Earnings Labs

Cronos Group Inc. (CRON)

Q3 2021 Earnings Call· Fri, Feb 18, 2022

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Transcript

Operator

Operator

Good morning. My name is Catherine, and I'll be your conference operator today. I would now like to welcome everyone to Cronos Group's 2021 Third 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.

Shayne Laidlaw

Management

Thank you, Catherine, and thank you for joining us today to review Cronos Group's 2021 third quarter financial and business performance. Today, I am joined by our President and CEO, Kurt Schmidt; our CFO; Bob Madore; and our Executive Chairman, Mike Gorenstein. Cronos Group issued a news release announcing these 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. Before I turn the call over to Kurt, I would like to remind you that our discussion during this conference call will include forward-looking statements that are based on assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements, including as a result of the factors described in cautionary statements and risk factors included in the company's earnings release and regulatory filings, included in the company's most recent annual report on Form 10-K and quarterly reports on Form 10-Q, by which any forward-looking statements made during this call are qualified in their entirety. I want to stress that this call will be limited to third quarter 2021 earnings and the restatement of our second quarter financial statements, and we will not be addressing or taking questions on full year 2021 results. Full year 2021 results will be discussed after we file our annual report on Form 10-K with the SEC. In addition, during this call, certain financial measures may be discussed that are not recognized under the U.S. generally accepted accounting principles referred to by the Securities and Exchange Commission as non-GAAP measures. We believe these non-GAAP measures assist management in planning, forecasting and evaluating business and financial performance, including allocating resources. Reconciliations of these non-GAAP measures to their most comparable reported GAAP measures are included in our earnings press release furnished to the SEC, which is available on the Press Room section of our website to cronosgroup.com. These non-GAAP measures may not be comparable to measures used by other issuers. I'd also like to note that we are conducting our call today from our respective remote locations. As such, there may be brief delays, crosstalk or minor technical issues during this call. We thank you in advance for your patience and understanding. We will now make prepared remarks, and then we will move into a question-and-answer session. With that, I'll pass it over to Cronos Group's President and CEO, Kurt Schmidt.

Kurt Schmidt

Management

Thank you, Shayne, and good morning, everyone. I want to thank our employees, Board of Directors and shareholders for their support and patience as we work through completing our Q2 restatement and our Q3 filings. A special thanks to our finance and legal teams for putting in the extra effort over the past few months. These situations are never easy but it's essential to learn and grow from them. We are committed to continuous improvement and have learned and evolved from this situation. Now I'd like to review recent developments related to our financial reporting and internal controls and the remediation actions we are taking, while Bob will take you through more details on these items shortly. As we noted in November 2021, the Audit Committee of the company's Board of Directors worked with our independent financial auditors to conduct a review to evaluate the goodwill and indefinite-lived intangible assets in the U.S. reporting unit for impairment. As a result of this review, we have recorded impairment charges on the U.S. reporting unit totaling $236.1 million with respect to goodwill and indefinite-lived intangible assets and on long-lived assets in the 3 months ended June 30, 2021. Accordingly, the company has restated the period's financial statements to reflect this new information. The restatement has no impact on cash and cash equivalents or revenues. We take these matters seriously. And in connection with the restatement, we commenced making changes to our internal control policies and procedures to further strengthen internal controls related to financial reporting. We are also undertaking a realignment of the business that we believe will best position Cronos to drive profitable and sustainable growth over time. I view the realignment in 3 distinct pillars. First, we have realigned the organization to better enable our go-forward strategy. This includes centralizing…

