Q4 2022 Cronos Group Inc Earnings Call

Speaker 1: You.

Speaker 1: The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 1-1.

Speaker 2: Good morning. My name is Corey and I'll be your conference operator today. I would like to welcome everyone to Kronos Group's 2022 fourth quarter and full year earnings conference call. Today's call is being recorded. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising that your hand is raised. To withdraw your question, press star one one again. At this time, I would like to turn the call over to Shane Laidlaw, Investor Relations.

Speaker 2: Please go ahead. Thank you, Corey, and thank you for joining us today to review Kronos' 2022 fourth quarter and full year financial and business performance. Today, I am joined by our Chairman, President, and CEO Mike Gorenstein and our CFO , James Holm. Kronos issued a news release announcing our financial results this morning, which is filed on our Edgarn CEDAR profile. This information, as well as the prepared remarks, will also be posted on our website under Industrial Relations. Before I turn the call over to Mike, let me remind you that we may make forward-looking statements and refer to non-GAAP financial measures during this call. These forward-looking statements are based on management's current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statement.

Speaker 2: Factors that could cause actual results to different materially from expectations are detailed in our earnings materials and our SEC filings that are available on our website, by which any forward-looking statements made during this call are qualified in their entirety. Information about non- GAAP financial measures, including reconcilations to USGAP, can also be found in the earnings materials that are available on our website. We will now make prepared remarks and then we will move into a question and answer session. With that, I'll pass it over to Corners' Chairman, President and CEO , Mike Cornstein. Thank you, Shane, and good morning, everyone. I want to start our call today by reflecting on the transformers that we took in 2022 to put our business on a better footing in preparation for the future growth of the global Canada industry. In 2022, we embark on a strategic reallignment of our business centered on a three-key objective. First, we centralize our function to improve strategic alignment. Second, we optimize our global supply chains to reduce complexity and drive enhanced innovation capabilities. And lastly, we implemented a cost reduction target to reduce operating expenses by 20 to 25 million, which we overachieved. The reallignment of our business was centered on our core objective.

Speaker 2: to create a portfolio of borderless products and brands across adult use product formats. Last year, we spent a lot of time getting our product mixed right for each market we operated. This involved strengthening our borderless product portfolio, including edibles, vases, and infused pre-roads, and exciting use Lyrogonetics that launched Canada and Israel. We also decided to exit the CBD Beauty category in the US and favor of focusing on adult use product formats. Quarter our strategic initiatives and continuous improvement efforts are getting canabinoid products in markets that elevate the consumer experience and leverage the number of supply chains. We are building a blueprint in Canada for what we think will win in other markets. Our focus is on borderless product innovation, meaning we're creating product lines and brands that we know from our experience will win when introduced to new markets. We've managed to do all this while cutting our costs significantly and reestablishing our mindset to ensure growth with attention to ROI and borderless innovation. Our slimmer cost structure enables us to fund the project initiatives to help grow products strategically. As we look ahead this year, we know there's more we can do to cut costs while maintaining our innovation growth engine. We remain seemingly focused on cutting costs throughout our business to ensure products and toys for long-term growth. As far as we know, we're not going to be able to do that. We are planning to optimize our supply chain. In early 22, we announced plans to begin winding down operations that are piece natural campus, including the shuttering of cultivation and moving certain that can be used to contract manufacturers. As you will know, we participate in industry that is constantly evolving. So it's important to stay agile. We continue to transition towards a more flexible footprint ensuring we have a capability to execute in current and future market opportunities. To that end, we decided to maintain select components of our operations that can be used to build campus.

Speaker 2: about the potential of CBC and have big plans for it in 23. Early sales point the strong consumer adoption to believe this product will be added to our overall company portfolio. In November , as we previously disclosed, we launched two infused pre-year-olds in Canada. The first under the Sence Brand is our fully charged atomic GMO.

