Cronos Group Inc

TSX:CRON

Earnings Call Transcript 2018-Q1

[Operator]

Good morning. My name is Lisa, and I will be your conference operator today.At this time, I would like to welcome everyone to the Cronos Group Inc. First Quarter Results Conference Call. [Operator Instructions] The company's Q1 2018 financials, related MD&A and earnings news release have been filed on its SEDAR and EDGAR profiles. This information as well as the prepared remarks will also be posted on its website at www.thecronosgroup.com under Investor Relations.During the course of this call, year-over-year comparisons that management makes will be in respect of the first quarter of 2018 versus first quarter of 2017, unless stated otherwise. During this call, various remarks management makes about future financial performance, strategic goals, plans and prospects of the company constitute forward-looking statements for the purposes of applicable U.S. and Canadian securities laws. These statements are based on assumptions that are subject to risks and uncertainties. Management refers you to the cautionary statement and risk factors included in the company's MD&A and annual information form filed on SEDAR and EDGAR for a description of these risks, uncertainties and assumptions. Although management believes that the expectations reflected in these statements are reasonable, it can give no assurance that the expectations of any forward-looking statements will prove to be correct. Actual results may differ materially from expectations, plans and prospects contemplated in these forward-looking statements as a result of various factors, including those discussed in the company's annual information form and MD&A filed on SEDAR and EDGAR.I will now turn the call over to company's management. Please go ahead.

[Michael Gorenstein, Chairman, CEO & President]

Thank you, and welcome everyone. It's only been a few weeks since year-end call, so this feels more like Part 2 of that. Because of the shortness in duration we'll skip highlights of the strategic accomplishments over the last quarter and pass you over to Billy.

[William Hilson, Chief Financial Officer]

Thank you, Mike, and good morning, everyone. So kicking off here revenues in the first quarter ended March 31, 2018 were $2.9 million, representing a 473% increase versus the same quarter in fiscal 2017. Revenues on a quarter over quarter basis increased by 82%. The main drivers associated with the increase in revenues were primarily due to the ramping up of production, accelerating patient onboarding, continued business-to-business sales and a ramping up of cannabis oil since Q4 2017. In the 3 months ended March 31, business-to-business sales represented 64% of reported revenue and domestic medical sales represented 30%. While export sales to Germany accounted for 6% of the reported revenue, as the company ramps-up international exports. Product sales continue to attract a forecast based on the introduction of new cultivars and expanding our strain-specific oil product offerings as well as continued strategic focus on building a platform for expanding international sales.Total cost of sales for the quarter of $1 million as compared to recovery of $0.5 million in Q1 2017. The change was largely driven by an increase in inventory expense to cost of sales, due to the increased sales and an increase in production cost incurred to support the growth of plants. Gene and biological assets for the quarter of $4.5 million is representative of an increase in the number of plants under cultivation at the quarter end, as we expand production and bring online new production facilities. During the quarter ended March 31, the total production of dry flower was 788 kilograms, at a cost of approximately $1.7 million, resulting in production cost of $2.18 per gram. Management anticipates a production cost per gram to improve significantly, as production output increases over the next couple of quarters. Operating expenses for the first quarter, including salaries and benefits of non-production staff, stock-based compensation, general and admin, sales and marketing, interest and depreciation expenses totaled $4.1 million, and represents an increase of approximately $2.3 million, from the same period last year. The increase in these costs includes investments made in staffing, business and corporate development activities, including one-time cost associated with the recent NASDAQ listing.As a result of the above, in the first quarter, Cronos recorded an operating loss of $2.2 million, compared to $0.7 million in the first quarter 2017. Total other income of $0.2 million for the first quarter ended March 31, representing an increase of $0.3 million compared to the same quarter in 2017. The increase is a result of the exercise of warrants of noncore strategic holdings namely ABcann as well as a small gain, pickup from our strategic 20.2% holdings of Whistler Medical. As a result of above, in the first quarter, Cronos recorded a net loss of operations of $1 million. Comprehensive loss of $1.1 million for the first quarter as compared to $0.1 million for the same period 2017, representing an increase of $1 million. The increase was a result of expenditures relating to the ramping up of production, higher sales and marketing cost as well as the one-time expenses related to NASDAQ.Turning to the balance sheet and cash flows. At March 31, the company's cash position was $32.4 million, representing an increase of $23.2 million since year end last year. Subsequent to the quarter end, the company closed an equity financing and has a current cash position of approximately $110 million.Inventory at March 31, amounted to $9 million, this is up from $8.4 million at year end fiscal 2017. Together with biological assets of $4.5 million, total inventory and biological assets at the quarter end amounted to $13.5 million compared to $12.1 million at year end 2017.Property, plant and equipment increased by $8.1 million, year end -- in the quarter, of which, the vast majority was attributable to the investment in the 315,000 square-foot production expansion and extraction lab project, which is on track for completion by mid-2018.And finally, turning to cash flows. The quarter ended March 31, resulted in $0.9 million in cash flow used in operating activities plus another $12.8 million deployed for working capital for deposits on equipments and reductions of payables. Mike, this concludes my review of the financials for the quarter ended March 31, 2018. And I hand it back to you.

