Cronos : 2022 – Q2 Transcript

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CRON.TO - Q2 2022 Cronos Group Inc Earnings Call

EVENT DATE/TIME: AUGUST 09, 2022 / 12:30PM GMT

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AUGUST 09, 2022 / 12:30PM, CRON.TO - Q2 2022 Cronos Group Inc Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Michael Ryan Gorenstein Cronos Group Inc. - President, CEO & Chairman

Robert L. Madore Cronos Group Inc. - CFO

Shayne J. Laidlaw Cronos Group Inc. - Director of IR & Strategy

C O N F E R E N C E C A L L P A R T I C I P A N T S

Andrew Richard Bond Jefferies LLC, Research Division - Equity Associate

John Zamparo CIBC Capital Markets, Research Division - Associate

Michael W. Freeman Raymond James Ltd., Research Division - Senior Associate

Shaan Mir Canaccord Genuity Corp., Research Division - Associate

Vivien Nicole Azer Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

William Andrew Carter Stifel, Nicolaus & Company, Incorporated, Research Division - VP

P R E S E N T A T I O N

Operator

Good morning. My name is Stacy, and I will be your conference operator today. I would like to welcome everyone to the Cronos Group 2022 Second 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. Shayne, you have the floor.

Shayne J. Laidlaw - Cronos Group Inc. - Director of IR & Strategy

Thank you, Stacy, and thank you for joining us today to review Cronos' 2022 Second Quarter Financial and Business Performance. Today, I'm joined by our Chairman, President and CEO, Mike Gorenstein; and our CFO, Bob Madore. Cronos issued a news release announcing our financial results this morning, which is filed on our EDGAR and SEDAR profile. 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 Mike, let me remind you that we may make forward-looking statements and refer to non-GAAP financial measures during this call. These forward-looking statements are based on management's current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Factors that could cause actual results to differ materially from expectations are detailed in our earnings materials and our SEC filings that are available on our website, by which any forward-looking statements made during this call are qualified in their entirety.

Information about non-GAAP financial measures, including reconciliations to U.S. GAAP, can also be found in the earnings materials that are available on our website. 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' Chairman, President and CEO, Mike Gorenstein.

Michael Ryan Gorenstein - Cronos Group Inc. - President, CEO & Chairman

Thank you, Shayne, and good morning, everyone. I want to start by reviewing the progress we've made towards our strategic realignment initiatives since our last call. We've continued to work hard to set Cronos up for the future and to prepare our company in the short term as we move through

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AUGUST 09, 2022 / 12:30PM, CRON.TO - Q2 2022 Cronos Group Inc Earnings Call

a more volatile macroeconomic environment and uncertain timing regarding regulatory change throughout our current markets and those in which we may look to operate in the future.

With a substantial portion of our Canadian manufacturing moving to GrowCo, the wind down of the Peace Naturals Campus is going as planned, and we're on track to fully cease operations at the facility by the end of the year. This changeover has been efficient, and we're grateful to our employees and partners for ensuring a smooth transition of our operations.

The build-out of our own space at GrowCo is progressing well, and downstream processing equipment will be up and running in the coming weeks. We continue to be pleased with the cultivation operations at GrowCo and look forward to having this joint venture become a primary supplier of our products in Canada. The cost savings we expect to realize in GrowCo are intended to aid the margin profile of our products over time, which is a critical strategic goal for us.

This quarter, GrowCo reported to us preliminary unaudited revenue of approximately $5.2 million to non-Cronos customers. And in the year-to- date period, GrowCo has achieved profitability. As a reminder, we are a lender to GrowCo and its principles. GrowCo began to repay its current $79 million senior secured loan in the first quarter. These loan receivables, combined with our balance sheet of approximately $945 million in cash and short-term investments set us up well to invest in new markets as they open.

Balance sheet management through economic uncertainty is paramount and our desire to maintain a significant industry-leading cash balance ahead of potential global strategic growth opportunities has guided many of our decisions year-to-date. In the second quarter, we implemented additional changes in the U.S. business as we continue to assess the best way to position our existing infrastructure to win in the U.S. and other markets globally with the borderless products we are creating today.

In the coming months, to limit operating expenses, while maintaining a foothold in the U.S., you'll see us pivot the Lord Jones brand away from the wholesale beauty category and lean into adult-use product formats. This will allow us to preserve the Lord Jones brand equity that should enable us to launch THC products and other cannabinoid products beyond CBD in the future. In addition, we decided to focus our energy on the direct-to-consumer channel over wholesale opportunities.

With switch to a DTC focus, we are striving for a higher gross margin profile and can reduce our SG&A further. We are focused on creating borderless products and brands that can easily be adapted to emerging cannabis markets as they become commercially viable opportunities. The pivot in our U.S. business further drives us towards our singular focus of creating adult-use cannabinoid products. Globally, we continue to be on track to deliver $20 million to $25 million of identified savings across operating expense categories in 2022, primarily driven by savings across sales and marketing, G&A and R&D.

