 2021, we plan to focus on four main pillars, to drive business results and growth across the organization.

[Jerry Barbato:]

Thanks, Kurt and good morning, everyone. Before discussing our financial performance, allow me to briefly touch on a change in the metrics we are reporting on. We are shifting away from reporting segment level operating income results in favor of reporting adjusted EBITDA at the segment level. We believe this is a more representative view of our business, and aids in management's review of performance and capital allocation. We also hope it further helps the investment community evaluate our business performance. We review these results on an adjusted basis, which excludes certain non-cash items that may be highly variable, unusual or infrequent at in the store underlying business trends and results. For more details regarding our calculation of adjusted EBITDA, please refer to our earnings press release, which is available on our website thecronosgroup.com on the Investors page.

[Kurt Schmidt:]

Thank you, Jerry. What's clear is that our products are winning with consumers and our brands continue to resonate in the markets we operate. This past year has offered opportunities for growth despite the unprecedented effects of the pandemic. And we're credibly motivated to continue that growth in 2020. With a focus on continuing to build successful teams, perfecting regional strategies, supporting our breakthrough technologies and R&D progress, and building leading brands, I know we can continue to win as an organization, and lead the global cannabinoids industry into its next phase of growth. With our strong balance sheet, a best-in-class strategic partner, and a team that is built to win, I'm excited about the opportunity to lead Cronos in the next chapter. With that, let's now open it up for the line of questions.

[Operator:]

. Your first question comes from Andrew Carter with Stifel.

[Andrew Carter:]

I wanted to start it off with asking about the gross margin. On the gross margin side, I understand the expected continued fluctuations, but excluding the charge, the margin would have shown progress. So first off, kind of where do you think your inventory levels are? But then also throughout the year, you do have internal supply for GroCo coming online, and you have Israel domestic coming online. So should we see in Rest of World like significant gross margin expansion, at least on an underlying basis throughout 2021?

[Kurt Schmidt:]

I think you're still going to see some fluctuations in that gross margin, as price and mix change from quarter-to-quarter, and what -- I really touch on that. That mix change is not only the products that we have in the Canadian market, but as you point out the change in the Israeli market, when you think about the ROW segment, and we're in the early innings in Israel, as it’s just ramping up. So I think as that becomes a bigger portion, you'll also have some mix changes as we launch oil in that category. And as you know, we took some price decreases over the second half of 2020. Different products have different margin profiles in different provinces in Canada, which also leads to some of that mix change. And while we are buying third-party flower, every quarter, the prices continue to come down. You need to play through that inventory that you bought in previous quarters. So we expect that our cost per gram on the flower side of the business though, depending how mix changes, will have an impact on that. So I think, it's hard to predict what it will be in the future. But we definitely see some volatility in margin going forward.

[Operator:]

Your next question comes from Vivien Azer with Cowen.

[Vivien Azer:]

I want to follow-up on that line of questioning, if you don't mind. Just want to get a better sense of the output that you guys are producing now, plus your inventory, because I feel like we're hearing like slightly mixed messages around price deflation, I think net for the entire category on a weighted average basis, yes, it's deflationary because you and many other competitors have introduced value and deep value. But I'm not hearing as much price compression at premium segments. So I'm just trying to understand what you guys are producing now, is that at risk of price deflation too and then what's the incremental risk that's still sitting on your balance sheet?

[Jerry Barbato:]

Sure, Vivien. I still think the Canadian market is deflationary across all price points, whether it be premium, the mid-tier or the value play, you're seeing that across all categories. And so as we looked at our brand offerings of both COVE and Spinach, and tried to make sure that we're at a price point that's competitive, you're seeing that we've taken some of these price changes across the second half of the year. And I don't know when that ends. As for the inventory, I think our inventory is at a reasonable place. I mean, we're only slightly higher than we were at the end of 2019. And we have, as Kurt alluded to in his prepared remarks, almost 100% growth on that revenue channel. So I feel comfortable that the amount of inventory on hand is appropriate for the size of our business.

[Operator:]

Your next question comes from Rahul Sarugaser with Raymond James.

[Rahul Sarugaser:]

So one of the bright light thought was actually the doubling of revenue in the U.S. CBD channel. Kurt you referred to sort of challenges around retail in the U.S., of course now without having a crystal ball as to what happened post-COVID, can you maybe talk about how you see that trajectory? Are you looking at it continuing doubling quarter-over-quarter and anymore color on expansion in that channel?

