Q3 2023 Cronos Group Inc Earnings Call

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Good morning, My name is Valerie and I'll be your conference operator today I would like to welcome everyone to Kronos 2023 third quarter earnings Conference call. Today's call is being recorded at this time I'd like to turn the call over to Shayne Laidlaw Investor Relations. Please go ahead.

Thank you Valerie and thank you for joining us today to review Kronos is 2023 third quarter financial and business performance today I'm joined by our Chairman President and CEO, Mike Ornstein, and our CFO James home.

<unk> issued a news release announcing our financial results. This morning, which is 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 Mike. Let me remind you that we may make forward looking statements and refer to non-GAAP financial measures during this call.

Forward looking statements are based on management's current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward looking statements.

That could cause actual results to differ materially from expectations are detailed in our earnings materials in our SEC filings that are available on our website by which any forward looking statements made during this call are qualified in their entirety.

Information about non-GAAP financial measures, including reconciliations to U S. GAAP can also be found in the earnings materials that are available on our website lastly, we will be making statements regarding market share information throughout this conference call and unless otherwise stated all market share data is provided by high fire will now make prepared remarks, and then we'll move into a question and answer session with that.

Pass over to <unk>, Chairman, President and CEO Michael Weinstein.

Thank you Shane and good morning, everyone.

I wanted to start by addressing the horrifying and is thinkable terrorist attacks in Israel in early October.

Our thoughts remain with all victims their loved one and all Israelis as they fight to be free from care today and in the future.

<unk> continues to prioritize the safety of our Israeli team and their families.

We will do everything we can to support them and our patients during this time.

While our hearts are with her Israeli team, we have not lost focus on growing in existing markets, where appropriate and opening new international markets, such as Germany and Australia.

James will go into more detail on our financial results during his remarks, but I want to comment on the win this quarter.

We grew revenue by 22% year over year, and 30% sequentially to $24 8 million.

<unk> by 40% year over year growth in Canada, driven by strength in three year olds flowers and edible.

Adjusting our gross margin for an inventory write down associated with transitioning out of our Winnipeg facility. The gross margin would have been approximately 19% in the quarter.

<unk> 260 basis point sequential improvement.

We continue to have an industry, leading balance sheet with a cash and short term investment balance of approximately $840 million.

The strength of our balance sheet and supported by improved gross margin lower operating expenses robust interest income and improved working capital management.

We intend to build on this momentum for the remainder of the year and into 2024, as we realized a P&L efficiencies and additional interest income from our cash and short term investments.

In September we sent our first order of candidates to our German distribution partner <unk> and we're very excited to bring that peace naturals brand back to the German market.

The entity that is one of the leading distributors of medical cannabis in Germany and has a network of approximately 2000 high volume candidate focused pharmacy at currently supply around 300000 patients.

Re entering the German market, which has about $83 million equal a significant milestone for us.

We are working closely with the Kansas team sales team, who are excited about selling this brand in the market.

Traction in the early innings of our launches strong and Kansas Eva has already received significant orders at peace Naturals.

Our goal is to continue to expand our reach and brand awareness in Germany with the help of Kansas Eva to establish our peace Naturals brand at the top medical brands similar to the brand's reputation in other international markets.

Reestablishing thrown us and our peace Naturals brand with German market will position us to capitalize on this growing opportunity with additional upside potential from future legislative changes.

<unk> in the event, the German government rescheduled candidates and no longer labeled candidates as narcotics.

Turning to Australia, we are in the process of filing our first order to mature with the first shipment to Australia plan to go out later this month.

As a reminder, kratos owned approximately 10% of the common shares of <unk>.

In addition to forming a commercial relationship with mature. We also received a cash dividend of approximately 346000 in Q3, making us the second dividend received from Victoria.

By tourism market, leading prescriber patient pharmacy and supplier online platform.

Focused on creating medicinal cannabis products and digital health solutions that connect and strengthen the cannabis ecosystem and the Australian medical cannabis market.

The Australian market has seen medical cannabis station approvals to the authorized prescriber pathway increased by over 120% year over year to approximately 300000 approvals as of the first half of 2023.

According to the Australian governments Department of health.

Expanding in this market is a top priority for front of us and we look forward to providing our partners at mature with high quality cannabis products.

Turning to Canada during the third quarter, we continued to execute our plan to create a robust operating a boiler products highlighted by new launches and strong market performance.

As of October expansion was the number one brand in the edible and flower category number three and base and the number three ranked candidates brand overall in Canada.