Speaker 2: which comes in a five-pack with a half gram for pre-roll. We also launched a CBG abuse pre-roll under the Spinach Field Grant, Tropic Peasle CBG which comes in a three-pack with a half gram for pre-roll. These new pre-rolls are quickly finding the market share ring, led by a fully charged atomic GMO and abuse pre-roll. A pre-roll market share grew by 40 basis points, sequentially from the third quarter to 1.4% in the fourth quarter. We have lagged the market in pre-rolls, but through extensive work in this category and the launch of abuse pre-rolls, we believe that we now have the right foundation. The moves have made in 2022 to improve our near-term competitive tradition in pre-rolls are just the beginning of the work we're doing in the category. We believe, like the Edibles category, pre-rolls will be a category with product differentiation, we'll drive brand separation, and one of our top priorities is to create next generation quarterless products. We're doing extensive work to develop a portfolio product that will separate us from the competition based on the several factors including reducing harshness, improving consistency, and hitting on consumer preferences around flavor and totemsy. In the base category, which is 4.8% market share in the fourth quarter, up 40 basis points in Q3, finding to number six in market share. We'll look to build on that momentum in 23, which can continue to push to include American avinoids in our base and drive innovation leading on our winning formulation across the portfolio.

Speaker 2: While flower-remecanadian market continues to be heavily weighted to 28 gram bags, we continue to fund market share in a 3.5 gram segment, with our GMO cooking skills, the highest-ranking 3.5 grams to you in the country, at number 6 in the overall dry flower category. We have a 5.1 percent share of the overall dry flower category in the fourth quarter, making space the number 3 grand in flower. In two four, Groco reported a preliminary unordered revenue of approximately 2.4 million from non-chronous customers, and in the full year, Groco had revenue of approximately 21 million to non-chronous customers. Our 50 percent share of Groco's net income, which is the count for under the equity methods accounting, weighted 3.1 million in 22. 1.1 million by Groco, as of December 22.

Speaker 2: In addition to printable repayment, Chrono's also receives 2.2 million of interest payments in Broco in 2022, which shows 5.2 million in cash payments to Chrono. The strong financial performance of Broco, building equity pickup, print, tax, and interest payments to Chrono is an important component to our overall financial picture, and I believe is an under-appreciated part of our story. We are very pleased to have quickly Broco achieve profitability and are excited that they are making significant strides and continuously improving their operation. Broco's performance on cultivation continues to be strong, hitting more than 30% CHC potency on recent harvest, which is a testament to our JV's complemented capabilities in cultivation and downstream processing, and our investment in genetic breeding and tissue culture. Turning to Israel, our piece natural products continue to be strong performance. In fast-forwarder, we launch two new flyer feet, Miami Sky, and Atomic Sower, powered by our flyer genetics and breeding program.

Speaker 2: which continues to set up the part from the competition in Israel. Our end-market sales and marketing strategies have resonated, and our products have become synonymous with quality and consistency, driving the brand to sell. In terms of the US market, we see the production of both Happy Dance and Pete Plus, the streamlined of brand portfolio, and our operations to focus on adult use product format under the Lord Jones brand. We are pleased to move forward in 23 with a leaner portfolio of brands and a mix of products we feel confident we will evolve and build our brand portfolio over time. We want to maintain the Lord Jones brand equity we built in the US and ensure that when the time is right, we can bring other cannabinoids in and reengage consumer base that is looking for a high quality hemp derived product. We have a similar system of assembled VIP. The tour continues to execute, hosting a record for a staff of 23 with gross revenue of $57.6 million in Australian dollars, and EBITDA of $11.89 million. The medical market continues to grow in Australia, and the tour has positioned incredibly well to take advantage of the market opportunity. As of the end of 2022, our stake in the tour is worth approximately 22 million, which we believe is an under-appreciated asset on our balance sheet. Last but certainly not least, I would like to congratulate and introduce you to James Holt, our new CFO , who joined us in November of 22. James brings the Chronos roughly 20 years of experience in various finance and accounting roles at leading companies across industries. It has been immensely impactful to our business during his first four months, and it looks forward to having him as part of the team helping steer Chronos forward. With that, I would like to pass it on to James to take you through our financials. Thanks, Mike. Good morning, everyone. I am very pleased to be joining my first earnings call with Chronos, and I'm looking forward to all the great things we are going to accomplish. Turning to 2022, on a consolidated basis, we increased revenue 23% year-over-year to 91.9 million.

