Cronos Group Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Unaudited U.S. GAAP statements; amounts below are U.S. dollars. Cronos operates in U.S. hemp-derived products and international cannabis markets.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net revenue, after excise taxes | $11.4m | $5.8m | $29.7m | $16.4m |
| Gross profit (loss) | $(1.5)m | $(3.1)m | $(10.9)m | $2.5m |
| Gross margin | (14)% | (54)% | (37)% | 15% |
| Operating loss | $(41.2)m | $(30.7)m | $(120.9)m | $(57.5)m |
| Net income | $68.5m | $604.1m | $36.4m | $1,104.0m |
| Cash used in operating activities | — | $(104.7)m | $(76.8)m |
Revenue increased 96% in Q3 and 80% year to date. Growth reflected Canadian adult-use sales, Israeli medical-market sales, and a fuller contribution from Redwood, acquired in 2019. Despite higher sales, cost of sales rose sharply; the nine-month gross loss included $11.0m of inventory write-downs. Excluding those write-downs, management said year-to-date gross profit would have been approximately $0.1m.
Net income was substantially affected by non-cash gains from revaluing Altria-related derivative liabilities: $105.3m in Q3 and $182.8m year to date, versus $632.5m and $1,158.0m in the comparable 2019 periods. Thus reported net income does not indicate profitable core operations.
At September 30, cash and cash equivalents were $1,097.8m and short-term investments were $202.9m, a combined $1,300.7m, down from $1,506.0m at year-end 2019. Total assets were $1,918.9m; total liabilities were $154.4m, including $102.7m of derivative liabilities. Lease obligations totaled approximately $9.9m. The filing reports no conventional loans payable at period-end. Cash declined $101.8m during the nine months; investing activities provided $37.8m, while financing activities used $4.2m. Capital expenditures were $21.3m.
Material changes and management commentary
- U.S. segment revenue was $1.6m in Q3 and $6.0m year to date, while segment operating losses were $12.2m and $24.3m, respectively. Management attributed weak growth partly to COVID-19-related retail closures and reduced customer activity.
- Rest of World revenue was $9.7m in Q3 and $23.7m year to date. The segment’s year-to-date gross loss widened to $13.3m, reflecting purchased flower costs, lower wholesale sales, inventory write-downs, and operational changes at the Peace Naturals Campus.
- Goodwill and intangible-asset impairment charges totaled $40.0m in Q2: $35.0m for the U.S. reporting unit and $5.0m for the Lord Jones brand. No additional impairment was recorded in Q3.
- General and administrative expense included $8.8m year to date for review and defense costs associated with the 2019 interim financial-statement restatement and related matters. Adjusted operating loss, a non-GAAP measure excluding these costs, was $40.2m for Q3 and $112.1m year to date.
- Management said existing cash and short-term investments should fund operations and capital expenditures for at least the next 12 months. No quantitative revenue or earnings guidance was provided.
- Subsequent to quarter-end, the company launched Happy Dance and Lord Jones products, began selling PEACE NATURALS oils in Israel, and continued plans to sell its OGBC production facility, classified as held for sale.
Risks, contingencies, and unusual items
- COVID-19 continued to weigh on U.S. retail demand and could disrupt suppliers, shipping, production, and customer access. Management expects U.S. revenue growth and operating results to remain negatively affected while retail disruptions continue; the overall duration and financial impact remain uncertain.
- Pricing pressure and Canadian market oversupply may cause further inventory write-downs and margin pressure. Management also cited possible higher marginal production costs at Peace Naturals.
- Disclosure controls were not effective at September 30 because material weaknesses in internal control over financial reporting remained. Remediation controls had been implemented and internally tested, but management did not expect full remediation until year-end 2020.
- Shareholder class actions and regulatory reviews relate to the 2019 restatement and revenue recognition. A Canadian consumer class action seeks C$500m plus C$5m in punitive damages against each defendant, including Cronos; the company had not responded as of the filing. The filing says outcomes are uncertain and litigation may increase.
- The company revised Q3 2019 diluted EPS from $0.42 to $1.62 after identifying an error in the calculation; it concluded prior statements were not materially misstated and no restatement was required.
- Foreign-exchange exposure is unhedged; the filing estimates that a 10% change in relevant exchange rates could affect the carrying value of net assets materially. Derivative valuations also depend on Level 3 assumptions and share-price volatility.
Key facts for investors to verify
- Whether revenue growth can translate into positive gross margins, given inventory reserves, supply-contract costs, pricing pressure, and production economics.
- Cash burn and capital needs relative to management’s stated 12-month liquidity assessment.
- Progress and testing of internal-control remediation, and any developments in restatement-related regulatory reviews or litigation.
- U.S. segment demand, retail-channel recovery, and the assumptions supporting the $40.0m impairment assessment.
- Potential effects of Altria-related derivative liabilities and dilution: the Altria Warrant covers up to approximately 79.1m shares and expires in March 2023.