Cronos : 2021 - Q4 Transcript

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CRON.TO - Q4 2021 Cronos Group Inc Earnings Call

EVENT DATE/TIME: MARCH 01, 2022 / 1:30PM GMT

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MARCH 01, 2022 / 1:30PM, CRON.TO - Q4 2021 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

Kurt Thomas Schmidt Cronos Group Inc. - President & CEO

Michael Ryan Gorenstein Cronos Group Inc. - Executive 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

Gaurav Jain Barclays Bank PLC, Research Division - Research Analyst

John Zamparo CIBC Capital Markets, Research Division - Associate

Michael Scott Lavery Piper Sandler & Co., Research Division - Director & Senior Research Analyst

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

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 Myra, and I'll be your conference operator today. I would like to welcome everyone to Cronos Group's 2021 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. Sir, please go ahead.

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

Thank you, Myra, and thank you for joining us today to review Cronos Group's 2021 Fourth Quarter and Full Year Financial and Business Performance. Today, I am joined by our President and CEO, and 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 the cautionary statements and risk factors included in the company's earnings release and regulatory filings, including the most recent annual report on Form 10-K by which any forward-looking statements made during this call are qualified in their entirety.

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, the cronosgroup.com. These non-GAAP measures may not be comparable to measures used by other issuers.

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MARCH 01, 2022 / 1:30PM, CRON.TO - Q4 2021 Cronos Group Inc Earnings Call

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 Thomas Schmidt - Cronos Group Inc. - President & CEO

Thank you, Shayne, and good morning, everyone. We appreciate your patience and for joining us for the second time in about 2 weeks. We are pleased to share our 2021 fourth quarter and full year results and business updates with you. As I touched on during our call on February 18, we've started this year by undertaking a realignment of the business to position Cronos to drive profitable and sustainable long-term growth. This realignment puts our products and agility at the focal point.

I view the realignment in 3 distinct pillars. First, we have realigned the organization. removing redundancy and centralizing functions under common leadership. Second, we are reducing complexity and continuing our asset-light model. As part of that, we have decided to exit the Peace Naturals Campus. I'll elaborate more on these plans in a minute. We're also continuing to perform product reviews and pricing optimization scenarios across our brands and products. And finally, we have implemented a cost reduction initiative expected to reduce operating expenses by approximately $20 million to $25 million in 2022.

When we spoke 2 weeks ago, we brought you updates primarily on the first and third pillars of our realignment initiative. Today, we'd like to provide a further development on the second pillar. This morning, we announced in our earnings release that we are exiting our Peace Naturals Campus in Stayner, Ontario. Extensive analysis went into this decision. And while we know this will mean transition and change, we also know this is the right decision to help ensure Cronos' long-term growth. Our goal has always been to operate in an asset-light business, focused on brands and R&D. This transition aligns us to that vision.

We have always maintained that cultivation will shift to large-scale agricultural specialists as the industry matures, which is why we focused on building joint ventures and partnerships around the world with best-in-class operators. We now feel confident that the industry and our supply chain in Canada are at a maturity level where we can implement this approach.

We have consistently focused on having a diverse supply chain, aided by contract manufacturers and third-party producers to supplement our cultivation and manufacturing needs. In addition to building those relationships over many years, we have been developing capabilities with our JV partner, Cronos GrowCo, in order to execute this move. We are very pleased with their premium flower cultivation, which has increasingly become an important component to our biomass supply. And we know their capabilities and efficient downstream processing will enable our goal of improved profitability.

Protecting top line growth and continued momentum on R&D is of the utmost importance for our go-forward strategy, and they are top priorities for the transition. To ensure smooth execution, Cronos will continue to operate the Peace Naturals Campus with a phased reduction and transition of activities throughout 2022, with a planned exit by the end of 2022. In addition, we are focused on maintaining our relationship with our Canadian customers. We intend to obtain a sales license from Health Canada at GrowCo's facility to ensure that continuity.

Regarding our R&D efforts, all initiatives will continue as planned across our various facilities. There will be many moving pieces and complexity to manage during this transition. But we're focused on staying as close to our timeline as possible while maintaining our eye on growing revenue and bringing innovative products to market. We are grateful to our Stayner associates for their hard work and contributions to Cronos Group. And we appreciate those associates who will continue to work in our Peace Naturals Campus to provide a seamless transition out of the facility throughout this year.

