Cronos : 2022 – Q1 Transcript

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CRON.TO - Q1 2022 Cronos Group Inc Earnings Call

EVENT DATE/TIME: MAY 10, 2022 / 12:30PM GMT

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MAY 10, 2022 / 12:30PM, CRON.TO - Q1 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

Gaurav Jain Barclays Bank PLC, Research Division - Research Analyst

John Zamparo CIBC Capital Markets, Research Division - Associate

Matt Bottomley Canaccord Genuity Corp., Research Division - 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 Amanda, and I will be your conference operator today. I would like to welcome everyone to Cronos Group 2022 First Quarter Earnings Conference Call. Today's call is being recorded.

At this time, I'd like to turn the call over to Shayne Laidlaw, Investor Relations. Please go ahead.

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

Thank you, Amanda, and thank you for joining us today to review Cronos Group's 2022 first quarter financial and business performance. Today, I am joined by our Chairman, President and CEO, Mike Gorenstein; and our CFO, Bob Madore.

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 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 Group's Chairman, President and CEO, Mike Gorenstein.

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

Thanks, Shayne. I don't know if you missed me as much as I've missed all of you, but since this is a one-way line, I'm just going to go ahead and dive right in. I founded Cronos because of the once-in-a-lifetime opportunity to help build and shape an industry that has the potential to improve countless lives. As CEO, I am committed to re-instilling a startup culture with the founder's mentality across all levels of the organization.

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MAY 10, 2022 / 12:30PM, CRON.TO - Q1 2022 Cronos Group Inc Earnings Call

I want to thank our dedicated employees who have worked very hard and continue to bring their passion for the industry and for Cronos to work with them every day as we navigate our strategic realignment. We have set a strong foundation for ourselves. We have a lot more work ahead of us in continuing to execute our vision.

Since this is my first call back as CEO, I will start off by explaining Cronos' strategy, then I'll outline my 4 immediate priorities and finish with some color on our encouraging results this quarter.

The evolving legalization of the cannabis industry presents a lot of opportunities for value creation in different verticals such as agriculture, ingredient supply, branded products, distribution and retail. While many of the most well-known cannabis companies are characterized by pursuing an asset-heavy vertically integrated model, Cronos is different. We believe that by focusing our resources on being the best branded products company, we will be able to win with consumers versus companies trying to be all things to everyone. There is more than enough opportunity in the cannabis industry to create tremendous shareholder value by winning in any one vertical, and ours is branded cannabinoid products.

When I started Cronos 7 years ago, I picked Canada because it was the first federally legal market, and that created a unique opportunity to develop intellectual property, building an elite team and ultimately have a leading branded portfolio of disruptive borderless products that we could deploy in other markets like the U.S. as they open up. That is still our strategy today. And as I'll discuss later, we are starting to see the results with consumers in Canada and Israel.

Creating an iconic branded cannabinoid product is about identifying a consumer need and building a product that hits that need. Like other consumer products, cannabinoid products are differentiated by taste, aroma, appearance, the look/feel of the product and the story of the brand. But perhaps the most important point of differentiation for us is the effect. There are well over 100 unique cannabinoids that individually and in combination deliver different effects. And we continue to advance a disruptive platform that can deliver differentiated experiences, leveraging rare cannabinoids through custom tailored delivery systems that delight consumers in ways that legacy cannabis products could not.

We're aware that winning in the brand and product vertical is not an easy task, and I want to address that head on. There is fierce competition in every mature legal market, and the illicit market is extremely resilient. But most of that competition is focused on price rather than quality and differentiation.

As a legal cannabinoid company, we have a natural cost disadvantage to the illicit market in North America with the tax and regulatory framework. But we also have a unique advantage to deliver iconic branded products because we have the resources to think long term and innovate. That is why it's so important for us to take the time to create the best products because it enables us to win on quality rather than competing in a race to the bottom. We believe that better will beat first, and we've seen that through the performance of our leading borderless innovations in the market today, like SOURZ by Spinach and Spinach FEELZ. And we believe that these superior borderless products will win with consumers in other markets as well.