[Kurt Schmidt:]

Yes, well, I think, the COVID impact of restricted store openings and other related things to the pandemic has certainly hurt. But as the vaccination rolls out, we believe the things we're going to start turning, right, and we're already seeing green shoots in that area, it really comes down to the brand strength and investment. And for -- in the U.S. we are a happy to -- we're very pleased, we just announced the ULTA partnership, which is certainly going to be an accelerant for that business. And you're going to see investment in marketing on both our Lord Jones and ULTA brands. So, again, our focus was on growth. And as we get through this pandemic, when it comes to the U.S., I think the fact -- the second half of the year, everybody is feeling fairly confident that we will be fairly well -- with the vaccine, fairly well penetrated. So, we should see the retail sector continuing to open up and that's a good sign, obviously a good sign for us.

[Rahul Sarugaser:]

And then sort of a follow-up. One area, as you know that we're quite interested in is the partnership with Ginkgo and the wide initiatives, you talked about focusing on CBG. Mike had previously referred to September being the timeline, target timeline for having first products from Fermentation starting its shelf. Is that still the timeline that we're looking at? And what can we think about in terms of, product formats and potentially broadening of Fermentation based cannabinoids into your products?

[Kurt Schmidt:]

Yes, we currently expect to achieve commercialization by the third quarter of 2021. And, as I said in my opening remarks, we really are prioritizing the rare cannabinoids because we believe that it's going to be a greater ability to innovate and provide consumers with differentiated products. And so we're really excited about that. I don't want to go in the exact products right now. But, we're well on our way. So, again, we are on track, and we're feeling very good about it. And obviously, the rare cannabinoids offer some really unique differentiated consumer products and benefits that we obviously want to focus on.

[Operator:]

Your next question comes from John Zamparo with CIBC.

[John Zamparo:]

I wanted to ask about the creation of the internal team looking at the U.S. markets. And specifically, you have levers you can pull today to deploy capital into the U.S. without a full scale legalization, whether it's optionality deals or arrangements with CBG brands or potentially partnerships with retailers. Just any thoughts or observations on that front would be helpful.

[Kurt Schmidt:]

Yes, this is Kurt. I'm going to kick it off. But I think this is important to hear from Mike. So Mike will comment on this as well. As you guys know, when it comes to active or really direct investments in the U.S., it's important that we get federal action that removes cannabis, or THC as a controlled substance. Also on that is the operation side and there's a number of targeted fields that allow for really streamlining and making an effective industry. And again, Mike is looking at a range of entry strategies besides these active investments. So, it is great, that Mike comments on that at this point.

[Mike Gorenstein:]

Sure, thanks, Kurt. Hey, John. So when we think in the U.S., there's really three phases that we try to think of. The first would be the phase that we're in now, where the legal regime as Kurt noted means that we can't directly and actively enter. But I think there are certain levers that can still be pulled. The next phase is really what you hear talked about, on the government right now where cannabis prohibition in the U.S. ends and that would allow us to actively and directly participate in states that have put in place responsible cannabis frameworks. And then, finally, are responsible and comprehensive framework that at the federal level that provides for interstate commerce and high product standards. And when we think about that third phase, that's really where our strategy is focused on positioning ourselves, right now, so that we can eventually deliver value there. And we still believe it's going to be authentic brands that are built on technology that differentiate the products. And that's what's going to ultimately drive terminal value. So any levers or anything that we're looking to pull now is really thinking in the future, how are we best set up to win? And that's really where our focus is.

[John Zamparo:]

And if I can follow-up on that subject, on the formation of the USCC. I would have thought maybe the -- at first that the goals of those parties might -- the parties involved might differ a little bit. So what does that say about the fact that there's American and Canadian participants coming together to work together on this? And I guess one of the priorities near-term of the USCC, is it tactic of getting something done, like the SAFE Banking Act? Or is it more -- maybe more of a transformative goal and longer term goal?

[Kurt Schmidt:]

Yes. This is Kurt. Good question. Our view is it really needs to be a comprehensive approach, right, and that includes a bunch of areas, such as addressing historic injustice for communities of color, which have disproportionately faced in this area. It could include executive orders, that we believe to be coordinated between the various departments, which will be very important, such as the DOJ, Treasury, FDA and HHS, and legislative action would provide additional clarity, right, and there are several directions you can take. And through the council, and through our partnership with Altria, we are very much focused on being -- having a seat at the table and being able to deliver on that. But in essence, we do need a comprehensive approach in order to really create the right environment for the market and for the various issues that are happening right now in the U.S. And we're reasonably confident that it’s starting to move in the right direction.

[Operator:]

Your next question comes from Michael Lavery with Piper Sandler.