[Michael Gorenstein, Chairman, CEO & President]

Great. Thanks, Billy. So just a few things we'll give color on. The first that we, sort of, left off on Q4 was the royalty component for Germany. One of the things that we'll start to smooth out and be able to give a more clear picture of the quarter is that we receive a supply price, when we initially make a shipment, but we don't realize the bulk of the sales until a royalty is realized, once the product is booked and then rec'd out in Germany. One of the advantages of that is, is that we're able to get a very clear picture of what the actual contribution at the bottom line is. But I realize, focus is on top line, we're taking out on these sales or associated cost. So Germany still is our highest contribution channel. The other is, as far as what the breakdown of sales channel is, part of the color here, we ramped up production very significantly by having online buildings 1, 2 and 3. And although vaults are no longer required beginning in July, they still are required as of Q1. So the greenhouse vault was not licensed until, towards the end of the quarter, and that resulted in us having an excess of supply without having permits ready, so that was the main driver of some B2B sales. And finally, as far as operational costs, we've become more efficient over the first 3 buildings, but this quarter does include a lot of training, we brought online people that have started preparing for building 4, and, of course, operating the greenhouse without an associated harvest. So I understand that there is probably a flurry of M&A activity, everyone wants to try to digest, so let's just jump into questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Martin Landry from GMP Securities.

[Martin Landry, MD Equity Research & Equity Research Analyst]

My first question is on international sales, you talked about the revenue recognition and that's fine, but wondering if you can talk to us a little bit about looking at the different ways, how many kilos were shipped to Europe this quarter? And how does that compare to Q4?

[Michael Gorenstein, Chairman, CEO & President]

Yes. That's -- it's something we aren't disclosing the exact, I believe, details on what the quarters are because of the way royalty breaks down. It was lower than Q4, but you'll see a break because of the permitting. So there is the large amount of what was held, was intended to be sent, and you'll see it show up in Q2. Part of that also relates to registering the monographs and the strain that we're sending. So it's making sure we're growing out one specific strain -- multiple strains, but that specific strain is what we're sending, we can't piecemeal send any inventory we have. And I think that's a big shift from prior distributors, but given very built out supply chain in sales and marketing team of Pohl, they want to make sure we shift to a pharmacy, something that's consistent, so patients are able to get the same strain over time.

[Martin Landry, MD Equity Research & Equity Research Analyst]

Okay. So if I understand your comments, the reason why you didn't ship more product to Europe this quarter is because you didn't have enough of the strain that you're shipping there? I'm not too clear if I understand everything you said.

