Q3 2020 Cronos Group Inc Earnings Call

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Good morning, My name is Ginny and I will be your conference operator today I would like to welcome everyone to the Kratos groups third quarter 2020 earnings Conference call. Today's call is being recorded at this time I would like to turn the call over to Shane late law Investor Relations. Please go ahead.

Thank you Jamie and thank you for joining us today to review Kronos groups third quarter, 2020 financial and business performance today, I am joined by our President and CEO Curt Smith, our executive Chairman, Mike Orenstein, our CFO, Jerry Barbato, and our SVP of legal and regulatory affairs, assuming some furnace group issued a.

A news release announcing our 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 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 statement and risk factors included in the Companys.

Earnings release, and regulatory filings, including the company's most recent annual report on form 10-K, and quarterly reports on form 10-Q, 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 us generally accepted accounting principles referred.

To by the Securities and Exchange Commission as non-GAAP measures. We believe these non-GAAP measures assist management and planning forecasting and evaluating business and financial performance, including allocating resources reconciliations of these non-GAAP measures to their closest reported GAAP measures are included in our earnings press release furnished to the SEC, which is available on the pressroom section of.

Our website the Kronos group Dotcom. 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 cross talk or minor technical issues. During this call. We thank you in advance for your patience and understanding will now make prepared remarks, and then we will move.

To the question and answer session with that I'll pass it over to Kronos Group Executive Chairman Mike currency.

Thank you Shane and good morning, everyone.

I'm proud to speak to you today as Kronos as executive Chairman.

As many of you know after careful planning and thoughtful consideration we expanded our leadership structure with the appointment of Kurt Schmidt as our new President and CEO in September.

And I have transitioned to the executive chairman role or I will lead the board and work with Kurt to continue to drive products group strategy going forward.

I am incredibly confident that Curt will help can prone to build on our strong track record of growth and lead us toward many more industry defining accomplishment.

Kurt is a highly experienced consumer package goods executive with the expertise to push growth even further.

During his three plus decade career, Kurt has built a track record of driving outstanding performance at some of the most respected global consumer goods company.

Including Blue Buffalo, Natalie Gerber and crafted.

He has demonstrated tremendous success partnering with founders of startups to accelerate growth and.

And we are excited to leverage his expertise as credit continues to expand.

When I met Curtis part of my year long search for someone to take over the CEO role that was immediately apparent that he is uniquely suited to drive the company's next phase of growth and uphold our commitment to lead the industry forward responsibly.

He's a passionate believer in our mission and potential of our incredible company.

I'm excited to partner with Kurt to leverage growth the strength and continued to deliver best in class brands and products to our consumers.

Our industry is new but that doesn't mean, they can't learn from seasoned executives from adjacent sectors.

In addition occurred we further strengthened our senior leadership team by adding Shannon buggy as senior Vice President Global head of people.

Before joining Kronos Shannon was the SVP of global human resources for Nielsen, where she led HR strategy for Nielsen media.

With over 25 years of experience Shannon has a proven track record of leading and managing global human resources team.

As we prepare for the next chapter in sharing our employees throughout the organization are taking care of it is of the utmost important.

We've come a long way and the industry at large has evolved in a short period.

Together, we forged a truly differentiated business model with great brands technology strategic partners, a strong balance sheet and importantly, a great team focused on driving results.

As I look at Kronos today, it's clear that the opportunities before us are more exciting than ever.

We look forward to continuing to launch innovative can avenue at product in Canada and to foster a portfolio of us have derived CBD brands.

Internationally, we're excited to bring our products to more pockets of the world as regulations evolve and continue to establish ourselves as industry leaders.

I want to thank the talented team the Kronos, who have brought us this far and continue to push us forward.

These past few months I've had a crash course in the industry challenges and opportunities as.

As well as things that matter most to Kronos and how my expertise can help push us forward.

For those who do not know me well I want to share some of my key beliefs and leadership principles.

I believe and creating high quality products for consumers and the importance of building brands that exceed consumer expectations.

I've seen companies rally around products, and feel immense pride and bringing quality products and consumers.

Kronos mission to improve lives by unlocking the full potential of cannabis aligned with my core belief in the power of innovation.

End marketing at Kronos.

In the kidney market I look forward to sharing more details soon on innovation launches to the adult use market.

Our innovation team has been working diligently under Todd to hone our next generation of product for our brands bring.

Bringing them to more consumers is a focus of mine as the Canadian market continues to grow and sophistication and science.

Flower annoys.

Although I have not been able to get through our Israeli operations due to covid.

We <unk>, we have had extensive virtual team meetings and I look forward to working with them in person.

We have an excellent opportunity to be leader in this rapidly growing medical market.

As well as the potential don't use market when it opens up.

I've had the opportunity to spend time with Todd and our partners that kinko regarding our fermentation work.

As a former farmer executive I have significant experienced in the permutation of teen gradients and I am encouraged by this project and how transformative it can be.

I'm pleased with the progress to date and look forward to sharing more updates in the future.