These edibles accounted for 17, 9% of the markets retail sales in Q3 remained the market leader and edibles.

We have an incredible product that continues to launch a new flavor profiles and cannabinoid plant the.

The Perfect example of our borderlands scalable products.

In the third quarter, our newest salaries by finished flavor pink lemonade became the ninth most popular edible in Canada.

In total we have five edible products and the top 15.

And dried flower, we continue to see strong performance.

The answer was the number two brand in dried flower in Q3 with five 8% market share and we have three products in the top 15 best selling skus.

Led by our GMO cooking genetic across various tax items.

We carry the Q3 strength in October.

They're excited to say that Spanish roes to be the number one flower brand in Canada.

This achievement is the culmination of years of genetic breeding and best in class cultivation that separate our products in the field.

And the Vape category, we held a four 7% market share in Q3 climbing the number six.

Looking at the monthly breakdown finish Roes to be the number five brand in September and even more impressively grew to be number three in October.

We've done a lot of work on our VA portfolio over last year and it's great to finally see the strong results in the market.

Our one gram blueberry dynamite and our new one two gram format, which had been flying off the shelves have helped us gain share in the vape category.

We will build on this momentum in the remainder of 2023 and into 2024 with a continued push to include flavor forward profiles and rare cannabinoid interface.

This year, we launched several new offerings to bolster bolster the spinach payroll portfolio, including Sonic Lemon fuel <unk> and three new infused fierro offerings, pink lemonade teach punch and strawberries lurking.

In Q3 finished roes to be the number seven market share ranked <unk> brands, a significant improvement from our 2022 position powered by our number one ranked flower as a base to our payroll.

We can grow in this category and our payrolls are already receiving additional attention from consumers and industry.

In October our finished brand won best payroll at the Grub Awards for our spinach fully charged atomic GMO in future periods.

The growth awards celebrate excellence in the cannabis industry, recognizing outstanding achievements in innovation and various cannabis related categories.

We are incredibly proud to be recognized by the Grub Award in this category.

Winning with our payroll is particularly important for us as we overhauled our portfolio earlier this year to ensure offerings enhance and elevate the consumer experience.

We continue to invest our resources and expertise and to expanding our innovation pipeline and look forward to bringing new high quality fuel to market in the coming year.

In October we launched our much anticipated THC vision focused products in the vape and gummy category.

The spinach feels volatile THC in CATV and gummies are designed to provide a boost at an elevated high.

We plan to launch <unk> infused Piero later in Q4, adding an additional offering under our robust for your own portfolio.

We're incredibly excited about the possibilities in CATV, we put a lot of work into these proprietary formulation that offer a unique and differentiated experience. We know consumers have been eager to try.

These fields, where can avenova infused products have helped bolster at gummy <unk> and for your offerings.

Under this finish brand umbrella.

This field is a leading brand in Canada with a lineup featuring rare cannabinoid TVN CBD CBC and now Tacb many of which are made using our proprietary fermentation methods.

Earlier this year, we mentioned our intention is to bring our award winning candidates brand Lord Jones, the Canadian adult use market.

In November our first product under this brand launched and we're thrilled to bring the Lord Jones brand back to its roots with bold and elevated THC focused products.

The Lord Jones brand is inspired by the possibilities of candidates and we plan to leverage its brand to explore creative in unexpected ways to bring candidates to the world and shape the category future.

Lord Jones products have been artfully crafted scientific precision to bring the purest products and bolder flavors that deliver an unparalleled candidate experience.

We can't wait for adult consumers to go above and beyond with us and try these new products.

The first products under the Lord Jones brand in Canada is has fusions payrolls.

Popularity of Hach products and premium for Euro is increasing amongst adult consumers.

Cash is currently the most popular solvent less infusion into the second most popular infusion overall in the <unk> category.

These have fusion for euro go beyond delivering an elevated true to plant consumption experience.

These three roles are crafted with an optimized ratio of premium high potency flower and complementary solvent less ice water hash, which preserves about natural surfing.

With a reusable ceramic chip to help fuel the smoke.

This new product has been extensively researched and sensory tested to deliver a smoother experience featuring bold flavors.

Later this month, we'll also launch a Lord Jones live revenue base, which will feature sought after cultivars and deliver a flavor full spectrum light <unk> hi.

Our next highly anticipated edible that was researched and developed over multiple years, the Lord Jones Chocolate fusion will launch early in 2024.

And sensory panel testing these products receive even more buzz in their category and our award winning a number one ranked that is Sarah gummies.