Speaker 2: $1.2 million, representing a $6.1 million improvement versus the prior year period. The improvement was primarily driven by a decline and expenses across general and administrative, sales and marketing and research and development. Turning to our reporting segments, in the rest of the world segment, we reported net revenue in the fourth quarter of $22 million.

Speaker 2: A 3% decline from the prior year period. Constant currency in that revenue in the rest of the world's segment increased 5% to 24 million. Revenue change was primarily driven by declining cannabis flower sales in Canada, largely attributable to the mixed shifts from 3.5 gram offering to 28 gram offering and the impact of the weakened Canadian dollar against the US dollar during the period. This was partially offset by growth in cannabis extract in Canada and cannabis flower sales in the Israeli medical market. Gross profit for the rest of the world's segment in the fourth quarter was 1.3 million, representing a 1.1 million decline from the prior year period. The decline was primarily driven by lower fixed cost absorption, packaging changes, and an adverse price mixed shift in the Canadian flower market, partially offset by growth in cannabis extracts in Canada, increased flower sales in Israel and lower biomass cost. Adjusted EBITDA on the rest of the world's segment for the fourth quarter was negative 13.4 million, representing a 1.2 million improvement from the prior year period.

Speaker 2: The improvement versus the prior year was primarily driven by a decrease in research and development and general and administrative expenses. Turning to the U.S. segment, we reported net revenue in the fourth quarter of 850,000, a 73% decrease in the prior year period. The decline year over year was driven by a reduction in promotional spending and skewer rationalization due to the strategic realignment of our U.S. business. Growth profit in the U.S. segment for the fourth quarter was negative 1.5 million, representing a 1 million decline from the prior year period. The decline year over year was primarily due to lower sales volume and increased inventory reserves associated with discounted, discusing, discontinued products as we transitioned away from beauty products and focused on adult use product formats. Adjusted eva da in the U.S. segment for the fourth quarter was negative 4.3 million, representing a 4 million improvement from the prior year period. The improvement versus prior year was primarily driven by a decrease in sales and marketing and general administrative expenses. Turning to the balance sheet, the company ended the quarter with approximately 878 million in cash and short term investments, which is down approximately 11 million from the third quarter of 22. As foreign exchange rate volatility has impacted our P&L, it's also had a large impact on our balance sheet. If you apply the FX rates for the period ended December 31, 2021, to the current period value of the FX rate, the FX rate is very low.

Speaker 2: We would have approximately 914 million cash in short-term investment, an approximately $36 million difference. Last year, we made significant strides to reduce spending and improve our cash burn rate. We started 22 with the targets to reduce cash operating expenses by 20 to 25 million, which we were able to surpass by 3.7 million, saving a total of 28.7 million throughout 22. A free cash flow improved by approximately 43% in 22 versus prior year, driven by operating expenses, saving, and approximate 60% reduction in CAPEX, which was down to 5 million in 22. As we embark on 2023, we are setting a new goal to reduce cash operating expenses by an additional 10 to 20 million. We continue to be thoughtful in our approach to cost reduction to not hamper our growth or our ability to execute on building borderless products. With that, we are able to turn it back to Mike. Thanks, James.

