Q3 2021 Cronos Group Inc Earnings Call

February 18, 2022

Good morning, My name is Catherine and I'll be your conference operator today.

I would now like to welcome everyone to Kronos group's 2021 third 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. Please go ahead.

Thank you Catherine and thank you for joining us today to review Kronos group's 2021 third quarter financial and business performance today, I am joined by our President and CEO , Kurt Schmidt, our CFO , Bob <unk>, and our executive Chairman, Mike Garnsey Furnace group issued a news release announcing these financial results. This morning, which are 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.

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 cautionary statements and risk factors included in the company's earnings release and regulatory filings.

Included in the company's most recent annual report on Form 10-K , and quarterly reports on Form 10-Q by which any forward looking statements made during this call are qualified in their entirety I want to stress that this call will be limited to third quarter of 2021 earnings and the restatement of our second quarter financial statements and we will not be addressing or taking questions on full year 2021 results.

Full year 2021 results will be discussed after we file our annual report on Form 10-K with the SEC. 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 because management planning forecasting and evaluating business and financial performance.

And that's 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 in the press room section of our website the cross group Dot com.

These non-GAAP measures may not be comparable to measures used by other issuers I'd also like to note that we're 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 we will now make prepared remarks, and then we'll move into our question and answer session with that I will pass.

It over to Curtis group's president and CEO Kurt Schmidt.

Thank you Shane and good morning, everyone I want to thank our employees board of directors and shareholders for their support and patience as we work through completing our Q2 restatement and our Q3 filings.

Special Thanks to our thanks to our finance and legal teams for putting in the extra effort over the past few months.

<unk> are never easy, but it's essential to learn and grow from them. We are committed to continuous improvement and have learned and evolved from this situation.

Now I'd like to review recent developments related to our financial reporting and internal controls and the remediation actions were taken well Bob will take you through more details on these items shortly.

As we noted in November 2021, the audit committee of the company's board of directors work with our independent financial Auditor to conduct a review to evaluate the goodwill and indefinite lived intangible assets in the U S reporting units for impairment.

As a result of this review we have recorded impairment charges on the U S reporting unit totaling $236 $1 million with respect to goodwill and indefinite lived intangible assets and on long lived assets and the three months ended June 32021.

Accordingly, the Companys restated the period's financial statements to reflect this new information.

The restatement has no impact on cash and cash equivalents.

Our revenues.

We've taken the Fad is seriously and in connection with the restatement, we convince making changes to our internal control policies and procedures to further strengthen internal controls related to financial reporting.

We're also undertaking a realignment of the business that we believe will best position Kronos to drive profitable and sustainable growth over time.

I view the realignment in three distinct pillars.

We are realigning the organization to better enable our go forward strategy.

This includes centralizing functions under common leadership, allowing us to distribute what resources more efficiently and prove strategic alignment and eliminate duplicative roles and costs.

We will reduce complexity, leading to a decrease in fixed expenses.

We are undergoing an evaluation of our global supply chain to become leaner and increase our ability to adapt quickly to the changing landscape we.

We are performing product reviews pricing optimization and pursuing distribution that matches. Our go forward strategy across North America.

We are steadfastly focused on aligning department priorities and team structure to support these initiatives.

Finally, we will implement an operating expense targets to help us optimize our cash deployment.

As more states legalize cannabis in the U S. We are eager to build off our investment in pharma can bring adult use THC products and brands to U S consumers upon federal legalization.

We have set the foundation for our entry through the strategic investment in pharma can and we are gaining invaluable experience through our existing businesses in Canada and other international markets with our new organizational structure, we will be ideally positioned to enter and deliver.

The overall strategic realignment initiatives expected to deliver $20 million to $25 million and initially identified savings across operating expense categories in 2022.

Primarily driven by sale by savings in sales and marketing general administrative and research and development.

As part of the first pillar of our realignment the centralized decision, making under common leadership.

<unk> appointed Jeff Jacobson to the position of senior Vice President head of growth.

Mr. Jacobson previously served as the Companys General manager of Canada and Europe .

Mr Jacobson and I assume that the <unk> group since December 2016, and previous to that.

He was a co founder of peace Naturals Mr.

Mr Jacobs expertise and experience in licensing and compliance New business development project management and resource management will have protocols group lead in domestic and international markets.

The company also appointed John Creek, the position of senior Vice President head of operations.

Mr. Greece, joining Kronos group in August 2021, as Vice President of operations. Mr. Greece has worked with several candidates organization and was most recently the chief operating officer for the Supreme Cannabis Company.

Prior to Supreme discrete kind of candidates experienced stern California's adult use implementation at cielo for global cannabis Company Crystal Pharma Ltd.

Prior to that he spent the majority of his career in supply chain and operations with Pepsico necessarily and Safina foods Mr.

Mr. <unk> experience in building supply chains around the World will help the company win in the markets. We are in today, while Stanley staying nimble in order to move fast and pivot as the industry changes over time.

I'm confident these realignment efforts will better position Kronos to continue to assemble a portfolio of best in class brands and intellectual property.

While preserving the financial flexibility to make additional strategic investments in our R&D pipeline and brands as we continue to innovate and evolve with our consumers' wants and needs are.

Our future structure will be a brand centered organization with teams focused on accelerating growth on the core margin accretive innovation winning in rare cannabinoids.

The us adult use market entry and streamlining the organization to make better decisions, while increasing alignment and agility.

There is a lot to look forward to as this process unfolds, and we will providing updates in the coming quarters.