Now that we've level set the Cronos identity and strategy, I want to discuss my 4 key priorities: first, delivering margin-accretive growth focusing on adult-use products. During my first stint as CEO, you heard me primarily focus on building our platform, doing research and developing a great pipeline of branded products. After years of hard work and investment, we now have a solid platform, great institutional knowledge of what consumers want and what cannabinoids can do and great branded products hitting the market. My first priority is validating the Cronos investment thesis by delivering top line growth. We want to outgrow the industry in both Canada and Israel, and I want to make sure we are growing in the right way, and that means margin accretive growth.

I've talked in the past about being okay with having higher OpEx and variable costs in the beginning of our product launch cycle to prove out the demand and get to critical mass. With the results we've been seeing from our products that are in market today, we're able to start focusing on improving margins.

Second, increased operational efficiencies, disciplined expense management and leading a successful transition from our Peace Naturals campus to a more agile supply chain. Our business model was never to be the farmer. The wind down of our operations at our Peace Naturals campus

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MAY 10, 2022 / 12:30PM, CRON.TO - Q1 2022 Cronos Group Inc Earnings Call

further aligns us with our priorities of focusing on brands and R&D. We now feel confident that the industry and our supply chain in Canada are at a maturity level where we can implement this approach.

The Peace Naturals campus is where it all began for us, so the closing is sad for me personally. I want to take a moment to recognize the contributions of the team members there. We wouldn't be where we are today without their hard work and dedication, and we will always think of them as part of the Cronos family. Optimizing our supply chain is a great start, but I want to make sure that we get back to operating like a lean scrappy start-up, so we will continue to evaluate our cost structure across all areas of the business.

Third, focusing investments on the highest return opportunities, specifically borderless investments. We will continue to invest in our innovation pipeline to bring consumers the products they want and novel products that can surprise and delight. It is important to us to have superior branded products that we can consistently replicate, produce and distribute in multiple jurisdictions as they open up in the future.

We're creating borderless innovations that we test, learn and improve in the Canadian market with our Spinach brand. The success of Spinach is proof that we have the fundamentals right and our borderless products winning in Canada is one of the best ways to be prepared for legalization in other markets.

We also want to continue to drive rare cannabinoid development and commercialization. Rare cannabinoids give us the ability to differentiate our products by delivering unique effects that hit specific consumer needs. Launching our rare cannabinoid sub-brand, Spinach FEELZ, a platform designed to deliver unique and enhanced experiences made possible through proprietary blends of rare cannabinoids is a great example of a borderless product.

Our cultured CBG gummy and vape product lineup are doing well in market, and we're just getting started. I want our company to be mission ready to execute on bringing our amazing borderless products to new markets with speed and efficiency, and we have a very exciting innovation pipeline to execute on. And last but certainly not least, positioning Cronos to ultimately win in the U.S. cannabis market.

We bring most of our adult-use products to consumers in Canada, but we continue to conduct extensive consumer insight work in all the regions in which we operate with a specific focus on the adult-use market in the U.S. The U.S. remains a great place to learn more about the evolution of consumer preferences, while we focus on creating approaches and strategies to win in the markets we operate in today.

During my time serving as Executive Chairman, I was focused on assessing opportunities in the U.S. The deal we did with PharmaCann sets a strong foundation for entry into the U.S., and we will continue to foster potential strategic relationships that we expect will enable adult-use success in the U.S. With our evolving product portfolio and the most robust balance sheet in cannabis, I believe we sit in a solid position to execute on the branded cannabinoid product opportunity in the U.S., both through organic product development and disciplined and opportunistic M&A.

Turning to our results, I want to highlight the progress in our Rest of World segment, which is led by strong performance in both Canada and Israel.

First, in Canada, we continue to streamline our branded adult-use portfolio to focus on Spinach and continue to organically grow market share across Canada. According to Hifyre data in the first quarter of 2022, Spinach held an approximate 17% market share in the gummies category.

The 3 original SOURZ by Spinach gummies all ranked in the top-10 for market share in Canada.

In March, we launched the fourth flavor of SOURZ by Spinach, Cherry Lime, which is also quickly climbing the market share ranks. Given we launched our first gummy in July of '21, the rapid consumer adoption of SOURZ demonstrates our theory that first isn't always best and our strong ability to deliver differentiated borderless products. We continue to bolster our Spinach flower offerings to meet consumer demand for larger formats that don't compromise on quality. We recently launched Wedding Cake and we'll continue to bring our highly sought-afterstrain-specificlarge-format SKUs to market.