While rightsizing our cost structure to strengthen our overall business, we still continue to make significant progress with expanding our borderless product portfolio in Canada under the Spinach brand and its sub-brands SOURZ and FEELZ. In the second quarter of 2022, according to Hifyre data, Spinach held an approximate 18.6% market share in the gummies category. Furthermore, 3 out of 4 SOURZ ranked in the top 10 for market share in Canada in Q2, and all 5 of our gummy products across SOURZ and FEELZ that were available in the market in Q2 were in the top 15.

Last week, to further build on our category leadership, we launched a gummy featuring CBN under the Spinach FEELZ brand, Deep Dreamz Blueberry Pomegranate featuring 10 milligrams of THC and 5 milligrams of CBN per pack. We intend to bring our success and learnings in the gummy category to the vape category as well. Following the switch to offering one gram formats earlier this year, our Spinach-based and FEELZ cultured CBG vape product lineups are doing well in market.

In July, we launched another rare cannabinoid product featuring CBN, the Spinach FEELZ Blackberry Kush, THC-CBN1-gram vape, which provides a mellow and dreamy high. In June, in partnership with Ginkgo, we achieved the productivity target for THCV, the cannabinoid believed to reduce the appetite enhancing property of THC. Spinach FEELZ is our platform designed to deliver unique and enhanced experiences made possible through proprietary blends of rare cannabinoids.

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AUGUST 09, 2022 / 12:30PM, CRON.TO - Q2 2022 Cronos Group Inc Earnings Call

We are excited about the possibility that THCV is expected to give us and look forward to getting THCV products in the market in the future to complement our growing portfolio of rare cannabinoid offerings. As a reminder, last quarter, we announced a bolstering of our flower portfolio to meet the increasing demand for the 28-gram format. With the launch of strain-specific28-gram offerings, Wedding Cake and Tangerine Twist, we now have 3 flower SKUs in the top 10 for market share as of June 2022, according to Hifyre.

Let me take a moment to discuss Cronos' retail sales performance in the Canadian market. All following numbers will be referencing retail sales for the second quarter of 2022, provided by Hifyre. Cronos grew retail dollar sales by 69% year-over-year, while the broader Canadian market grew by just 23%. Differentiated gains for Cronos were driven by a 36% growth in flower versus no market growth and 271% growth in vape versus the market growth of 34%. We didn't offer edibles for the vast majority of second quarter in 2021. And now we have 14.3% market share in the broader edibles category and 18.6% market share in the gummies category, maintaining our strong #2 position in gummies. We lagged market growth in pre-rolls, growing 9% versus market growth of 62%, we have a plan to improve this trajectory through SKU architecture and innovation. Despite challenges in the Canadian market, we continue to be focused on building profitable market share, utilizing our growing portfolio of borderless products.

Moving to our results in Israel. Coming off a record first quarter for the team. This quarter, we celebrated the second anniversary of our Peace Naturals brand launch. In the second quarter, we recorded $7.2 million in revenue of branded product sales, up 212% year-over-year. And as of June 30, we have sold more branded products than we did in all of 2021, incredible growth in just 1 year. Similar to macro environment in other markets during early growth phases, Israel is not without its challenges.

As we know well, regulations, especially in cannabis, can change rapidly. There are two regulatory challenges that the Israeli market is currently facing; a pause in cannabis imports and a slowdown in patient permit authorization by the Yakar. While we believe the pause in imports will be resolved over the coming months, we feel well equipped to manage a prolonged pause, given our domestic cultivation and third-party supplier relationships in Israel. We believe the slowdown in patient permit authorization led to an increase in competitive discount.

Recently released patient permit data for July showed evidence of a recovery in patient growth, growing slightly over 2% sequentially from June. We expect these regulatory issues will be resolved over the coming months, and our business will return to strong growth. We're investing for the long term in the Israeli market and plan to expand on our leadership position. Our products continue to be sold in nearly all pharmacies offering medical cannabis, and we maintained our top 3 market share status in the quarter. As this market evolves, our continued focus on product quality and innovation will differentiate us and drive more consistent patient and consumer loyalty with our brand, Peace Naturals.

Moving to Australia, where we have an approximate 10% stake in Cronos Australia, the team is executing at a high level in the early stages of the market development. Cronos Australia reported a preliminary '22 revenue range of AUD66 million to AUD68 million and an EBITDA range of AUD10 million to AUD11 million. Australia's cannabis market growth has picked up pace and is estimated to have a market size of $400 million by the end of year 2022, up from $230 million in calendar year 2021. We are pleased with the team's progress in this growing market.

Turning to appointments within the organization. I am pleased to announce that Arye Weigensberg was appointed SVP, Head of Research and Development after serving in an interim capacity since November of 2021. Arye has been with Cronos since 2019 and has played a foundational role in our innovation program. Prior to serving as interim Head of R&D, Arye was the General Manager and Vice President of Research and Technology at Cronos Research Labs. And before that, Arye was the CEO of Altria Israel an Altria Research and Development Hub. I'm confident Arye will drive Cronos' research and innovation initiatives forward as we look to the future and further develop our borderless product portfolio.