Meantime, we remain focused on driving the initiatives forward advancing our core business priorities and preparing for entry into the U S.

While we are confident our realignment strategy will improve certain areas of business I believe kronos is sitting in a great position within the global cannabis landscape.

Which is a credit to Mike our instincts prudent leadership in the early days of legalization in Canada, and the evolving landscape across the world.

From the very beginning Kronos has taken a different approach.

Instead of gaming for a multiple unfunded capacity, we stayed relatively lean and focused on R&D, while creating cultivation partnerships with large scale agricultural specialists.

Instead of controlling positions in countries outside of the U S, Canada, and Israel, we chose low capital intensive partnerships to create exposure while limiting risk.

Instead of a desire to be first to market. We are focused on differentiation and delivering products that consumers didn't know where possible.

While this approach was not the most popular and requires patience from our shareholders partners employees, we are beginning to see it pay off.

The success, we are seeing is proven and point of sale that.

Our salaries by Spanish edibles achieved double digit market share on the company's category and Canada within six months of launch and our breeding and genetics program as yield some of the best selling high THC flower skus on the market in Canada.

We weren't first to achieve these rankings.

Can push go on these product launches reprove, the muscle we have across our organization and the desire to win.

We have looked and continue to look at the Canadian adult use market is a test and learn market.

We all know why it's not the easiest market to operate in but we are focused on making it work for us that means focusing on lending losses with an eye towards profitability, but most importantly, creating products through extensive R&D develop turnkey solutions for any market we operate in.

Kronos is not without its challenges and has had missteps were aware of that and we're working to address them with the strategic realignment.

But at the same time, we have a lot of confidence.

We have one of the strongest balance sheets in the industry and strength across our organization.

Which I believe makes kronos poised to be a leader in any market we operate.

Now getting into updates on some of the items that are working today.

In October 2021, we launched the first candidates edible and Canada. The feature culture, CPG spinach feels chill blast to to want THC CBD gummies.

Following the successful launch in January 2022, we launched a one gram THC vape pen featuring cultured CPG.

Further extending our leadership position and bringing high quality rare cultured cannabinoids to the market.

Subsequent to the third quarter, we hit the equity milestone for culture, <unk>, which is a crucial step to developing culture Tacb. We're very proud of the work we are accomplishing with ginkgo and how we are positioning this company to win with rare cannabinoids.

Spinach brands, New platform spinach field will deliver a variety of cannabis products, which will prominently feature rare cannabinoids, they're using our proprietary processes designed to provide unique and enhanced experience.

As a reminder, kronos believes that the best way to sustain sustainably women candidates is to compete with differentiated products.

Just competing on price, we feel we've done a great job executing that strategy with our flagship adult use brands spinach by delivering consumers better products and providing great overall value and we're just getting started.

As part of the second pillar of our strategic alignment, we are conducting product and brand reviews across our portfolio.

Decided to stop selling the cole brand in Canada.

Over the last year, we have increased our focus on growing spinach, a cross category.

We believe we have something exceptional that's finished.

That will be transferable across borders when that tenant comps there may be opportunities in the future for additional brands to Denver and cause of adult use cannabis market in Canada and different price tiers, but for now we are focusing on our highest ROI brand spinach.

We also wanted to provide an update on Kronos broke up.

During the third quarter of 2021, we started to purchase biomass producer growth both for our Canadian operation.

Kronos has always maintained that working with experts and large scale agriculture as a strategic way to build an efficient supply chain.

Seeing early successes from Broadcom has proven our instincts are correct and we're happy to see our vision for this partnership come to life.

In Israel, our medical business continues to perform incredibly well posting another quarter of strong top line growth.

We're proud of what we've accomplished in this market and establishing the relationships with patient and distributing to nearly all pharmacies carry medical cannabis accordingly.

According to a recent survey published by candidates magazine, our Peace Naturals brand was the most recognized brand in the Israeli medical cannabis market.

True Testament to the team's efforts in Israel.

As of December 2021, the candidate patient Count Israel is approximately 109000, which is up 40% versus the same period last year.

We believe this market is still in the early early innings of growth, which gets kronos a great opportunity to continue to grow our peace naturals brand with medical consumers in Israel.

Turning to the U S segment.

Turning to the U S segment, Jeff Jacobson and his new role as head of growth is digging into the business with his team.

All of whom are critical components to the success, we have experienced in Canada.

Jeff is leading the charge on a full portfolio for you.

It will likely include pricing optimization, SKU rationalization and pursuing distribution that matches our go forward strategy.

Jeff and team have had a lot of great products to work within our U S. CBD portfolio as we advance we will be focused on driving future innovation towards products that better align with our desire to be an adult use cannabis company.

With a keen focus on doing fewer things better and a strict mandate on return on investment. We don't expect this recovery to happen in a straight line, but we look forward to sharing the evolution with you over time.

As we realign 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.

We have a lot of work ahead of us, but I feel confident in the actions we are taking to prove our business.

With that I would like to welcome Bob <unk> to his first earnings call as Kronos. This group's new CFO , Bob Please take it away.

Okay.

Thanks, Kurt and good morning, everyone machine.

Shane indicated in his opening remarks, my discussion is limited to the results in the third quarter of 2021, and the restatement of our second quarter financial statements I will not be addressing or taking questions on our full year results for 2021.

Before getting into the financial results for the third quarter of 2021 allow me to talk about the impairment charges and restatement of the second quarter of 2021 that we announced today.

The company's restated second quarter of 2021 financial statements to request a total of $236 1 million impairment charge with respect to goodwill and indefinite lived intangible assets and long lived assets in the U S reporting unit.