These edibles will feature Mouthwatering, multi textured artisanal chocolate and high quality ingredients in three flavors.

Cookies, and cream dazzled, aerie pop and salted caramel crunch.

Turning to Kronos broke out their performance and cultivation continues to be strong.

<unk> reported us preliminary unaudited revenue of approximately $6 2 million from non front end customers in the third quarter.

Additionally, the credit facility that Kronos previously provided <unk> currently has $69 4 million outstanding following the principal repayment of $1 1 million by <unk> in Q3.

In addition, broker made a $1 2 million interest payment in Q3.

The solid financial performance that broke out yielding equity pickup interest payments and loan payback to Kronos is a vital component of our overall financial picture.

In Israel, our team impressively achieved sequential growth in the third quarter, despite relatively stagnant patient growth and continued competitive pricing pressures.

Despite the war and challenging situation our team continued to execute in market, maintaining distribution and launching new products.

Still the bigger priority in the near term is ensuring we do what we can for our Israeli employees their families and the broader <unk> population.

Turning to the U S market, we were pleased with reports of HHS his recommendation to the DEA, suggesting a candidate to be reclassified as a schedule III drug under the controlled substances Act.

Reclassification would signify a significant shift away from candidates with current schedule one drug status.

Schedule III substances are recognized as offering potential therapeutic benefit and can be obtained with a prescription.

Regardless of the specific of how federal regulation in commercialization of cannabis products evolve rescheduling it would be a massive step for U S Canada.

Now three quarters into the year, we are well on our way to achieving our previously guided 20% to $25 million of cost savings in 2023.

And we still anticipate saving an incremental $10 million to $15 million in 2024, as we fully realize the savings from our actions taken this year.

This quarter successes have resulted in significant top line growth and operating expense savings, culminating in a substantial improvement in cash flow from operation, which better positions us to assemble a portfolio of border with products with strategic infrastructure and global partnerships.

The combination of these efforts and an industry, leading balance sheet sets us up well to execute in any market.

With that I would like to pass it onto James to take you through our financials.

Thanks, Mike and good morning, everyone I will now review, our third quarter 2023 results in relation to the prior year period the.

The company reported consolidated net revenue in the third quarter of $24 8 million or 22% increase from the prior year and up 30% from the second quarter.

Constant currency consolidated net revenue increased by 27% to $26 million.

The revenue increase was primarily driven by higher cannabis flower and extract sales in Canada, and the initiation of cannabis shipments to Germany, partially offset by lower cannabis flower sales in Israel due to competitive activity relatively stagnant patient growth and political out of that.

Reported consolidated gross profit in the third quarter was $4 million equating to a 16% gross margin representing a <unk> 8 million improvement from the prior year adjusted.

Adjusted for the <unk> 7 million inventory write down associated with the wind down activities at Kronos fermentation gross margin would've been approximately 19%.

The increase was primarily driven due to higher cannabis flower and extract sales in Canada lower candidate biomass cost and continued supply chain optimization.

We have displayed solid sequential progression on the gross margin line. This year from Q1 at 15% to Q2 of 16% in Q3 and 19% gross margin on an adjusted basis.

With this you can see encouraging signs of improvement and stability and we intend to build off this momentum into 2024.

Consolidated adjusted EBITDA in the third quarter was negative $15 2 million.

Presenting at $3 $3 million improvement from the prior year.

The improvement was primarily driven by a decline in general and administrative and research and development expenses and an improvement in gross profit.

As previously mentioned, we increased our target earlier this year to reduce operating expenses by 20% to $25 million in 2023, and anticipate capturing an incremental $10 million to $15 million in full year savings in 2024, following the significant cost savings initiatives, we implemented in Q3.

Turning to the balance sheet. The company ended the quarter with approximately $140 million in cash and short term investments, which is down by about $1 million from the second quarter. In addition to maximizing the return on our cash we received an interest payment on our <unk> senior secured loan of $1 2 million and a principal repayment of $1 1 million for total cash paid by <unk>.

COTA Kronos, a $2 3 million in Q3, having.

Having the best balance sheet in the cannabis industry enables us to take calculated strategic bets, while we remain steadfastly focused on reducing cash burn.

Moving to the cash flow statement cash flow from operations was negative approximately 180 reps.

Representing a substantial improvement we will continue to work to improve further as we create a fully self sustaining operations.

Free cash flow defined as operating cash flow less capex with only negative 510000, another great achievement.