[Michael Gorenstein, Chairman, CEO & President]

We have multiple strains we're shipping, but there's a lag when you place an order between getting the permits and what you have available. So the permits are very cannabinoid specific. And we can't, so let's say, we grow 1,000 kilos in a quarter, we can't just send the 1000 kilos, everything has to be adjusted for supply chain and make sure that a specific genetic is tied to what the product is and then we ship that. So if you remember, I think when we were on the tour, we were growing a specific strain Infinity for Germany, so that's the -- one of the main strains being sent, so we're growing specific to order now. And I think you'll see that type of supply chain management is going to be required for the larger distributors or retailers like OCS as well, where you're filling a specific SKU on the shelf and you're only shipping that for a specific permit.

[Martin Landry, MD Equity Research & Equity Research Analyst]

Okay. So and your comments for Q2 regarding international sales. Is that -- you are going to have a lot more products shipped there? Is that my understand -- is that a correct understanding?

[Michael Gorenstein, Chairman, CEO & President]

Yes. That's right. So the products even if they are available in Q1, it's just when the permit comes in and it's ready to be cleared, there is probably a 45-day lag between permitting and testing. So yes, I think you'll see the real impact showing up Q2 and as far as actual volume. But the flip-over and doing QA, testing its ability to make sure everything was ready to go is what accounts for that.

[Martin Landry, MD Equity Research & Equity Research Analyst]

Okay. And you know you talked about your restrained vault capacity, which forced you to do a little bit of B2B sales in Canada. Wondering how are you getting ready for the recreational market that's coming up shortly? I think Ontario had their product call closed a week or 2 ago. What's -- like how aggressive are you or how prudent are you to -- in your RSB to supply the provinces right now?

[Michael Gorenstein, Chairman, CEO & President]

Yes. We certainly participate. We're more focused on, I think, narrowing on a few provinces and making sure we can fill the needs rather than going after every single province. If you're trying to figure out, which provinces we're going to, a lot of our employees would like to be able to buy the product on the shelves where they work, so that's the easy way to project where we'd be participating. But those processes are ongoing, and it happens to be that Ontario and BC, I think, are taking a pretty broad and thorough process. So I wouldn't expect that to be an immediate announcement, but it's something we plan to be a big part of. We have a presence here and it's a market we want to serve. We also aren't able to directly predict the exact changeover in medical patients to recreational, so I think it's something that we need to do, otherwise, we could be in a situation, where it's only in international channel. So we're active, we're participating, we're ramping up the inventory build. When we're looking at maintaining a certain amount to make sure that we can fill the channels on day 1, specially given that we have such a quick ramp up in production. What we're delivering in 1 month, we may be, say multiples of that, able to produce in subsequent months once building 4 is online. So if it's started today, we'd be able to deliver initial shipments. And we'll keep monitoring inventory to make sure that whatever we're building is still fresh product, because for us the number 1 priority is brand management. So if -- we initially expected that to require us to start shipping this month, so if you look at safety stock inventory we've built, if that was the case, we would have been ready. Now it comes down to details of just making sure we understand exactly how we're packaging, how we're adhering the tax stamps, and how we're plugging into the different supply chain systems.

[Operator]

[Operator Instructions] Our next question comes from the line of Vahan Ajamian from Beacon Securities.

[Vahan Ajamian, Research Analyst of Special Situations]

A couple of questions, first of on Israel. Any update, for the last couple of weeks regarding your or the country's ability to allow exports?

[Michael Gorenstein, Chairman, CEO & President]

Yes. We continued to be -- to strongly expect that exports will be allowed. There've been public comments made and private comments made that suggested it's -- excuse me, inevitability. I think the question that's, sort of, out there is how many, how many farms will be allowed to export, but it's still something we are -- we fully expect. If there were to be any change, which is again not something we anticipate, it would just mean that the Phase 2 would likely be shifted to another international low-cost [indiscernible] for exports, and we would supply the domestic market. But we think that by the -- certainly by the end of the year, we should see some announcement allowing or putting that framework in, but our expectations from when we began the project last year was always, that would be late this summer, that you have the regime in place.

[Vahan Ajamian, Research Analyst of Special Situations]

And so you are looking at other low-cost jurisdictions other than Israel for growing?