This restatement is noncash in nature. So therefore does not impact cash cash equivalents or revenues.

We're taking action to improve internal policies and procedures and strengthen internal controls. These efforts include bolstering of talent across our finance organization to help implement stronger internal controls.

Curt and I are leading the reinforcement of company policies and procedures.

Making enhancements to our sub certification process and Clawback policy to drive additional accountability.

And expanding training programs for finance personnel.

We take these matters very seriously as Kurt and I walk you through and we're committed to taking action.

Now turning to the third quarter of 2021 results.

The company reported consolidated net revenue in the third quarter of 2021 of $20 4 million, an 80% increase from the prior year period.

Revenue growth year over year was primarily driven by the continued growth in the adult use Canadian cannabis market.

Sales in the Israeli medical market and.

And increased sales in the U S segment.

Consolidated gross profit for the third quarter of 2021 was negative zero point $7 million representing.

Representing a 0.8 million improvement from the third quarter of 2020.

The improvement versus the prior year was primarily driven by an increase in sales of cannabis extracts in.

In the Canadian market, which carries a higher gross profit than other product categories.

I'll dig into this line item a bit more on a segment by segment basis shortly given different dynamics are driving the respective businesses.

Adjusted EBITDA for the third quarter of 2021 was negative $46 8 million.

Presenting a $16 7 million decline from the third quarter of 2020.

The decline year over year was primarily driven by an increase in general and administrative expenses driven by a $13 2 million dollar increase in <unk>.

Allowance for expected credit losses.

An increase in sales and marketing spend primarily due to brand development in the U S segment.

And an increase in R&D, driven by spending on product development and <unk>.

Philip developing cannabinoid intellectual property.

Turning to our reporting segments.

And the rest of the World segment reported net revenue in the third quarter of 2021 of $18 3 million.

88% increase from the prior year period.

Revenue growth year over year was primarily driven by growth in both the adult use flower and extract categories in Canada and sales in the Israeli medical cannabis market.

Gross profit for the rest of the World segment in the third quarter of 2021 was zero point $6 million, representing a $2 8 million increase from the third quarter of 2020.

The increase versus prior year was primarily driven by an increase in sales of cannabis extracts in the Canadian market, which carries a higher gross profit than other product categories.

We've experienced some price compression in certain categories such as baby.

Our differentiation is a bit harder to achieve while we were more insulated to those dynamics in certain flower skus.

Edibles, given our superior product quality and differentiation.

We are happy with our progress on gross profit and believe the realignment that Kurt spoke to will further enable kronos group to improve the trajectory of this line item across our businesses and regions over time.

Adjusted EBITDA in the rest of the World segment for the third quarter of 2021 was negative $29 8 million representing.

Representing a $15 $4 million decline from the third quarter of 2020.

The decline year over year was primarily driven.

Driven by an increase in G&A expenses, primarily due to an increase in the allowance for expected credit losses of $13 2 million as previously discussed as well as increases to head count an increase in R&D spending and an increase in sales and marketing expenses.

Turning to the U S segment.

We reported net income in the third quarter of 2021, a $2 1 million or 28% increase from the prior year period.

Revenue growth year over year was primarily driven by the introduction of new CBD products.

As Curt noted the U S. CBD business is not where we want it to be.

Jeff Jacobson and his team are in the early stage of realigning the business strategy.

Gross profit in the U S segment for the third quarter of 2021 was negative $1 3 million, representing a $2 million decline from the third quarter of 2020.

The decline year over year was primarily due to increased inventory valuation adjustments and increased production costs.

Adjusted EBITDA in the U S segment for the third quarter of 2021 was negative $12 2 million, representing a $6 5 million decline from the third quarter of 2020.

The decline year over year was primarily driven by an increase in sales and marketing costs related to brand development and an increase in general and administrative expenses.

Now turning to our cost savings initiatives as Curt mentioned, we have initiated a strategic realignment.

<unk> to deliver $20 million to $25 million and initially identified savings across operating expense categories in 2022.

Narrowly driven by savings in sales and marketing general and administrative and research and development costs.

Our realignment is focused on right sizing the cost structure to be more aligned with our go forward plans we.

We are focused on the highest ROI opportunities.

Further ingrain, the mentality of doing fewer things better.

As part of our internal analysis, we took special care to ensure cost reductions would not inhibit growth. So you'll see continued investments in revenue generating activities.

While going forward operating expenses aimed to be more direct tie to a percentage of revenue.

Turning to the balance sheet.

The company ended the quarter with approximately $1 billion in cash and short term investments, which is down approximately $60 million from the second quarter of 2021.

Capital expenditures for the quarter were $2 5 million with the spending focus across our global strategic priorities.

Capital expenditures are down.

<unk> seven <unk>, 70% year over year, driven by reduced spending on enterprise resource planning implementation.

Capital improvements across our facilities.

We remain committed to deploying capital in a disciplined manner and only in ways that align with our strategic priorities.

With that I'll turn it back to Curt.

Thank you Bob the strategic realignment that we've begun to implement as a companywide initiative across every function, we are identifying opportunities to reduce duplication and centralized capability.

That's more efficient and cost effective as an organization.

These changes are centered on our focus return to doing fewer things better we remain committed to bringing best in class adult use cannabis products market using rare cannabinoids as a core differentiator.

While we worked through the realignment we are focused on not losing sight of what is working today.

Turning to elevate the spinach brand and expand its leading market position in Canada, and bringing high quality medical cannabis under the peace Naturals brand.

Gray leaf medical patients.