I sure Mike sentiment about how transformative project and be for our business both on margins in on the innovation Si brew.

We remain confident in our original target achieving commercialized scale of Kevin noise by September 2021.

Which will allow fermented camp cannabinoids to be utilized in future finished crops.

Lastly regarding U S election, our organization like many of you listening to this call is interested to see what unfolds from a cannabis regulatory legalization standpoint.

Regardless of the party controlling various branches of government. It was clear during this election that cannabis is gaining popularity across the United States, which is a continuation of the positive momentum for the industry.

Partially offset by nonrecurring wholesale revenue in the Canadian market in Q3 of 2019 and strategic price reductions on various adult use cannabis products in certain Canadian provinces in the third quarter of 2020.

Ranted cannabis products to the Israeli medical market.

Partially offset by nonrecurring wholesale revenue in the Canadian market in Q3, 2019, and strategic price reductions on various adult use products in certain Canadian provinces in the third quarter of 2020.

Looking briefly at the expansion in the Canadian candidates market. We are encouraged to see the continued growth of new retail locations in provinces, such as Ontario, providing.

Providing more convenient options for consumers to purchase cannabis products responsibly.

Gross loss for the rest of World segment was $2.2 million, a $1.4 million decrease in losses from the third quarter of 2019.

The improvement year over year was primarily driven by an increase in revenue, partially offset by an increase in cost of sales driven by a higher volume of adult use sales and the associated third party flower purchases and a decline in wholesale sales.

As we work to create an efficient global supply chain through 2020 and beyond for our rest of World segment. We anticipate that gross margin will continue to fluctuate as price and mix change from quarter to quarter.

Reported operating loss in the rest of World segment for the third quarter of 2020 was $18 million, representing a $3.2 million decrease in losses from the third quarter of 2019 the.

The improvement was primarily driven by a decrease in general and administrative costs driven by a reclassification of 4.6 million. So corporate expenses in the third quarter of 2020, which had no effect on the company's consolidated statement of net income.

And an improvement in gross loss, partially offset by an increase in R&D spending.

Turning to the US segment reported net revenue in the third quarter of 2020 was $1.6 million, a 143% increase from the third quarter of 2019.

The increase year over year is primarily driven by a full quarter of results in the third quarter of 2020 as opposed to 25 days in the third quarter of 2019.

Despite some weakness due to corporate restrictions, we won't accept that as an excuse and we are pleased with our performance in the U.S.

Three of 2020, the company recorded a non-cash gain of $105.3 million related to the change in fair value of these financial derivative liabilities.

<unk> continues to expect there may be significant reported earnings volatility, primarily driven by the fair value quarterly adjustments related to the movement of Kronos groups that price.

To the balance sheet. The company ended the quarter with approximately $1.3 billion in cash and short term investments, which held relatively flat from the second quarter of 2020.

Capital expenditures for the quarter or $8.3 million. This spending includes investments related to Kronos fermentation. The peace Natural's campus are Israeli facility and our new E. R. P system.

Industry and I'm excited to be leading Kronos on this journey.

With that let's now open the line for questions.

At this time, if you would like to ask a question. Please press star one on your telephone keypad you will be allowed one question and one follow up question, we will pause for a moment and kind of how the Q1 day roster.

And your first question comes from the line of John the parallel of the IVC.

Thanks, Good morning.

I was hoping you could give us a better understanding of the puts and takes in gross margin guidance.

Spaced out over the third quarter, but I think you'll you'll have the same situation, where we've launched a new brand and you'll <unk>, you'll see continued fluctuation in the margins based on mix.

Yeah. John This this car just add a point to that I think.

What you're saying, it's the deflationary pricing is really driven by the inventory situation. So I think that's something that people are working through and I think once that alleviates. That's to me a short term problem versus anything that's long term.

Okay got it thanks, and then the second question is more more brogues and it's more about your M&A strategy in your particular on the U S.

Or some kind of unsettled on the election, but if there is a split between white house and Senate, maybe we don't get that transformational reform that you'd need to get candidates off the controlled substances Act. So.

If that's the scenario does that make you think differently about M&A you start maybe looking at other countries with with more more urgency or do you maybe pushed the gas pedal a little more on CVV just about to get your Samsung how potential regular a regulatory requirement or lack of it changes your strategy in the next 12 to 18 months.

Yeah. Good question I think on the first half obviously, our balance sheet certainly provides us some flexibility.

And regardless of the political changes in the U S. The regulatory landscape is evolving and more evaluating I think one of the really important things about the changes we've done.

Elevating Mike to the the chairman role as Mike focus and he can speak to this is going to be on our strategy with.

What the U S.

I can't think of a better person to have in this world so to be able to guidance on this so I think that's important and I think that's important strategic market.

Versus looking at alternative markets right now so.

Mike I don't know if you want to add anything yeah.

Exactly what Kurt saying are are are focused in my focus has always been sort of the endgame number one priority is the U F C. H D market, we expect that the.