[Michael Gorenstein, Chairman, CEO & President]

Yes. Look, we're -- we want to spread international footprint and I think it's important to continue building out your presence internationally. When we think of sort of the greatest value we can create with the assets we have, it's using that IP and leveraging it to use the first mover advantage and to be able to set up different international hubs. So similar to Australia, finding a place in the South -- and consider South East Asia, there are other parts of the world where, from a regional perspective, it makes sense to build a presence. So it's certainly something we're actively pursuing, and we feel that if there was a delay in Israel, we would be well set up and able to complement that with other cultivation opportunities.

[Vahan Ajamian, Research Analyst of Special Situations]

And on the in rec side in Canada, you gave some good color on the 2 provinces, it seems like you're targeting the most, but any color you can give on your, I guess, your recreational banding strategy? How do you plan to differentiate your products in your strains from others?

[Michael Gorenstein, Chairman, CEO & President]

Yes. So the recreational brand, I think, the first of them will be launched in the near future, and you'll be able to start getting a sense of how we'll go about branding. A big differentiating factor we have is the indoor grown nonirradiated cannabis, and we've seen that very well received in the medical market, and we expect that to be even more well-received in the recreational markets. But the fact that all of the terpenes are still present in the strains, we think it's important, irradiation can really take away from that. So that's a big driving factor, and we'll continue to highlight that. And when you do have a reputation of not having the same robust taste and flavor profiles in licensed producer cannabis, I think it is because of irradiation.

[Vahan Ajamian, Research Analyst of Special Situations]

And just quickly on the Q2. Obviously, we're only have way through the quarter and I feel you give a new guidance, but in terms of revenues, and how they might be trending, I mean, just looking from your website, I see significantly wider variety of products, if one will see the flower side and the oil side, but it's tough to tell what the depth is of each variety? I mean, is it safe to assume that, that's indicative of production continue to ramp up from Q2 versus Q1?

[Michael Gorenstein, Chairman, CEO & President]

Yes, that is. And you'll also see a lot more oil so we certainly try to build safety stock to be able to supply and we've seen sales ramp up extremely quickly as far as the new channels. So I think, you'll continue to see that growth. And just to give you an idea, I think it was Q3 and Q4, we were saying you're starting to see the effects of buildings 3 and buildings 1 come online. We're now seeing that product passing through testing and being ready to be sold. And we went from operating in 40,000 square feet to adding another 28,000 and bringing on the new extraction lab, so that's a significant jump, and that very quickly goes from adding another 30 to adding another 286.

[Operator]

Our next question comes the line of Jesse Pytlak from Cormark.

[Jesse Pytlak, Analyst of Institutional Equity Research]

Just wondering are there any updates with the Indigenous Roots partnership, like is that still advancing or what's, kind of, happening with that?

[Michael Gorenstein, Chairman, CEO & President]

Jesse, as I'm sure you're seeing in the media, there's a lot of, let's say, a lot of resolution that's going to come on how C-45 and the framework specifically will relate to indigenous communities. Until we have clarity on how the rules will permit distribution to indigenous communities and whether that needs to be cleared through provincial distributors because of -- sorry, and that have actually grown on specific indigenous community, it will essentially be on hold, but that's one of the things we're working through. We don't want to build a facility and then not be able to ship direct to an indigenous retail channel, that would essentially defeat the purpose, and that's something that there's active lobbying and active discussions on.

[Jesse Pytlak, Analyst of Institutional Equity Research]

Okay. That's helpful. And then just in terms of the completion of B4. Are there any major construction hurdles that are still out there? Any long new time equipment orders that could, kind of, delay the expected timing?

[Michael Gorenstein, Chairman, CEO & President]

No, we're in very good shape. We've got flower rooms that are finished. It's pretty encouraging and we're really happy walking through there, but we're on track.

[Operator]

I'd now turn the call back to company's management for closing remarks.

[Michael Gorenstein, Chairman, CEO & President]

All right. Thank you, everyone for joining, and look forward to chatting soon.

[Operator]

This concludes today's conference call, you may now disconnect.