These remain our top priorities I look forward to all the new things, we have planned from a brand and product perspective across our global portfolio in 'twenty two and beyond.

With that I'll open it up for questions.

Thank you.

To ask a question you will need to press star one on your telephone to withdraw your question press the pound key.

And please limit yourself to one question and one follow up.

Our first question comes from John <unk>.

In parallel with CIBC Your line is open.

Thanks, Good morning, I wanted to start on the strategic realignment and in particular, you had mentioned a reduction in R&D expenses I Wonder how you think about this because it seems like R&D is pretty central to the strategy. Both in biosynthesis, but also just generally creating differentiated products. So is it you think that much of your RM work is all.

Already done.

Or is there some other element to this I'd just like to better understand that part of the strategic update please.

Yes. This is Kurt.

Really about focusing the R&D on those categories and segments of the business.

That really will drive performance and I mentioned two.

Two of those areas one is margin accretive innovation really focusing on adult use cannabis products that we believe can drive that.

<unk> is a great example, in the edible side and the other area is winning in rare cannabinoids.

We remain extremely focused.

And a lot of our efforts is focused on bringing these kind of differentiate us to mark there is always efficiencies to be had.

Any function, including R&D.

But as we shift more towards the adult use segment.

We feel that will be fully armed to really drive the innovation that.

We're planning over the next few years.

Okay. Thanks, and my follow up is on the margin structure.

And I'd like to understand what it is youre trying to achieve here because you've doubled sales in rest of world and you are seeing some margin expansion.

Still negative, but I would take if you can keep growing sales at or close to that pace you'd get some pretty good torque on that line item, but it is part of the strategic review to make the cost structure more variable and Kronos has never struck me as a company that needs to be a manufacturer, but but do you want to make the cost structure more variable and outsource more of your production, particularly in Canada.

Yes, John this is Bob Thanks, Thanks for that question, Yes, obviously, we're very focused on growing sales but.

One of the not changes, but deeper focus is pursuing innovation opportunities and product categories and products.

Really grow sales profitably.

The other thing and it's a big focus of the strategic realignment to Kurt spent a lot of time talking about it.

Really the evaluation of our supply chain, and really making us more agile more cost competitive and we've got a number of things that we're evaluating looking at in that regard and I think.

Rest of the World as an example in this quarter, having a positive.

Gross margin is.

Testimony to our focus on that and really having some early wins in that carrier.

In that category. In addition to just some revenue mix shifts that drive improved.

Gross margin.

The other aspect of the realignment is really just.

Looking at our cost structure scale.

Scaling it back to where we really are today with the business and where our growth plans are.

And just being more strategic with where we.

Invest our dollars whether it's in R&D as Kurt.

Answered your question or sales and marketing and G&A.

So it's it's a multi pronged initiatives.

<unk> strategic alignment plan that is very focused on really having impacts across the entire P&L.

Alright understood. Thank you very much.

Thank you. Our next question comes from Rahul <unk>.

Yes, Sir with Raymond James Your line is open.

Good morning, correct, Bob Thanks, so much for taking my questions.

Good morning on the on the top line morning Top line. So you mentioned that the U S has been a little disappointing we've seen the U S market sort of take longer than many people have anticipated so focusing on Canada, we've seen.

Relatively good escalations in terms of market share in edible primarily driven based on your differentiated products.

And I think that the market. However is still primarily lower how should we be thinking about kronos.

Market share gains going forward, both in terms of organic growth given the differentiated fermentation drive products, but also into sort of more traditional flower based cloud based products.

Yes, well, let me start off by saying.

Flower sales just to take part of the.

The scope of the business and its still performing incredibly well for us in Canada subsets over 90% in the quarter and Thats really driven and focused by concentrating on THC strengths unique genetics, which we've been very successful.

Yeah.

Okay, great. Thank you and then just as a quick follow up now focusing on the implementation drive products.

Again, we have seen rapid market share gains in Canada with that.

How should we thinking about global expansion of those up the amount of cannabinoid fermentation dry products.

I mean thats ahead of us I mean, we've only hits the two molecules out of the eight that we're planning to go we still want to build it remember Canada as a test market. We are building up this brand in Canada once we round out the portfolio.

And early days are fantastic on our first edible as I said in the script.

Then everything is ahead of us, but we're still in the early days of developing it but.

Certainly.

As we said about Canada test marketed sets the platform for our brand to go forward in other markets.

Great. Thanks for taking my questions I'll get back in the queue.

Yeah.

And.

Next question comes from Andrew Carter with Stifel. Your line is open.

Hey, Thanks. Good morning first question is with the delayed 10-Q filing I would assume filing. The 10-K is on track for March. So my question around all of that is are there any kind of regulatory restrictions, resulting from this will you still be able to issue equity for acquisitions or are you in the penalty box just help us help us out on that first.

Yes, there are.

No regular regulatory restrictions other than.

Management fees trade order associated with our delayed filings, we're now on timeline as of today.

And we foresee no delays associated with our ability to file our 10-K.

Great.

Second question I wanted to ask and I understand the krona story, using Canada as a test market for future opportunities, particularly in the U S.

I guess, what the cost savings the expense target and now that kind of a realignment can you be profitable or at least near breakeven cash flow with the market opportunities currently in hand, Canada adult use medical Israeli Israeli medical as well as kind of some of the opportunistic global medical markets. Thanks.

Yes, I'll take that one and Kurt if you want to add some color at the end for my response, but.