Biggest profit pool, and looking at different scenarios and different structures for us it's about how we enter it not not weather.

Whether we enter and of course, the regulatory environment will certainly dictate.

When and how that is but.

It's top of mind for us.

Got it thank you very much.

Your next question comes from the line as Andrew Carter.

Stifel.

Alright. Thank you good morning, So I Wanna I Wanna double click on that gross margin question, because I I I think we all see the price competition on flowers and understand you're kind of lowered your prices kind of to keep the gaps in line, but what I'm not clear on is kind of a third party costing you mentioned a lot of inventory is it an issue where the third party.

High quality flower costs are not decreasing at the same rate.

I guess I would ask if that's for our you upside down on prices and how do you see that see that alleviating kind of like the high quality flower and being able to kind of get your supply chain line, where you have a cost to serve sort of the Canadian Dalton's Margaret.

Yeah.

Jerry comment as well, but.

The pricing.

Pricing issues from a couple of quarters ago. So I think we're going forward your you're saying the.

Better better raw material pricing, but we still got this inventory and passed so.

I see that alleviating itself as we move forward as demand gets more insane.

Supply is excuse me it gets more in sync with the demand side.

Sure.

Yeah, Yeah, Andrew just to add a little bit more to that we are seeing that are third party purchases. The price program is coming down even for the high quality high THC.

But it was it really have to separate that inventory based.

Based on flour, and oil and where it's going and we use a weighted average cost so.

That cost will go down over time, but like I talked about and Curtis said in the short run there's just a lot of deflationary pressures of the Canadian market that we have to work with them.

Okay got it and then second I want I wanted to ask about Israel, because I think you reported 500000 sales outside of North America. So I wanted to understand I think Israel's kind of my estimates about $250 million annualized market work at that business look like for next year and could Israel actually be a bigger driver of growth.

Essentially next year than Canada. Thanks.

Yes. This is Kurt.

Yeah, <unk>, what really positive on Israel, I mean, it's early stages yet.

But.

The patient count continues to grow so we see that.

Growing at a pretty.

Good clip and then we are I think position very well there.

Just received our certifications required for cultivation in production and marketing a dried flower free roles in oil drops in Israel, and we are now selling dry flour and oils into the peace natural brands, which it's been well received so we're really bullish on the market.

Get into where I see how big it will get.

The price gaps relative to the illicit market any incremental color would be helpful. Thank you.

Yes.

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Go ahead Gerry.

Yeah, what I would say you know as is typical of most CPG companies, we perform a regular strategic review of the landscape and look at differentiation amongst our brands, both cold and spinach by product format and price point.

And then on the th seaside we have an innovation we're building an innovation funnel. We're we're looking at our marketing mixed model to make sure we're hitting the right <unk>.

And happy dance, we're very excited about and also an early early date, but that launch was very very exciting and well executed in the beginning swearing yearly earnings, but it has really been positive momentum and we're gonna carry that forward.

Terrific. Thank thanks, so much that clarity and then so when my follow up would be around around the penetration of course so.

Three quarters from what you're projecting in terms of Kronos his first products coming from the permutation facility.

Are you on track with that are there specific product format that we should be thinking about and and how is Curtis planning unplugging. The different these products into the Canadian market versus the U S market given the different regulatory paradyne's with can I have been Oh, it's beyond CVT in each of these markets.

Yeah. Thank you for that question Yeah, we are on track.

Great that's very helpful and thanks for taking my question.

Your next question comes from Tammy 10 of BMO capital markets.

Refreshing, so the marketing campaign and with with kind of directly and put some encouragement I'm wondering if you could just elaborate on that a little bit more what exactly a new strategies and trying or what are some neat things another.

The pipeline for that thank you.

Yeah, I think it's just accelerating lovely lovely that what the team has been working on so again that'll be you know marketing investments I it'll be distribution side and it'll be innovation side as we lay out the innovation funneled, which will be an important piece and you'll see that develop over the next 12.

<unk>.

Uh-huh.

Yeah. Thank you.

And your final question comes on the line of Bill K F M. K M partners.

Hey, Thanks for taking the question mine mine relates to reporting adjustments Uhm, just just to clarify something was the U S separation equity comp adjusted out of the U S segment adjusted operating loss. It to me it doesn't appear so, but then I see the share based comp adjustment adjustment too.

Consolidated EBITDA. So I guess can you help me understand how that U S separation accomplished treated in the adjustments segment number versus the adjusted consolidated EBITDA number.

Yeah sure. Thanks for the question no. We did we did not adjusted out so what's included in that adjusted operating lost in the U S segment.

And we'd have to be consistent we adjust sure base camp out of our adjusted EBITDA number.

Okay, so not adjusted a segment, but adjusted to consolidated.

Suggested that the consolidated EBIT number yes.

Okay that that was the clarification needed. Thank you.

And there are no further questions E Q really have any additional closing remarks.

No just thanks, everybody and I look forward to working with all of you in the future.

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

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