We have many went to point to market share gains strong top line growth steady gross margin improvement opex reduction cash balance optimization and improving cash flow from operations.

Looking back on those improvements I, Sharon <unk> confidence in the trajectory of the business and our preparedness for entry into new markets as they become available.

I'll turn it back to Mike.

Thank you James.

Our brands are winning globally. Thanks to all the hard work from our employees to bring best in class cordless products to market.

Our Spanish brand hold the top 10 market share position in Canada, and all categories. It participates in which our flower three year old Vapes and edibles.

We are confident that as regulations change we will be among the best positioned cannabis companies to capture additional market share in any market.

Before getting into questions I want to level set what is under the Kronos umbrella and where things stand today.

We closed the quarter with approximately $840 million in cash and short term investments and zero debt.

Generation over $30 million of interest income in Q3, and we anticipate generating generating approximately $15 million in interest income in Q4.

In Canada, our Spanish brand as a following market share range through October 2023.

Overall expansion the number three candidates brand, including number one in edible number one in flower number three and base and number 700 railroad.

We have brought the Lord Jones brand in the Canadian adult use cannabis market with products, we know can win.

We have a leading medical brand peace naturals in Israel, which posted $5 7 million in net revenue in Q3.

This quarter, we shipped candidates to Germany, and intend to ship to Australia in November extending our global reach.

We have a six 3% stake in pharma, Ken one of the largest private U S. Msos currently on our books of $49 million.

We own 50% of the equity in front us broke out which is profitable and <unk> paid a $2 3 million in principal and interest payments in Q3 on an outstanding loan balance of $69 4 million.

We have an approximate 10% stake in <unk>, a leading medical cannabis company in Australia on our books for $13 million and finally, we have an exclusive partnership with Altria on a global basis.

At the close of the market yesterday, Kronos traded at a market cap of approximately $730 million and an enterprise value of approximately negative $110 million.

We have stabilized our cash balance and drastically improved our cash flow trajectory, making us one of the best positioned cannabis companies to take advantage of new market growth opportunities.

With that I'll open the line for questions.

Thank you, ladies and gentlemen, I would like to ask a question. Please press star one on your telephone again to ask a question. Please press star one one we do ask that you. Please limit yourself to one question and a follow up. Thank you one moment for our first question.

Our first question comes from the line of John <unk> of CIBC. Your line is open.

Thank you good morning, I wanted to start on Lord Jones is exciting to see that that brand launch in Canada, I presume it will be positioned as a premium product. So I wonder in the research you're doing do you see more openness or willingness among consumers to shop within cream.

Premium rather than just focusing on THC per dollar.

Thanks, John Yes, that's a great question when we look overall at the Canadian market, obviously, you see value as kind of a largest share but.

The category, we think is increasingly challenged whereas premium I think.

You have an opportunity to really carve out a niche I think it is.

A segment that we can win and I think it's more predictable to have durable margins and when were looking big picture at creating a boarder list product portfolio being able to win in that segment in Canada, where we do think there is room, that's going to translate into other markets a lot easier than something like a value brand.

So.

Very excited what we can do with what the edibles and Theyre very differentiated excited what we can do with pre rolls and base and I think you are offering a much different proposition than just simply what's the potency per dollar.

Okay. That's helpful. Thanks, and then.

My second question more broadly on the market when you look across the Canadian landscape do you see any signs of more rational behavior in this sector and do you get a sense that there is either a greater likelihood of participants exiting the market or a greater likelihood.

Operators behaving more rationally when it comes to pricing.

Yes, I don't think much has changed there.

I will say I think that you are seeing a lot of exits I don't know that thats necessarily because of.

Decision, making from companies that maybe investors, who just no longer are seating losses and.

Bankruptcy processes playing out.

But I do think that regardless of the reasons you are seeing exits and I think that will lead to some rationalization.

So.

It's just making sure we get to the other side.

For us focusing on the consumer is the way to do that and I think the macro environment plays out.

Understood Alright, Thank you very much I'll pass it on.

Thank you one moment please.

Our next question comes from the line of Vivien as there.

Of TD Cowen Your line is open.

Thank you good morning.

So I was hoping to just start with a housekeeping item. Please.

Comment on the revenue benefit, but you may have realized in the quarter from the sullen onboard gas products.

Yeah.

Hey, Valerie So this is James.

Sorry, Vivien there was minimal benefit from Lord Jones, Youll see that start to pick up in Q4 and beyond.

So we really anticipate that being a major driver into 2024.