Listen, we're very focused on a big focus of the strategic realignment is really continuing to drive the rest of the world segment to profitability right and we were very encouraged by the results of this quarter and what we're seeing thus far and it's it's a huge focus of that as Kurt pointed out.

<unk>.

Canada is more of a test and learn market and with the current market dynamics.

It's a challenging market to be profitable, but at the very least and we're very encouraged by the progress to date and what we foresee in the very near future.

Definitely have the ability to be more profitable than we are today.

The great thing is with our innovative pipeline that we have we not only are dominant in flour and we've got three of the top 10 strands out there at the end of the day, but we're very very excited about the growth and market share growth that we've experienced in other categories such.

<unk> such as Edibles, we demonstrated our ability to grow categories beyond just flower.

And we're going to continue to expand on that the cannabis extracts part of the business also enjoys a higher gross margin, which is only going to further benefit the <unk>.

<unk> ability profile of Canada, but thats very much in the crosshairs of.

Of our realignment strategy to Kurt kind of explain.

Yes.

Thanks Pat.

Yes, we have great brands, and we're showing that we can drive those brands.

And that makes me very optimistic about Canada.

Okay.

Thank you and Thats all the time, we have for questions. This concludes today's conference call and thank you for participating you may now disconnect.

[music].

Okay.

Sure.

[music].

Yes.

Okay.

[music].

Good morning, My name is Catherine and I'll be your conference operator today.

Now I'd like to welcome everyone to Kronos group's 2021 third 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. Please go ahead.

Thank you Catherine and thank you for joining us today to review Kronos group's 2021 third quarter financial and business performance today, I am joined by our President and CEO , Kurt Schmidt, our CFO , Bob <unk>, and our executive Chairman, Mike Garnsey Kronos Group issued a news release announcing its financial results. This morning, which are 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 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 and cautionary statements and risk factors included in the company's earnings release and regulatory filings.

Full year 2021 results will be discussed after we file our annual report on Form 10-K with the SEC. 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 this management planning forecasting and evaluating business and financial performance.

Womens, 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 in the press room section of our website the cross group Dot com.

Is it over to Curtis group's president and CEO Kurt Schmidt.

A special thanks to our thanks to our finance and legal teams for putting in the extra effort over the past few months.

<unk> are never easy, but it's essential to learn and grow from them. We are committed to continuous improvement and have learned and evolved from this situation.

Now I'd like to review recent developments related to our financial reporting and internal controls and the remediation actions. We are taking will Bob will take you through more details on these items shortly.

As we noted in November 2021, the audit committee of the company's board of directors working with our independent financial auditors.

Dr Review to evaluate the goodwill and indefinite lived intangible assets in the U S reporting unit for impairment.

Accordingly, the company's restated the period's financial statements to reflect this new information.

The restatement has no impact on cash and cash equivalents.

Our revenues.

We take these matters seriously and in connection with the restatement, we commence making changes to our internal control policies and procedures to further strengthen internal controls related to financial reporting.

We're also undertaking a realignment of the business that we believe will best position to drive profitable and sustainable growth over time.

I view the realignment in three distinct pillars.

We are realigning the organization to better enable our go forward strategy.

This includes centralizing functions under common leadership, allowing us to distribute what resources more efficiently and prove strategic alignment and eliminate duplicative roles and costs.

We will reduce complexity, leading to a decrease in fixed expenses.

We are undergoing an evaluation of our global supply chain to become leaner and increase our ability to adapt quickly to the changing landscape we.

We are performing product reviews, and pricing optimization and pursuing distribution that matches. Our go forward strategy across North America.

We are steadfastly focused on aligning department priorities and team structure to support these initiatives.

Finally, we will implement an operating expense targets to help us optimize our cash deployment.

As more states legalize cannabis in the U S. We are eager to build off our investment in farm Mccann to bring adult use THC products and brands to U S consumers upon federal legalization.

We have set the foundation for our entry through the strategic investment in pharma can and we are gaining invaluable experience for our existing businesses in Canada and other international markets with our new organizational structure, we will be ideally positioned to enter and deliver.

The overall strategic realignment initiatives expected to deliver $20 million to $25 million and initially identified savings across operating expense categories in 2022.

Primarily driven by sales by savings in sales and marketing general administrative and research and development.

As part of the first pillar of our realignment the centralized decision, making under common leadership.

When I was appointed Jeff Jacobson to the position of senior Vice President head of growth.

Mr. Jacobson previously served as the Companys General manager of Canada and Europe .

Mr. Jacob Suen Thats been Thats Protos groups since December 2016, and previous to that.

He was a co founder of peace Naturals Mr.

Mr Jacobs expertise and experience in licensing and compliance New business development project management and resource management will have Kronos group lead in domestic and international markets.

The company also appointed John <unk>, the position of senior Vice President head of operations.

Prior to Supreme Ms. <unk> Kotler candidates experienced stern California's adult use implementation at Cielo for global cannabis company Crystal Pharma limited prior.

Prior to that he spent the majority of his career in supply chain and operations with Pepsico Naphthalene Safina foods Mitch.

Mr. <unk> experience in building supply chains around the World will help the company win in the markets. We are in today, while Sally staying nimble in order to move fast and pivot as the industry changes over time.

I'm confident these realignment efforts will better position Kronos to continue to assemble a portfolio of best in class brands and intellectual property.

While preserving the financial flexibility to make additional strategic investments in our R&D pipeline and brands as we continue to innovate and evolve with our consumers' wants and needs are.

Our future structure will be a brand centered organization with teams focused on accelerating growth on the core margin accretive innovation winning in rare cannabinoids.