Robert Madore

Management

Thanks, Kurt, and good morning, everyone. As Shayne indicated in his opening remarks, my discussion is limited to results in the third quarter of 2021 and the restatement of our second quarter financial statements. I will not be addressing or taking questions on our full year results for 2021. Before getting into the financial results for the third quarter of 2021, allow me to talk about the impairment charges and restatement of the second quarter of 2021 that we announced today. The company has restated its second quarter of 2021 financial statements to reflect a total of $236.1 million impairment charge with respect to goodwill and indefinite-lived intangible assets and on long-lived assets in the U.S. reporting unit. This restatement is noncash in nature, so therefore, does not impact cash, cash equivalents or revenues. We are taking action to improve internal policies and procedures and strengthen internal controls. These efforts include bolstering the talent across our finance organization to help implement stronger internal controls, Kurt and I are leading the reinforcement of company policies and procedures; making enhancements to our sub-certification process and clawback policy to drive additional accountability and expanding training programs for our finance personnel. We take these matters very seriously, as Kurt and I walk you through, and we're committed to taking action. Now turning to the third quarter of 2021 results. The company reported consolidated net revenue in the third quarter of 2021 of $20.4 million, an 80% increase from the prior year period. Revenue growth year-over-year was primarily driven by the continued growth in the adult-use Canadian cannabis market, increased sales in the Israeli medical market and increased sales in the U.S. segment. Consolidated gross profit for the third quarter of 2021 was negative $0.7 million, representing a $0.8 million improvement from the third quarter…

Kurt Schmidt

Management

Thank you, Bob. The strategic realignment that we've begun to implement is a company-wide initiative across every function we are identifying opportunities to reduce duplication and centralize capability, making us more efficient and cost effective as an organization. These changes are centered on a focused return to doing fewer things better. We remain committed to bringing best-in-class adult-use cannabis products to market using rare cannabinoids as a core differentiator. While we work through the realignment, we are focused on not losing sight of what is working today, continuing to elevate the Spinach brand and expand its leading market position in Canada and bringing high-quality medical cannabis under the PEACE NATURALS brand to Israeli medical patients. These remain our top priorities. I look forward to all the new things we have planned from a brand and product perspective across our global portfolio in '22 and beyond. With that, I'll open it up for questions.

Operator

Operator

[Operator Instructions] Our first question comes from John Zamparo with CIBC.

John Zamparo

Analyst

I wanted to start on the strategic realignments, and in particular, you mentioned a reduction in R&D expenses. I wonder how you think about this because it seems like R&D is pretty central to the strategy both in biosynthesis but also just generally creating differentiated products. So is it -- you think that much of your arm work is already done? Or is there some other element to this? I'd just like to better understand that part of the strategic update, please.

Kurt Schmidt

Management

Yes. This is Kurt. It's really about focusing the R&D on those categories and segments of the business that really, really drive performance. And I mentioned 2 of those areas. One is margin-accretive innovation, really focusing on adult-use cannabis products that we believe can drive that. SOURZ is a great example on the edible side. And the other area is winning in rare cannabinoids. We remain extremely focused, and a lot of our efforts is focused on bringing these kind of differentiators to market. There's always efficiencies to be had in any function, including R&D. But as we shift more towards the adult-use segment, we feel that we'll be fully armed to really drive the innovation that we're planning over the next few years.

John Zamparo

Analyst

Okay. And my follow-up is on the margin structure. And I'd like to understand what it is you're trying to achieve here? Because you exceed double sales in rest of world and you are seeing some margin expansion. It's still negative, but I would think if you can keep growing sales at or close to that pace, you get some pretty good torque from that line item. But is part of the strategic review to make the cost structure more variable? And Cronos has never struck me as a company that needs to be a manufacturer. But do you want to make the cost structure more variable and outsource more of your production, particularly in Canada?

Robert Madore

Management

Yes, John, this is Bob. Thanks for that question. Yes, obviously, we're very focused on growing sales, but one of the -- not changes, but deeper focus is pursuing innovation opportunities and product categories and products that really grow sales profitably. The other thing, and it's a big focus of the strategic realignment that Kurt spent a lot of time talking about is really the evaluation of our supply chain and really making us just not more agile but more cost competitive, and we've got a number of things that we're evaluating and looking at in that regard. And I think rest of the world is an example in this quarter. Having a positive gross margin is a testimony to our focus on that. And really having some early wins in that category in addition to just some revenue mix shifts that drive improved gross margin. The other aspect of the realignment is really just looking at our cost structure, scaling it back to where we really are today with the business and where our growth plans are. And just being more strategic with where we invest our dollars, whether it's in R&D, as Kurt kind of answered your question, or sales and marketing and G&A. So it's a multipronged initiative and strategic alignment plan that is very focused on really having impacts across the entire P&L.