I now want to turn to our business and walk you through some highlights from the fourth quarter and full year 2021. While this year had its

challenges, it's also important to note our wins. All the fundamental work we have put in to making our brands successful and win with the consumer is starting to shine through in our results. The Spinach brand continues to win in the Canadian market. In the fourth quarter, SOURZ by Spinach

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MARCH 01, 2022 / 1:30PM, CRON.TO - Q4 2021 Cronos Group Inc Earnings Call

gummies continue to strengthen its double-digit market share in the category. All 3 SOURZ by Spinach flavors were in the top 10 in the edibles category nationally. And within Ontario, Blue Raspberry holds the #1 spot.

Our market share for Spinach in the flower category ended the quarter in the high single digits. The strength in the flower category is a result of years of R&D work in breeding and genetics. Importantly, we have shared a lot of the genetics with GrowCo and look forward to continuing to help them elevate their flower portfolio over time.

We also launched our sub-brand Spinach FEELZ, a brand designed to deliver unique and enhanced experiences, made possible through proprietary blends of rare cannabinoids alongside more common cannabinoids like THC and CBD with a wide variety of products and formats. In October 2021, we launched our first cultured cannabinoid product under Spinach FEELZ, the Chill Bliss gummy, which is making significant inroads within the edibles category. And although our vape launch utilizing cultured CBG is early, we are happy with the trends.

The success of our Spinach brands and products to date is a testament to getting the fundamentals right. We will continue to invest in our innovation to bring consumers the products they want and other products they haven't even thought of. We're starting to see success in the Canadian market with Spinach, while readying ourselves to utilize our innovation and key market learnings in other markets as they emerge.

As we restructure the organization to match our go-forward strategy, the primary focus of our energy will be towards elevating our brands by utilizing rare cannabinoids and focusing on adult-use products. We have always viewed the Canadian market as a region to fine-tune our innovation and product development initiatives. We bring most of our adult-use products to consumers in Canada, but we continue to conduct extensive consumer insights work in all the regions we operate in, with an eye towards adult-use in the United States. The United States remains a great place to learn more about the evolution of consumer preferences. While we focus on creating those turnkey solutions within the markets we operate in today.

Turning to Israel. We continue to be delighted with the results of our medical business. We started selling our Peace Naturals brand to medical patients through participating pharmacies in the second quarter of 2020. We have increased our distribution to participating pharmacies to nearly all pharmacies that sell medical cannabis. And we will continue to expand as more pharmacies come online. Total patient count in Israel has also increased substantially to approximately 109,000, which is up 40% versus the same period last year, with a long runway for continued growth. And with the recent survey conducted by Cannabis Magazine, naming Peace Naturals the most recognized cannabis brand in Israel, we have a lot to look forward to as we work towards meeting our patient demand in this market.

Given the growth of our business, we thought we'd take some time to dive more into the Israeli market and how we positioned ourselves as a leader there. Israel has a population of just over 9 million people and boasts one of the world's highest cannabis usage rates. Unlike the North American cannabis market, Israel has a much less competitive illicit market given Israel's stringent border controls and security infrastructure. The rapid growth in Israeli medical market reminds us of the early days in Canada's medical market, with demand outpacing supply and the stigma associated with the product quickly fading away. With our manufacturing footprint, established local team, strong brand and product portfolio, we are very well positioned to succeed in the Israeli market. As we realign the organization to match our go-forward strategy, the primary focus of our energy will be towards elevating our brands by utilizing rare cannabinoids and focusing on adult-use products.

I want to conclude by outlining our 4 core business priorities, all of which are focused on driving initiatives aligned with our vision and designed to deliver sustainable growth. In 2022, we look to, one, accelerate growth by focusing on the core business, leveraging our top-selling products to deliver on each brand's potential, while maintaining a disciplined approach to investing our time and resources and the opportunities we believe will provide the most significant returns. Two, diligently evaluate our manufacturing strategies to ensure that we only move forward with new products and processes that add incremental value and contribute to our strategic vision. Three, create a robust platform for innovation across Cronos' Group portfolio of global brands, supported by our belief that rare cannabinoids will drive differentiation. Fourth, keep U.S. market entry as our north star by managing our internal capital spend and external capital allocation to maintain the flexibility to capitalize on opportunities that will position Cronos as a leader in the U.S. market.