Understood well then all the more encouraging.

The growth that you guys saw in the Canadian marketplace absent that so my follow up question on would be given the market share momentum that you guys are seeing across several key categories, coupled with price deflation in flower can we just revisit gross margin by product type. So specifically if you could just debenture lives how we should think about Chris part gross margin gap.

Or just rank ordering them between flower pre rolls Davidson levels.

Sure.

Our edibles the number one edibles are still the highest margin products right and we are working to continually improve those.

Do see I'll, just mention the Lord Jones Chaco by.

Also being accretive to the overall company margin.

And then that's followed by base, which we are again working on optimizing that portfolio. We just highlighted the $1 two brand launches and are steadily taking share in that category.

And then followed by a pre rolls very closely and.

And again, we're working to optimize that structure as we continue to assess supply chain.

And further optimize where where there is opportunity and then last but not least flower and again, it's still decent margins there, but that is our lowest current category as you might expect but the current price competition, but all of that said right art flower is outstanding still continues to win versus competition and is improving in that category.

Perfect. Thank you.

Yes.

Thank you one moment please.

Again, ladies and gentlemen, I'd like to ask a question. Please press star one wondering your telephone.

One moment for our next question.

Our next question comes from the line of key one Yang of Canaccord Genuity. Your line is open.

Hi, there. Thank you. Good morning. This is Alan came on behalf of Matt Bottomley.

So I wanted to kind of really back to what John was saying with ice to Canadian adult use landscape.

The country sides five year anniversary of its recreational legalization.

Thanks to the increase immediately puts us to other licensed producers exiting a market given the continued headwinds in the space and so I want to ask if you could provide your perspective on that have you been seeing increased level of competition on the license producer level and I guess trickling down to pricing has it impacted your ability to price any of your products at a higher point.

Thanks.

Sure. Thanks.

I think we have seen the number that are exiting and I think if you look at the overall bankruptcies in Canada certainly.

Cannabis is towards the top of the list.

How many bankruptcies there are.

So you are seeing some exits, but also we've had a wave of new companies enter.

They just said where backlog so it hasnt been something thats immediate and I think.

The reality is that you are going to.

Continue to see in the <unk>.

More supply than demand in the short to medium term, but I think what happens is that really plays out in the value tier so.

Youre seeing a lot of competition and a lot of irrational behavior.

When it comes to the big pack formats.

Lower quality products.

But you are seeing opportunity areas, we see opportunity still in mainstream and premium to be able to continue to take share to be able to grow.

And while I don't know that Youre seeing.

Based opportunities to increase prices I think that we are getting cost down and as you innovate I think that that's where you are able to have some pricing power. So for us the margin improvement the market share growth, that's really driven by innovation and innovation has really been been king for us. So I think we'll continue to see that going for.

Lord and over time, I think you will see that rationalization of lot of the companies are not going to be able to continue to stay.

In the market I still expect will be a diverse group of the company is able to participate and as things eventually normalize.

The overall market opportunity will drastically improve.

But we've sort of learned it doesn't make sense for us to just try to keep punting and waiting for that and we have to be able to do it now and that's why it's been so important for us.

Focus on on getting costs down on growing and improving margins.

Got it thank you and just shifting gears to the international landscape side. Thanks.

Thank you Martin media reports, indicating that there has been an increase in supply going into European markets.

Canadian license producers until I guess.

But your pricing ability with respect to exports that you've been providing to their European partners, including San Francisco This quarter.

If you could provide any additional commentary on what you're seeing in Australia as well with respect to the.

The pricing of the exports going into that market.

Sure. So I think when we compare it to Canada certainly it's.

<unk>.

When you don't have excise tax factored anything you don't have the.

The provincial distributors you are looking at something that Martin.

Margin accretive overall.

And while it is not like a few years ago, we only had one or two companies that were able to ship I think it still isn't really about having a quality product.

These markets as more suppliers of popped up also consumers have become more sophisticated and knowing what they're looking for.

And I think that helps us we we like knowing that consumers are making choices based off the quality of product because ultimately we think that that's going to drive more momentum and more share for us.

So I think medical Youre, almost always likely going to have a.

Better margin profile than in a more developed adult use market.

And we haven't really seen anything that reverses that that trend so whether it's Israel, Germany, Australia, we still see a lot of positives overall can flower.

Thank you.

Thank you I'm showing no further questions at this time, ladies and gentlemen. This does conclude today's conference. Thank you. All participating you may now disconnect have a great day.

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