The us adult use market entry and streamlining the organization to make better decisions, while increasing alignment and agility.

There is a lot to look forward to as this process unfolds, and we will providing updates in the coming quarters.

Meantime, we remain focused on driving the initiatives forward advancing our core business priorities and preparing for our entry into the U S.

While we are confident our realignment strategy will improve certain areas of business I believe kronos is sitting in a great position within the global cannabis landscape, which is a credit to Mike Weinstein's prudent leadership in the early days of legalization in Canada, and the evolving landscape across the world.

From the very beginning Kronos has taken a different approach.

Instead of gaming for a multiple unfunded capacity, we stayed relatively lean and focused on R&D, while creating cultivation partnerships with large scale agricultural specialists.

Instead of controlling positions in countries outside of the U S, Canada, and Israel, we chose low capital intensive partnerships to create exposure while limiting risk.

Instead of a desire to be first to market, we focused on differentiation and delivering products that consumers didn't know where possible.

While this approach was not the most popular and requires patience from our shareholders partners and employees, we are beginning to see it pay off.

The success, we are saying is proven and point of sale that.

Our salaries by Spanish edibles achieved double digit market share in the company's category and Canada within six months of launch and our breeding and genetics program as yield some of the best selling high THC flower skus on the market in Canada.

We weren't first to achieve these rankings, but what can we push go on these product launches. We proved the muscle we have across our organization and the desire to win.

We have looked and continue to look at the Canadian adult use market is a test and learn market.

We all know why it's not the easiest market to operate in but we are focused on making it work for us that means focusing on limiting losses with an eye towards profitability, but most importantly, creating products through extensive R&D does develop turnkey solution for any market we operate in.

Hello notes was not without its challenges and as have missteps were aware of that and we're working to address them with the strategic realignment.

But at the same time, we have a lot of confidence.

We have one of the strongest balance sheets in the industry and strength across our organization, which.

Which I believe makes kronos poised to be a leader in any market we operate.

Now getting into updates on some of the items that are working today.

In October 2021, we launched the first candidates edible and Canada. The feature culture, CPG spinach feels chill blass two to one THC CBD gummies.

Following the successful launch in January 2022, we launched a one gram THC vape pad featuring cultured CPG.

Extending our leadership position and bring a high quality rare cultured cannabinoids to the market.

Subsequent to the third quarter, we hit the equity milestone for culture, <unk>, which is a crucial step to developing culture tacb.

We're very proud of the work we are accomplishing with ginkgo and how we are positioning this company to win with rare cannabinoids.

The spinach brands, new platform spinach field will deliver a variety of cannabis products, which will primarily feature rare cannabinoids may using our proprietary processes designed to provide unique and enhanced experience.

As a reminder, kronos believes that the best way to sustain sustainably women candidates is to compete with differentiated products.

Just competing on price, we feel we've done a great job executing that strategy with our flagship adult use brands spinach.

By delivering consumers better products and providing great overall value and we're just getting started.

As part of the second pillar of our strategic alignment, we are conducting product and brand reviews across our portfolio and we've decided to stop selling the cole brand in Canada.

Over the last year, we have increased our focus on growing spinach, a cross category.

We believe we have something exceptional that's finished.

That will be transferable across borders from the talent comps there may be opportunities in the future for additional brands to Denver enter the adult use cannabis market in Canada and different price tiers, but for now we are focusing on our highest ROI brand spinach.

We also wanted to provide an update on Kronos broke up.

During the third quarter of 2021, we started to purchase biomass producer growth both for our Canadian operations.

Kronos has always maintained that working with experts and large scale agriculture as a strategic way to build an efficient supply chain.

Seeing early successes from broker has proven our instincts are correct and we're happy to see our vision for this partnership come to life.

In Israel, our medical business continues to perform incredibly well posting another quarter of strong top line growth.

We're proud of what we've accomplished in this market and establishing the relationships with patients and distributing to nearly all pharmacies that carry medical cannabis. According.

According to a recent survey published by Cannabis magazine, our Peace Naturals brand was the most recognized brand in the Israeli medical cannabis market.

True Testament to the team's efforts in Israel.

As of December 2021, the cannabis patient count Israel is approximately 109000, which is up 40% versus the same period last year.

We believe this market is still in the early early innings of growth, which gets kronos a great opportunity to continue to grow our peace naturals brand with medical consumers in Israel.

Turning to the U S segment.

Turning to the U S segment, Jeff Jacobson and his new role as head of growth is digging into the business with his team.

All of whom are critical components to the success, we have experienced in Canada.

<unk> is leading the charge on our whole portfolio, which will likely include pricing optimization, SKU rationalization and pursuing distribution that matches our go forward strategy.

Jeff and team have had a lot of great products to work within our U S CBD portfolio.

As we advance we will be focused on driving future innovation towards products that better align with our desire to be an adult use cannabis company.

With a keen focus on doing fewer things better and a strict mandates on return on investment. We don't expect this recovery to happen in a straight line, but we look forward to sharing the evolution with you over time.

We have a lot of work ahead of us, but I feel confident in the actions we are taking to improve our business with.

With that I would like to welcome Bob <unk> to his first earnings call as Kronos as group New CFO , Bob Please take it away.

Okay.

Thanks, Kurt and good morning, everyone.

Before getting into the financial results for the third quarter of 2021.

Now me to talk about the impairment charges and restatement of the second quarter of 2021 that we announced today.

The company's restated in second quarter of 2021 financial statements to request a total of $236 1 million impairment charge with respect to goodwill and indefinite lived intangible assets and on long lived assets in the U S reporting unit.