We have a lot of work ahead of us, but I feel confident that the actions we've outlined today will improve our business and set us up for success in the long term.

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MARCH 01, 2022 / 1:30PM, CRON.TO - Q4 2021 Cronos Group Inc Earnings Call

With that, I would like to pass it to our CFO, Bob Madore.

Robert L. Madore - Cronos Group Inc. - CFO

Thanks, Kurt, and good morning, everyone. Before getting into financial results, allow me to provide further details on our planned exit from our Peace Naturals Campus. As a result of the company's planned exit from the Peace Naturals Campus, the company has incurred a $119.9 million non-cash impairment charge on long-lived assets in the fourth quarter of 2021. In addition, the company expects to incur charges of approximately $4.5 million in connection with the planned exit, all of which impact the ROW segment. These charges include employee- related costs, such as severance, relocation and other termination benefits as well as contract termination and other related costs, which are expected to be incurred primarily in the second half of 2022.

In addition, the company anticipates capital expenditures of approximately $2.5 million to modernize information technology systems and build distribution capabilities.

Cronos Group looks forward to leveraging GrowCo's capabilities in premium flower cultivation and efficient downstream processing, with the intention to improve profitability of the company's Canadian operations. In addition to further leveraging its joint venture with GrowCo, Cronos Group will continue to maintain a network of third-party licensed processors to supplement cultivation and manufacturing needs.

Now getting into the financial results filed today. In 2021, on a consolidated basis, we increased revenue 59% year-over-year to $74.4 million, with strong performance in the Rest of the World segment highlighted by Canada and Israel. Our Rest of the World segment recorded net revenue in 2021 of $64.6 million, representing a 73% increase year-over-year. The United States segment increased 4% year-over-year to $9.9 million. In light of slower growth in the U.S., we're committed to rightsizing the U.S. segment to realign it with our go-forward strategy with a focus on improving profitability.

Now turning to the fourth quarter of 2021 results. The company reported consolidated net revenue in the fourth quarter of 2021 of $25.8 million, a 51% increase from the prior year period. Revenue growth year-over-year was primarily driven by the continued growth in the adult-use Canadian market and increased sales in the Israeli medical market. Consolidated gross profit for the fourth quarter of 2021 was $1.9 million, representing a $16.8 million improvement from the fourth quarter of 2020. The improvement versus prior year was primarily driven by a decrease in inventory write-downs and increased gross profit in the Rest of the World segment.

Consolidated adjusted EBITDA in the fourth quarter of 2021 was negative $27.4 million, representing a $25.8 million improvement from the fourth quarter of 2020. The improvement versus prior year was primarily driven by an improvement in gross profit and a decline in sales and marketing and research and development expenses.

Turning to our reporting segments. In the Rest of the World segment, we reported net revenue in the fourth quarter of 2021 of $22.7 million, a 68% increase from the prior year period. Revenue growth year-over-year was primarily driven by growth in both the adult-use extracts and flower categories in Canada and sales in the Israeli medical market. Gross profit for the Rest of the World segment for the fourth quarter of 2021 was $2.4 million, representing a $19.1 million improvement from the fourth quarter of 2020. The improvement versus prior year was primarily driven by a reduction in inventory write-downs and an increase in sales volume of cannabis extracts in the Canadian market, which carries a higher gross profit than other product categories.

Adjusted EBITDA in the Rest of the World segment for the fourth quarter of 2021 was negative $14.6 million, representing a $21.8 million improvement from the fourth quarter of 2020. The improvement versus prior year was primarily driven by an improvement in gross profit and a decrease in research and development expenses.

Turning to the U.S. segment. We reported net revenue in the fourth quarter of 2021 of $3.1 million, an 11% decrease from the prior year period. The decline year-over-year was driven by a reduction in volume due to competitive pressures. We spoke at length approximately 2 weeks ago that the U.S. CBD business is not where we want it to be. The strategic review of this business, including the potential for price optimization, SKU

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