Cronos Group Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Unaudited U.S. GAAP financial statements; amounts below are U.S. dollars. Financial statement figures are in millions unless stated otherwise.
Business context and reporting period
Cronos is a cannabinoid company with cannabis operations in Canada and Israel and brands including Spinach, PEACE NATURALS and Lord Jones. After exiting its U.S. hemp-derived cannabinoid product operations in Q2, it reports one segment covering Canada and Israel; U.S. results are presented as discontinued operations, with prior periods reclassified.
Key financial metrics
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Net revenue after excise taxes | $19.0 | $21.6 | $38.5 | $44.3 |
| Gross profit | $3.1 | $4.3 | $6.0 | $11.0 |
| Gross margin | 16% | 20% | 16% | 25% |
| Operating loss | $(20.6) | $(25.3) | $(41.4) | $(57.1) |
| Net loss, including discontinued operations | $(8.5) | $(20.3) | $(27.8) | $(53.0) |
| Adjusted EBITDA, continuing operations | $(15.9) | $(16.6) | $(31.6) | $(32.1) |
- Revenue mix: Q2 continuing-operations revenue before excise taxes was $25.8 million, with $6.8 million of excise taxes. Q2 net revenue comprised $14.0 million of flower, $4.9 million of extracts and $0.1 million of other revenue.
- Profitability: Reported net loss improved year over year, but gross profit and margin declined. Higher interest income and lower operating expenses contributed to the smaller net loss; the Q2 result also included a $5.2 million gain on revaluation of financial instruments. Adjusted EBITDA remained materially negative.
- Cash and liquidity: June 30 cash and cash equivalents were $409.4 million and short-term investments were $431.5 million, or $840.9 million combined, versus $877.7 million at December 31, 2022. Management said these funds should cover operations and capital expenditures for the next 12 months.
- Cash flow, six months: Operating activities used $59.5 million, investing activities used $299.0 million and financing activities used $0.8 million. Investing outflow primarily reflected purchases of short-term investments; cash declined by $355.2 million. Income taxes paid were $33.0 million.
- Balance sheet: Total assets were $1.168 billion and total liabilities $31.7 million. The filing reports no conventional borrowings; liabilities primarily comprise payables, accruals, lease obligations, amounts due to non-controlling interests and deferred taxes. Loans receivable totaled $76.1 million, including the secured GrowCo facility.
Material changes versus prior comparable periods
- Q2 net revenue fell 12% reported, or 6% on a constant-currency basis; first-half revenue fell 13% reported, or 7% constant currency. Management attributed the decline principally to lower Israeli flower sales amid competition, slower patient permit authorizations and geopolitical unrest, and Canadian flower price/mix that increased excise taxes as a share of revenue. Currency weakness also reduced reported results.
- Gross margin fell 4 percentage points in Q2 and 9 points for the first half. First-half gross profit declined 45% reported, reflecting weaker Israeli flower sales and unfavorable Canadian flower price/mix.
- Operating expenses decreased 20% in Q2 and 30% for the first half. Lower professional fees, Ginkgo milestone costs, bonuses and insurance, as well as the absence of prior-year restructuring and impairment charges, were partly offset by increased sales and marketing spending.
- Net loss improved by $11.8 million in Q2 and $25.2 million for the first half. Interest income rose substantially as a result of higher rates and short-term investment balances. Prior-year comparisons also included larger gains on derivative revaluations and equity-method income, plus a $11.2 million investment impairment in the first half of 2022.
- Cash plus short-term investments decreased 4% reported from year-end. Cash alone declined 46%, largely because the company shifted funds into short-term investments and funded operating cash use.
Outlook, management commentary, risks and unusual items
- Outlook: The filing provides no quantified revenue, earnings or margin guidance. Management stated that cash and short-term investments were expected to fund operations and capital expenditures for the next 12 months.
- Restructuring: In August 2023, the board approved winding down the Winnipeg fermentation facility and listing it for sale, with approximately $1.2 million of expected restructuring costs, primarily in the second half of 2023. Additional organization-wide reductions are expected to cost approximately $2.0 million, mostly in the second half. Potential impairment from the Winnipeg exit could not yet be quantified.
- Commercial developments: The company planned a Lord Jones brand return to Canadian adult-use markets in Q4 2023. In July it signed a German medical-cannabis distribution agreement and anticipated shipments beginning in Q3 2023. New Spinach products were launched during the quarter and in July.
- U.S. exit items: Discontinued operations recorded a $2.8 million Q2 loss, including an $0.8 million inventory write-down and a $0.2 million lease-asset impairment. U.S. discontinued-operations revenue was $0.4 million in Q2 versus $1.5 million a year earlier.
- Concentration and operating risks: Three major customers accounted for 67% of first-half revenue before excise taxes; two customers represented 41% of accounts receivable. The company cites competition, regulation, consumer demand, foreign exchange, supply-chain execution and the uncertain benefits and costs of restructuring as risks. It does not currently contemplate foreign-exchange hedging.
- Legal and regulatory matters: An Israeli proposed class action filed in April 2023 seeks ILS 420 million against multiple cannabis-related parties, including three Cronos Israel entities; the company cannot predict outcomes of legal proceedings. Prior SEC and Ontario securities regulator investigations relating to financial statement restatements were settled in 2022. The SEC settlement required undertakings and restricted certain offering exemptions and well-known-seasoned-issuer status for specified periods.
- Controls: Management concluded disclosure controls were not effective as of June 30, 2023 because of an unremediated material weakness in IT general controls over user access, including privileged access. The company reported no identified financial statement misstatements from the weakness and said remediation work was ongoing.
Important facts for investors to verify
- Whether revenue and gross-margin trends stabilize, particularly in Israel, and whether Canadian pricing and excise-tax mix improve.
- Operating cash burn and the composition, liquidity and returns of short-term investments as cash is redeployed.
- Execution and realized savings from the U.S. exit, Winnipeg facility wind-down and additional cost reductions, including any asset impairment charges.
- Progress in Germany and other markets, customer concentration, and the collection and credit quality of receivables and GrowCo-related loans.
- Remediation and independent testing of the IT access-control material weakness, and developments in the Israeli class action and other legal matters.