Operator

Operator

Our next question comes from Rahul Sarugaser with Raymond James.

Rahul Sarugaser

Analyst · Raymond James.

So I'll focus on the top line. So you mentioned that the U.S. has been a little disappointing. We've seen the U.S. market sort of take longer than many people had anticipated. So focusing on Canada, we've seen relatively good escalations in terms of market share in edibles, primarily driven by based on your differentiated products. But recognizing that the market, however, is still primarily flower. How should we be thinking about Cronos' market share gains going forward, both in terms of its organic growth, given the differentiated fermentation drive products? But also into sort of more traditional flower-based products?

Kurt Schmidt

Management

Yes. Rahul, let me start off by saying flower is still a big part of the business, and it's still performing incredibly well for us in Canada. It's up over 90% in the quarter. And that's really driven and focused by concentrating on THC strengths, unique genetics, which we've been very successful at.

Rahul Sarugaser

Analyst · Raymond James.

Okay. Great. And then just a quick follow-up. Now focusing on the fermentation-derived products. Again, we have seen rapid market share gains in Canada with that. How should we think about global expansion of those of the fermentation-derived products?

Kurt Schmidt

Management

I mean that's ahead of us. I mean, we've only hit the 2 molecules out of the 8 that we're planning to go. We still want to build it. Remember, Canada is a test market. We're building up this brand in Canada. Once we round out the portfolio and early days are fantastic on our first edible, as I said in the script. Then everything is ahead of us, right? But we're still in the early days of developing it. But certainly, that, as we said about Canada, it's our test market, it sets the platform for our brand to go forward in other markets.

Operator

Operator

And our next question comes from Andrew Carter with Stifel.

W. Andrew Carter

Analyst · Stifel.

First question is with the delayed 10-Q filing, I would assume filing the 10-K is on track for March. So my question around all that is are there any kind of regulatory restrictions resulting from this? Will you still be able to issue equity for acquisitions or are you in the penalty box? Just help us out on that first.

Robert Madore

Management

Yes. There are no regulatory restrictions other than management sees trade order associated with our delayed filings that we're now on time with as of today. And we foresee no delays associated with our ability to file our 10-K on time.

W. Andrew Carter

Analyst · Stifel.

Great. Second question I wanted to ask, and I understand the Cronos story. It's using Canada as a test market for future opportunities, particularly the U.S. I guess with the cost savings, the expense target and now the kind of realignment, can you be profitable or at least near breakeven cash flow with the market opportunities currently in hand Canada adult-use medical, Israeli medical as well as kind of some of the opportunistic global medical markets?

Robert Madore

Management

Yes, I'll take that one and Kurt, if you want to add some color at the end from my response. But listen, we're very focused, and a big focus of the strategic realignment is really continuing to drive the rest of the world segment to profitability, right? And we were very encouraged by the results of this quarter and what we're seeing thus far. And it's a huge focus of that. As Kurt pointed out, Canada is more of a test-and-learn market. And with the current market dynamics, it's a challenging market to be profitable. But at the very least, and we're very encouraged by the progress to date and what we foresee in the very near future, we definitely have the ability to be more profitable than we are today. The other great thing is with our innovative pipeline that we have, we not only are dominating flower, and we've got 3 of the top 10 strands out there at the end of the day. But we're very, very excited about the growth and market share growth that we've experienced in other categories such as vapes, such as edibles. We demonstrated our ability to grow categories beyond just flower, and we're going to continue to expand on that. The cannabis extracts part of the business also enjoys a higher gross margin, which is only going to further benefit the profitability profile of Canada. But that's very much in the crosshairs of our realignment strategy that Kurt kind of explained.

Kurt Schmidt

Management

Yes, we have great brands, and we're showing that we can drive those brands and that makes me very optimistic about Canada.

Operator

Operator

Thank you. And that's all the time we have for questions. This concludes today's conference call, and thank you for participating. You may now disconnect.