Speaker 2: Before getting any questions, I want to level up what's under the chronos umbrella and worthings stand today. We closed the year with 878 million cash in equivalent and zero debt. With the move of interest rates, we expected generate significant interest income from our cash in 2023. Our Canadian business reached 56 million revenue in 2022. And within that business, our Spanish brand has the following market share ring provided by high-fired data for January 23. Overall, Spanish is the number three cannabis brand and edible the number one brand and flower the number three brand and three roles the number nine brand and quickly taking share and invades the number six brand and also gaining ground. We have a leading brand in Israel, totaling revenue of 30.5 million in 2022. With a 6.3% stake in farm, one of the largest private USM as of currently on our book, 49 million. We have an appropriate 10 million. 10% stake in the mature a leading publicly traded Australian medical cannabis provider worth a approximately 22 million as of year end. We own 50% of the equity in chronos roco, which is profitable and they paid us 5.1 million in principle and interest payments in 22. We ended the year with a remaining balance of approximately 86 million on our combined loans to roco and partners. Roco has a growing book of business outside of the health chronos. Before and in us, they sold 21 million to non-frontal customers in 22.

Speaker 2: We have a growing portfolio of intellectual property associated with fermentation of cannabinoids, patent-hending product formulations, and a constantly growing portfolio of genetics. We own real estate and multiple licensing facilities free from any income residues. And finally, we have an exclusive partnership with Altria on a global basis. Close the market yesterday, Chronos created a market cap that talks to 794 million and enterprise value approximately negative 84 million. I don't believe there's a cannabis company today that has more under-appreciated value in the product. With that open line for question. Thank you. At this time we will conduct a question and answer session. As a reminder to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. We ask that you please limit yourself to one question and one follow-up. One moment, stand by while we compile the Q&A roster. First up is Michael Freeman of Raymond James. Michael, do you want to open? Good morning, Mike and James and Shane. Thanks for my question. I wanted to first ask, we have a great interest in your partnership with King Caballerox and the commercialization of layers. I wonder, after many quarters selling layers in a distributed product, I wonder if you could describe how to high level the impact you've seen in other layers of sales and the market penetration of these layers. Yes, thanks. I think it's been a great impact. I don't...

Speaker 2: have the right portfolio of wireless products because as you'll see at any market, certainly there's an initial way of excitement with whoever can supply the market first because there's always that imbalance. But as the market starts to reach a supply demand equilibrium, what really matters is who has the best branded products. And for us, making sure that we continue to have optionality with a strong balance sheet and that great portfolio product, we're ready to move into markets as they all go. And we think about that.

Speaker 2: Israel and the growth we think can continue there. We think Australia, there's certainly some from tailwind, Germany of course and the US, but other markets that start to open up faster and we'll be ready to move. Thank you. Stand by for our next call. Our next call comes from William Carter of Seivel. William you're open. Hey thanks, this is Andrew on for William. Just wanted to ask real quick first off, I want to ask about the growth margin in the quarter, the compression accelerated, were there any one time issues and just is is that growth margin does it inflect significantly from here because just kind of get an idea of what really changes that I know you said volume, the leverage but volume and flowers that help out the price. Just anything you've helped on that. Thanks. Sure, thanks Andrew. So yeah, the primary drivers of decline in the growth, growth, growth profit in the ROW segment were adverse price mix shifts in the cannabis flower and lower sales in the US business. We also did have an increase in US reserves due to the strategic repositioning of the portfolio more focused on the adult use prior formats, right? So to be one time or two. We alluded to and then we had lower fixed cost absorption and packaging changes in the ROW segment again, one time issues as you alluded to. However, those negative impacts were partially offset by strength in cannabis flower sales in Israel, as well as the growth of cannabis extracts bail in Canada, the carrier higher margin profile, then other product categories. Israel gained significant operating leverage in their cost structure going from 13.4 million in revenue in 21, the 30.5 million in revenue in 22 for 128%. And then lastly, we benefited from lower cannabis biomass cost as we can.