Our growth is coming from branded products, not a value play that is an outlet for lower-quality flower. Our success in the flower category is the culmination of years of genetic breeding work, allowing us to now launch these great strains in market. Similar to the agriculture market, we think the long-term value created in the flower category will largely come from breeding proprietary genetics. And as we've seen from our success in Israel, we believe this is the best way to create successful borderless flower products.

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MAY 10, 2022 / 12:30PM, CRON.TO - Q1 2022 Cronos Group Inc Earnings Call

Vape is an area where we don't want to just compete, we want to win. Following the switch to offering 1-gram formats and the launch of our CBG vape, we are starting to see market share pick up in this category. According to Hifyre data, in April, our Spinach vape portfolio entered the top 10

in market share in Ontario. Following this achievement, we are launching new vape products in May in Alberta, BC and Manitoba, including Cosmic Green Apple and Polar Mint Vortex in an effort to continue to expand national market share within the category.

Pre-rolls are a category we think we can win in as well. Long term, we expect pre-rolls to become an increasingly more important category and believe there is a lot of opportunity to differentiate. Like gummies, we don't need to be first to market. We want to be the best. We're working on several developments within this category and look forward to sharing more news with you when the time comes.

Now I want to turn to one of the most underappreciated aspects of the Cronos story, Israel. The Israel market is the best example of how quickly the cannabis industry can reach its potential with the right regulatory framework. The Israeli cannabis regulator, the Yakkar, has done a great

job of setting up a regulatory framework that provides superior patient access to cannabis and also a great opportunity for sustainable industry growth.

For Cronos, Israel isn't an opportunity to place excess supply from Canada. It is a core market for us to deliver branded products that meet the needs of our consumers. We believed and invested early in Israel back in 2017 and have boots on the ground actively manufacturing and selling Peace Naturals products.

Our strong position in Israel has helped Cronos gain recognition in the market with pharmacy operators and consumers and led to us achieving top 3 market share. These efforts have resulted in revenue within Israel of $9.1 million in the first quarter, up approximately 90% from fourth quarter of '21 and approximately 260% from the first quarter of '21.

Our results compare to an overall Israeli market that experienced an approximate 40% year-over-year growth in kilos sold in the first quarter. We are confident we have a long runway of growth ahead of us in Israel, both from our products that are already in market and the opportunity to launch more borderless products.

As a reminder, we started this year by undertaking a realignment of the business to better position Cronos to drive profitable and sustainable long-term growth. This realignment puts our brands and products at the focal point. We announced 2 primary changes to the organizational

structure. First, we centralized functions under common leadership, which is already bearing fruit in cost savings and driving faster decision-making. And second, we announced the planned exit of our Peace Naturals campus in Stayner to further drive our asset-light model.

With a substantial portion of our Canadian manufacturing moving to Cronos GrowCo, while we continue to maintain other third-party manufacturing relationships, we are working fast to build out our own space within GrowCo to support our needs moving forward. We are incredibly pleased with the cultivation operations at GrowCo and continue to purchase high-quality dried flower from them. This marks a milestone in the evolution of our supply chain, and you're seeing some of the beneficial COGS show through in the margin, which Bob will speak to about at greater length during his remarks.

High level, we were able to purchase high-quality flower from GrowCo for less than what our internal cost of cultivation was at the Peace Naturals campus. And since we also own 50% of the equity, there is additional upside to the margin improvement we get from shifting to GrowCo that will show up through bottom line contribution.

GrowCo is more than just a part of our supply chain. It is an underappreciated asset with hidden value. GrowCo is really just getting started, and while we are their largest customer, if you exclude our purchases they still had revenue of approximately $7 million this quarter to non-Cronos

customers. Given GrowCo's current and expected performance, we are confident in the total of approximately $97 million in senior secured loans that we made to GrowCo and the Mucci's in 2019, and GrowCo has already started repaying the loan. That only strengthens our already leading

industry balance sheet of approximately $1 billion in cash and short-term investments.

Turning to appointments within the organization. I'm excited to announce that Terry Doucet was appointed General Counsel after serving in an interim capacity since December of '21. Terry has been with Cronos since 2018 and has been a critical player in helping build the organization to where it is today. Terry has guided Cronos through significant growth over the last few years, including the build-out of our legal and regulatory

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