[Michael Lavery:]

Just curious if you can elaborate a little bit on CBG. And it sounds like you've got the biosynthesis markdown. But as far as the consumer, how much education do you have to do on the benefits of that? And how do you plan to go-to-market with it?

[Kurt Schmidt:]

Good question. We have tremendous capability in our consumer insights group. So in parallel to developing these rare cannabinoids, we are looking at the product innovation side and how we're going to talk about it, what products we're going to put that in. I don't want to get into what exactly we're going to do. But all that is well on its way. I will say another thing that's interesting about these rare cannabinoids is you can Google these products, THCV, and CBN, and CBG and you're going to get a wealth of knowledge and awareness of how people are talking about these and the benefits of these products. So, in some ways, consumers are really focused on these and they understand them and understand some of the benefits. And so that's sort of built in right now. So -- but again, it's very difficult to call rare cannabinoids because they're very difficult to get in scale. And that's what we believe we can deliver. And we could use our innovation and consumer insights and our innovation teams to develop some real unique products to deliver on those consumer promises.

[Michael Lavery:]

And then just on GroCo and adding capacity here, somewhat of unique in the industry doing that these days, can you just get a sense of the industry landscape and how you see capacity broadly? Is it being right-sized or is there still excess capacity? And is your initiative primarily just to ensure quality products or what some of your thinking on just bringing that online?

[Kurt Schmidt:]

I think it's a kind of a hybrid model so that we can source from GroCo, we can source from other third party biomasses. So we want that flexibility on it. GroCo received their license in 2012, cultivation license. So we expect that facility to come operational in phases beginning in the first half of '21. And what they benefit for us is to partner with an expert, which, you know, they're an expert in the field, and they can provide high quality biomass at a low cost. But it really is managing this hybrid model in the Canadian market at this point. And it's kind of approach we’ve taken with Israel as well.

[Operator:]

Your next question comes from Matt Bottomley with Canaccord.

[Matt Bottomley:]

Just curious if you can provide any more color on any of the dynamics you're seeing in the adult use market with respect to your brand penetration, whether that's the sequential I guess movements in how many orders the provinces are buying from you? And then if you have further data on how your products are selling to end consumers this quarter relative to last out of the retail touchpoints correctly?

[Kurt Schmidt:]

We don't give revenue guide -- yes, Jerry, you want to take that?

[Jerry Barbato:]

Sure. Yes, we don't give forward looking revenue guidance, but I think, some of the impacts of COVID that you've seen, especially in Ontario, where they had store closures and go to curbside pickup, I think you saw that early on in COVID when it first happened, that you saw, the growth slowed a little bit. And so you saw that in December and January across the categories. We think our brand penetration has been quite good, I mean you saw the growth sequentially, every quarter in 2020, I think we're making great strides in that area.

[Matt Bottomley:]

And do you have any estimate -- I know you don't provide it for presenting up, but any sort of goalposts of where you think your market share is in Canada right now on a branded level, and how that's moved in the last year or so?

[Jerry Barbato:]

Yes, there's not a lot of good data in Canada to try to really get that. So in normal CPG, there's Nielsen data or some other quantitative metric. I mean, we try to monitor ourselves internally. But it's difficult and it's also difficult to look at -- because of all these big value players and larger formats coming into the market, it's a bit challenging us for us to look at it that way. So we're really focused on growth of those brands and revenue growth.

[Operator:]

Your final question comes from Thea Wang with Jefferies.

[Thea Wang:]

I'm asking a question on behalf of my analyst, Owen Bennett. So just want to briefly touch on the product mix, because currently, the majority of the sales are still from the cannabis flowers. And there's very limited increase sequentially from the extracts. So I wonder what's your outlook on the product mix and do you expect that to kind of stay at the current like proportion levels going forward?

[Kurt Schmidt:]

This is Kurt. Well, one of the things we're seeing is the trend during COVID, right, and Jerry just talked about that. We have consumers on lockdown, and generally less mobile. And so we've definitely seen that preferences have shifted towards to buying more volume in the flower category over base or even pre-rolls, because it's better to go with solution, and since unfortunately in the last three months, no one's really been going anywhere. So this has driven our sales as well as the Canadian markets to be more heavy-oriented towards flower category. However, as things start to get better and we start opening up retail people have more mobility, we don't expect this to persist long-term. So again, we look forward to launching new and innovative products across the 2.0 spectrum over the course of 2021. So we do have plans. And again, very hopeful as vaccination starts rolling out and we start getting back to normal, we'll start seeing the market develop as we saw pre-COVID.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's call. You may now disconnect.