This restatement is noncash in nature. So therefore does not impact cash cash equivalents or revenues.

We're taking action to improve internal policies and procedures and strengthen internal controls. These efforts include bolstering our talent across our finance organization to help implement stronger internal controls.

Curt and I are leading the reinforcement of company policies and procedures.

Making enhancements to our sub certification process and Clawback policy to drive additional accountability and.

And expanding training programs for our finance personnel.

We take these matters very seriously as Kurt and I walk you through.

And we're committed to taking action.

Now turning to the third quarter of 2021 results.

The company reported consolidated net revenue in the third quarter of 2021 of $20 4 million, an 80% increase from the prior year period.

Revenue growth year over year was primarily driven by the continued growth in the adult use Canadian cannabis market.

Sales in the Israeli medical market and.

And increased sales in the U S segment.

Consolidated gross profit for the third quarter of 2021 was negative zero point $7 million representing.

Representing a zero point $8 million improvement from the third quarter of 2020.

The improvement versus prior year was primarily driven by an increase in sales of cannabis extracts.

In the Canadian market, which carries a higher gross profit than other product categories.

I'll dig into this line item a bit more on a segment by segment basis shortly given different dynamics are driving the respective businesses.

Adjusted EBITDA for the third quarter of 2021 was negative $46 8 million, representing a $16 7 million decline from the third quarter of 2020.

The decline year over year was primarily driven by an increase in general and administrative expenses.

And by a $13 2 million dollar increase in allowance for expected credit losses.

An increase in sales and marketing spend primarily due to brand development in the U S segment.

And an increase in R&D, driven by spending on product development and develop developing cannabinoid intellectual property.

Turning to our reporting segments.

And the rest of the World segment reported net revenue in the third quarter of 2021 of $18 3 million.

And 88% increase from the prior year period.

Revenue growth year over year was primarily driven by growth in both the adult use flour and extra categories in Canada and sales in the Israeli medical cannabis market.

Gross profit for the rest of the World segment in the third quarter of 2021 was zero point $6 million.

Presenting a $2 8 million increase from the third quarter of 2020.

The increase versus prior year was primarily driven by an increase in sales of cannabis extracts in the Canadian market, which carries a higher gross profit than other product categories.

We've experienced some price compression in certain categories such as bait.

Where differentiation is a bit harder to achieve while we were more insulated to those dynamics in certain flower skus and edibles, given our superior product quality and differentiation.

Adjusted EBITDA in the rest of the World segment third quarter of 2021 was negative $29 8 million.

Presenting a $15 $4 million decline from the third quarter of 2020.

The decline year over year was primarily driven.

Turning to the U S segment.

We reported net income in the third quarter of 2021, a $2 1 million or.

28% increase from the prior year period.

Revenue growth year over year was primarily driven by the introduction of new CBD products.

As Curt noted the U S. CBD business is not where we want it to be.

Jeff Jacobson and his team are in the early stage of realigning the business strategy.

Gross profit in the U S segment for the third quarter of 2021 was negative $1 3 million, representing a $2 million decline from the third quarter of 2020.

The decline year over year was primarily due to increased inventory valuation adjustments and increased production costs.

Adjusted EBITDA in the U S segment for the third quarter of 2021 was negative $12 2 million, representing a $6 5 million dollar decline from third quarter of 2020.

The decline year over year was primarily driven by an increase in sales and marketing costs related to brand development and an increase in general and administrative expenses.

Now turning to our cost savings initiatives as Curt mentioned, we have initiated a strategic realignment, which is expected to deliver $20 million to $25 million and initially identified savings across operating expense categories in 2022.

Primarily driven by savings in sales and marketing general and administrative and research and development costs.

Our realignment is focused on right sizing the cost structure to be more aligned with our go forward plans.

We are focused on the highest ROI opportunities further ingrain, the mentality of doing fewer things better.

As part of our internal analysis, we took special care to ensure cost reductions would not inhibit growth. So you'll see continued investment in revenue generating activities.

While going forward operating expenses aimed to be more direct tie to a percentage of revenue.

Turning to the balance sheet.

The company ended the quarter with approximately $1 billion in cash and short term investments, which is down approximately $60 million from the second quarter of 2021.

Capital expenditures for the quarter were $2 5 million with the spending focus across our global strategic priorities.

Capital expenditures are down.

Approximately 70% year over year.

Driven by reduced spending on enterprise resource planning implementation and capital improvements across our facilities.

We remain committed to deploying capital in a disciplined manner and only in ways that align with our strategic priorities.

With that I'll turn it back to Curt.

These changes are centered on our focus return to doing fewer things better.

<unk> committed to bringing best in class adult use cannabis products market using rare cannabinoids as a core differentiator.

While we worked through the realignment we are focused on not losing sight of what is working today.

<unk> to elevate the spinach brand and expand its leading market position in Canada, and bringing high quality medical cannabis under the peace Naturals brand.

Riley medical patients.

These remain our top priorities I look forward to all the new things, we have planned from a brand and product perspective across our global portfolio in 'twenty two and beyond.

With that I'll open it up for questions.

Thank you.

To ask a question you will need to press star one on your telephone to withdraw your question press the pound key.

And please limit yourself to one question and one follow up.

Our first question comes from John <unk>.

<unk> apparel with CIBC Your line is open.

Thanks, Good morning, I wanted to start on the strategic realignment and in particular, you had mentioned a reduction in R&D expenses and I Wonder how you think about this because it seems like R&D is pretty central to the strategy. Both in biosynthesis, but also just generally creating differentiated products. So is it you think that much of your RM work.