Lastly, it's been a while since we could speak to momentum in Washington, D.C. regarding cannabis reform. Although we remain conservative in our thinking, we are pleased with progress moving in the right direction. We continue to see a wave of legalization in various forms state-by-state across the U.S., further building the support for legalization at the federal level. We continue to participate directly in various industry associations and through our employee pack to drive the initiative forward.

Outside of direct participation through our government affairs initiatives, we also have an option agreement with PharmaCann, one of the country's largest cannabis companies. We are pleased with their progress following the merger with LivWell Health and are confident in their go-forward strategy as a combined company. Outside of North America, we are also seeing growing interest in cannabis legalization, leading to more potential

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AUGUST 09, 2022 / 12:30PM, CRON.TO - Q2 2022 Cronos Group Inc Earnings Call

market opportunities. Although most of these efforts are in their early stages, we are assembling a portfolio of borderless products with strategic infrastructure and partnerships globally, combined with an industry-leading balance sheet to execute when the time comes.

With that, I would like to pass it to Bob to take you through our financials.

Robert L. Madore - Cronos Group Inc. - CFO

Thanks, Mike, and good morning, everyone. The company reported consolidated net revenues in the second quarter of 2022 of $23.1 million, a 48% increase from the second quarter of 2021. Revenue growth year-over-year was primarily driven by an increase in net revenue in the Rest of the World segment, driven by growth in the Israeli medical market and the Canadian adult-use market.

Consolidated gross profit for the second quarter of 2022 was $4.1 million, representing a $19.9 million improvement from the second quarter of 2021. The gross margin was positive 18%, up from negative 101% last year. The improvement versus prior year was primarily driven by the absence of inventory write-downs in the current period and increased gross profit in the ROW segment, which I'll get into a little more shortly.

Consolidated adjusted EBITDA for the second quarter of 2022 was negative $18.8 million, representing a $31 million improvement from the second quarter of 2021. The improvement versus prior year was primarily driven by an improvement in the gross profit and a decrease in sales and marketing expenses, R&D expenses and general and administrative expenses as a result of the company's strategic realignment initiative.

Turning to our reporting segments. In the Rest of the World segment, we reported net revenue in the second quarter of 2022 of $21.6 million, a 61% increase from the second quarter of 2021. Revenue growth year-over-year was primarily driven by increased sales in the Israeli medical market, which was up 212% year-over-year driven primarily by the flower category and increased sales in the Canada adult-use market, which was up 35% year-over-year. The growth in Canada was led by the cannabis extracts product category, which we see the boost via the introduction of our gummies platform as well as the introduction of 1-gram vapes.

Gross profit for the Rest of the World segment for the second quarter of 2022 was $4.3 million, representing a $20.8 million improvement from the second quarter of 2021. The gross margin was positive 20%, up from a negative 123% last year. The improvement versus prior year was primarily driven by the absence of inventory write-downs as previously mentioned, increased cannabis flower revenue, the introduction of additional cannabis extract categories that carry a higher gross profit and gross margin than other product categories. And lastly, lower cannabis biomass costs. This was partially offset by lower fixed cost absorption due to the timing of the wind-down activities associated with the exit of the Peace Naturals Campus.

Although we don't typically address sequential changes, given the realignment initiatives, we're working through, I think this quarter warrants kind of breaking it down a little more. The fluctuation in margin from Q1 '22 to Q2 '22 was really largely driven by the timing in which we decided to cease our cultivation at Peace Naturals Campus, and it led to lower fixed cost absorption. While we experienced really good favorability on both product margin mix, talking a lot about increases in extract sales and biomass purchasing cost reductions year-over-year.

The strategic realignment is intended to create a more consistent and higher gross margin for the business going forward. And we still expect that to be the case moving into the balance of this year and beyond. Adjusted EBITDA in the Rest of the World segment for the second quarter of 2022 was negative $9 million, representing a $23.6 million improvement from the second quarter of 2021. The improvement versus prior year was primarily driven by an improvement in gross profit and a decrease in general and administrative expenses.

Now turning to the U.S. segment. We reported net revenue in the second quarter of 2022 of $1.5 million, a 34% decrease from the second quarter of 2021. The decrease year-over-year was primarily driven by a reduction in volume as a result of a decrease in promotional spend and SKU rationalization efforts as the company implements its realignment of the U.S. business, as Mike shed light on in his earlier comments. Gross profit for the U.S. segment for the second quarter of 2022 was negative $202,000, representing an $846,000 decline from the second quarter of 2021.

The gross margin was negative 14%, down from a positive 29% last year. The decline year-over-year was primarily due to lower sales volumes and increased inventory reserves, driven by the realignment activities. Adjusted EBITDA in the U.S. segment in the second quarter of 2022 was negative

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