Speaker 2: We've expected that to happen faster. I think that we're getting closer and closer. Depending which market you're talking about, there's different types of assets, but I just want to stress the thing that we will continue to be focused on is what is going to have long-term stickiness from a consumer perspective. So we aren't really focused on supply chain assets. It's really on branded products. I think that they're coming out there, but...

Speaker 2: There's, are they still some work to do and still some movement before a number of those are attractive, but there are still smaller set of them that we couldn't make move on. Thank you. One moment for our next question. Our next question comes from John Zampara of CBIC. Thanks, good morning. I wanted to ask about the Peace Natural Facility and the decision to remain there. And Mike, you referenced the continually evolving landscape in this sector. And I wonder what was it specifically in the late G3 or early G4 that led to the decision to keep part of that facility running. It seems like you're keeping a number of functions. I wonder if that cost escalated at third party providers or there are an element of control. But you want to maintain or something proprietary. I'm just curious about that. I hope to change here. Sure. Thanks. I think there's a number of things. I think first and foremost, we want to make sure that we have, we have the capabilities to be able to execute today and also in the future. And I think part of that, the distribution warehousing is really important. There's some RG activities that we want to make sure we could maintain. And also, we want to make sure that we can maintain. Also, some of the proprietary products, we just want to keep manufacturing and how it's done advanced to that. But another big factor, I think is that given the success that GROCO has been having, quick as they reach profitability, with still a lot of optimization to go. Also moving into GROCO did in a way sort of crowd and limit the potential for expansion of GROCO, but also sort of cap the growth that I think that we'd be able to have. Let me stay and give this the short term ability to execute better doors.

Speaker 2: have better margins but also longer term for both us and growth would be able to continue seeing growth. That was really a deciding factor. That's helpful. Thank you. My follow-up on the rare strategy and I wonder what success looks like for you here. I think I've asked in the past about this but I wonder if you have an update on exactly who is buying these. Is there an element of repeat customers? Is a lot of it trial because of novelty purposes? I wonder if you have any insights on the consumer within your rare portfolio. I think you are seeing repeat. We have a whole sum of brand that is dedicated to rare and you are seeing success there. I think when we talk about what success means, the fact that you are able to have incremental set of skews where you are not really canned wide and you are other skews because someone is looking for a targeted effect, I think that's really important. I think it's a really key part of differentiation. It's a very important part of the overall portfolio construction. Whether it's CBN, CBG and CBG are extremely excited about. Now they are able to start iterating and adding and combining different cannabinoids and they got to where you can see the next level of success that we will be able to have. But in a market, you walk into a lot of the dispensary. Everything looks the same. Being able to have some of this different from this more targeted. When people are asking for effects, you can get something that's actually got a little bit more backing than just indicator of the key. I think that's really important to acknowledge what we do.

Speaker 2: Thank you. One moment for our next question. Our next question comes from Vivian Azer of Cohen. Thank you. Good morning. I was wondering if you could comment, please, on the recent announcement from the OCS around the change to their margin profile and how you guys are thinking about that in regards to your pricing as well as competitive landscape. Sure. I think it's pretty early to see what the effect on the competitive landscape will be. I think overall, it's a step in the right direction. I think it's really good to see the acknowledgement that there's structural challenges in the industry. And that there are a lot of struggles for LPs to basically be sustainable and hit profitability. I still think that there's a lot more that needs to be done. But it is appreciated seeing that happen. But it's still pretty early to see, is this something worth price to take in? Is this something where a few ones that they could see the value from it? We'll probably be able to have a better idea of that by next quarter. Okay. That's helpful. And then just on my follow up, you know, a lot of call outs on innovation, which all makes good sense in particular, given some of the differentiation that you guys are able to bring with your genetics and the rare cannabinoids. But, you know, in lieu of your continued focus on cost, can you just articulate how you guys think about kind of inventory management, SK rationalization, and, you know, what kind of regulators you put in place to manage that? Thanks. Sure. And one of the things that we've done, and I think it's been really helpful is the structure that we have with GROCO, where, you know, it's not cultivating and then trying to find a way to sell product we have, whether or not it hits our spec. So, you know, when you're, when you're managing as grow on your own, it would be, okay, we need to, you know, our spec for a certain strain might be 26 to 30%. And it comes in at 31% or at 24%. And suddenly you can't sell it and you have to figure out what to do. When you're in more of a sourcing model, I think that, that makes it much more efficient. So less risk of inventory rights.