Already done.

Or is there some other element to this I'd just like to better understand that part of the strategic update please.

Yes. This is Kurt it's really about focusing the R&D on those categories and segments of the business.

That really will drive performance as I mentioned.

Two of those areas one is margin accretive innovation really focusing on adult use cannabis products that we believe can drive that salaries.

<unk> is a great example, in the edible side and the other area is winning in rare cannabinoids.

Remain extremely focused.

And a lot of our efforts is focused on bringing these kind of differentiate us to mark there is always efficiencies to be had.

And any function, including R&D.

But as we shift more towards the adult use segment.

We feel that will be fully armed to really drive innovation.

We're planning over the next few years.

Okay. Thanks, and my follow up is on the margin structure.

And I'd like to understand what it is youre trying to achieve here because you've doubled sales in rest of world and you are seeing some margin expansion.

So negative, but I would take if you can keep growing sales at or close to that pace you'd get some pretty good torque on that line item, but it is part of the strategic review to make the cost structure more variable and Kronos has never struck me as a company that needs to be a manufacturer, but but do you want to make the cost structure more variable and outsource more of your production, particularly in Canada.

Yes, John this is Bob Thanks, Thanks for that question, Yes, obviously, we're very focused on growing sales but.

One of the not changes, but deeper focus is pursuing innovation opportunities and product categories and products that really grow sales profitably.

The other thing and it's a big focus of the strategic realignment to Kurt spent a lot of time talking about it.

Really the evaluation of our supply chain, and really making us more agile more cost competitive and we've got a number of things that we're evaluating looking at in that regard and I think.

Rest of the World as an example in this quarter, having a positive.

Gross margin is.

Testimony to our focus on that and really having some early wins in that carrier.

In that category. In addition to just some revenue mix shifts that drive improved.

Gross margin.

The other aspect of the realignment is really just.

Looking at our cost structure scale.

Scaling it back to where we really are today with the business and where our growth plans are.

And just being more strategic with where we invest.

Invest our dollars, whether it's in R&D as Kurt kind of him.

To your question or sales and marketing and G&A.

So it's a multi pronged initiatives.

<unk> strategic alignment plan that is very focused on really having impacts across the entire P&L.

Alright understood. Thank you very much.

Thank you. Our next question comes from Rahul <unk>.

Yes, Sir with Raymond James Your line is open.

Good morning, correct, Bob Thanks, so much for taking my questions.

Good morning folks look at us on the on the top line morning Top line, you mentioned that the U S has been a little disappointing we've seen the U S market sort of take longer than many people without anticipated so focusing on Canada, we have seen.

Relatively good escalations in terms of market share in edible primarily driven based on your differentiated products, but recognizing that the market. However, it's still primarily lower how should we be thinking about kronos is.

Market share gains going forward, both in terms of organic growth given the differentiated fermentation drive products, but also into sort of more traditional flower based a lot of these products.

Yeah, well, let me start off by saying.

Lower sales just to take part of the.

Okay.

Okay, great. Thank you and then just a quick follow up now focusing on the implementation drive products.

Again, we have seen rapid market share gains in Canada with that.

How should we thinking about global expansion of those of the supplemental.

Implemented cannabinoid presentation of our products.

Sure.

I mean thats ahead of US I mean, we've only had two molecules out of the eight that we're planning to go we still want to build it remember Canada as a test market. We're building up this brand in Canada once we round out the portfolio.

And early days are fantastic on our first edible as I said in the script.

And then everything is ahead of us, but we're still in the early days of developing it but certainly that.

We said about Canada test marketed sets the platform for our brand to go forward in other markets.

Great. Thanks for taking my questions I'll get back in the queue.

Okay.

And <unk>.

Our next question comes from Andrew Carter with Stifel. Your line is open.

Yes, there are no regular regulatory restrictions other than.

Management fees trade quarter associated with our delayed filings that we're now on timeline as of today.

And we foresee no delays associated with our ability to file our 10-K.

Great.

Great second question I wanted to ask and I understand the Kronos story, using Canada as a test market for future opportunities, particularly in the U S.

Guess, what the cost savings expense target and now that kind of a realignment can you be profitable or at least near breakeven cash flow with the market opportunities currently in hand, Canada adult use medical Israeli Israeli medical as well as kind of some of the opportunistic global medical markets. Thanks.

Yes, I'll take that one and Kurt if you want to add some color at the end for my response, but.

<unk>.

Canada is more of a test and learn market and with the current market dynamics.

It's a challenging market to be profitable, but at the very least and we're very encouraged by the progress to date and what we foresee in the very near future. We definitely have the ability to be more profitable than we are today. The other great thing is with our innovative pipeline that we have.

Not only are dominant in flour and we've got three of the top 10 strands out there at the end of the day, but we're very very excited about the growth and market share growth that we've experienced in other categories.

Such as <unk>, such as Edibles, we demonstrated our ability to grow categories beyond just flower.

And we're going to continue to expand on that the cannabis extracts part of the business also enjoys a higher gross margin, which is only going to further benefit the profitability profile of Canada, but thats very much in the crosshairs of.

Of our realignment strategy to Kurt kind of explain.

Yes.

Thanks Pat.

Yes, we have great brands, and we're showing them that we can drive those brands.

And that makes me very optimistic about Canada.

Okay.

Thank you and Thats all the time, we have for questions. This concludes today's conference call and thank you for participating you may now disconnect.

Q3 2021 Cronos Group Inc Earnings Call

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