Speaker 2: is you're going to have to continue doing that in each category. And when I think of the flyer category, it's certainly genetic matters. But I think that you're going to be free rolls with really the area where we're able to differentiate. And you see that similar tobacco. The pipes tobacco is not a really big category, but you see cigarettes that separate. I think that there's a ton of opportunity for differentiation free rolls. I think it's a very similar category to edibles. I think that there will be some really segmented brands that are able to separate. It's going to be very product focused. And if you're not able to do that, I think you start getting closer and closer to selling the commodity. And the fact that we've seen a shift to 28 grand bag just supports that. Got it. Okay. And I wanted to circle back on Andrew's question talking about your cash position. It is a sizable.

Speaker 2: So those assets are very specific what we're looking at. We're seeing how they fold in both today and in the future. And in cannabis having cash, I think is a very rare and very valuable thing. So I think that we are in a extremely fortunate position. We certainly get quite a lot of inbound. There are a lot of assets available, but we are still going to continue to be disciplined.

Speaker 2: We have them passed and make sure that anything we have is a really strong fit. We can't do a little position on things that only last for a year. Thank you. One moment for our next question. Our next question comes from Nadine Sirowart of Bernstein. Nadine, you're open. Hi, thank you for the question. Two for me, please. First one on gross margin. I know you mentioned those one time impacts in the quarter. Is there a way that you could help size those one time impact? Or perhaps put another way, what would your gross margin have been without those? And how should we think about a normalized gross margin? When did those all drop out going forward for each of your segments? And then my second question is on Israel. You know, you continue to have robust performance in that country in contrast to many of your peers. So could you just give us an update on the underlying trends that you are seeing in that market and how you expect that to develop over this year? Thank you. Sure. Yeah. So on the margin right as we did allude to that, we're one time impacts due to the US repositioning of the portfolio. So we had increased inventory reserve. And then we did have some fixed cost absorption issues due to the supply chain issues that Mike had highlighted earlier.

Speaker 2: where we were shifting supply chain around right to to our contract manufacturers, and that we did have packaging changes in the ROW segment. So, I could say that the growth margin would have been significantly higher without those. We do anticipate a normalization without those, right? So kind of back to what we would have expected for the 2022 year. And we're expecting that in 2023, and obviously guiding towards hopeful improvement there with all of the actions we're taking. And then I'll hand it over to Mike for the Israel question. Yeah, thanks James. Look, we're really happy to see the results our Israel team continue to have. You know, I'll say this that we're very differently set up than the period we have in Canada, because I think most of typically looked at it as sort of an outlet to move expect that product, where we looked at it as an opportunity to create a long-term business and build a brand. You know, we've had boots on the ground in Israel for a long time. They've now been able to achieve distribution in nearly all the pharmacies that are currently selling cannabis. And it's a very it's a very attractive industry both for business and patients right now. You know, I think one thing also when you look at the future and the where it goes in January , there was an announcement that it might see from the government starting to push for a new regulatory change that would.

Speaker 2: significantly open up the market in terms of the patient count and pharmacies. But then within a week, actually, there is the health minister that have been leading that charge, his positions in flux, and there's now someone out there. But it's a fluid situation, but I do think that there is a good chance that we see a record for a change in Israel that does expand the market further. Still early it's still on timing, but it's been a little helpful. All right, perfect. Thank you. Thank you. I would not like to turn the call over to Mike Gourdstein. Thank you for taking the time ever on and have a great day. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Thank you. Thank you. Thank you.

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