Cronos Group Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; filed May 8, 2020. Financial statements are unaudited. Unless indicated otherwise, amounts below are U.S. dollars in millions.
Business context
Cronos is a global cannabinoid company with U.S. hemp-derived CBD products and cannabis operations in Canada and other international markets. Its reportable segments are United States and Rest of World. Q1 2020 included a full quarter of Redwood, acquired in September 2019.
Financial results and liquidity
| Metric | Q1 2020 | Q1 2019 / comparison |
|---|---|---|
| Net revenue, before excise taxes | $9.344 | $3.391; up 176% |
| Net revenue, after excise taxes | $8.432 | $3.004; up 181% |
| Gross profit (loss) / margin | $(6.476) / (77)% | $1.555 / 52% |
| Operating loss | $(45.060) | $(10.126) |
| Adjusted operating loss | $(40.653) | $(10.126) |
| Net income | $75.681 | $313.989 |
| Operating cash flow | $(38.898) | $(13.838) |
Revenue growth reflected higher Canadian sales, vaporizer launches and $2.2 million of Redwood revenue. The $7.962 million inventory write-down, mainly relating to dried cannabis and extracts, drove the gross loss. Excluding that write-down, management reported gross profit of approximately $1.5 million and an 18% consolidated gross margin.
Net income was primarily supported by a $113.368 million non-cash gain from revaluing Altria-related derivative liabilities; it should not be read as evidence of profitable core operations. The comparable 2019 quarter included a larger $328.216 million derivative revaluation gain. Basic and diluted EPS were $0.22 and $0.20, respectively.
At March 31, cash and cash equivalents were $1,128.396 million and short-term investments were $206.230 million, together $1,334.626 million. Total assets were $1,927.926 million; total liabilities were $212.658 million, including $10.511 million of lease obligations. The balance sheet reports no conventional borrowings. Cash declined by $71.297 million during the quarter, including a $91.037 million adverse foreign-currency translation effect. Investing activities provided $59.086 million, chiefly reflecting net short-term investment disposals; financing activities used $0.448 million. Management said available cash and investments should cover operations and capital requirements for at least 12 months.
Material changes and management commentary
- Revenue increased substantially year over year, but the consolidated gross margin fell from 52% to negative 77%, and operating losses widened.
- Operating expenses rose to $38.584 million from $11.681 million. General and administrative expense included $4.407 million of internal review costs related to the 2019 interim financial statement restatement.
- Rest of World revenue was $6.256 million, up 108%; U.S. revenue was $2.176 million, from Redwood. U.S. segment gross margin was 50%, but the segment recorded a $6.523 million operating loss.
- Management cited Canadian market oversupply and price compression, fixed-price supply contracts, and higher marginal production costs during the Peace Naturals campus repurposing as pressures on gross profit.
- Covid-19 had no material impact on Q1 revenue, according to management, but retailer restrictions and reduced purchase activity were expected to negatively affect the following quarter. Production facilities remained operational and designated essential at the time of filing. The duration and financial effects of the pandemic were not estimable.
- No quantified revenue or earnings guidance was provided. Management described Cronos Israel as approaching operational readiness and expected it to contribute as a growth driver in the second half of 2020 and thereafter, subject to approvals and execution.
Risks, contingencies and unusual items
- Management concluded disclosure controls were ineffective because of material weaknesses in risk assessment, segregation of purchasing and sales duties, and controls over non-routine transactions. Remediation was underway, with control improvements targeted for implementation and testing by the end of Q3 2020; management said weaknesses would not be remediated until controls operated effectively and were tested.
- The company was responding to regulatory information requests relating to its restatement of the first three quarters of 2019. Two U.S. shareholder class actions alleged inaccurate prior statements concerning revenue and internal controls; damages were not quantified. A separate U.S. hemp-product class action was dismissed without prejudice as of the filing date. Management said it could not predict regulatory outcomes and expected litigation and regulatory proceedings in these areas to increase.
- Foreign currency translation produced a $113.692 million Q1 loss in other comprehensive income. The company did not hedge currency exposure; management estimated a 10% exchange-rate change would affect the carrying value of net assets by approximately $171.5 million.
- Derivative liabilities were $166.176 million at quarter end and are sensitive to Cronos’ share price and other Level 3 valuation assumptions. Altria’s warrant, pre-emptive rights and top-up rights could also affect future dilution.
- Credit exposure included loans and advances to joint ventures; Q1 included a $0.917 million expected-credit-loss allowance on joint-venture advances and a $0.903 million allowance on the GrowCo credit facility.
Important facts for investors to verify
- Whether revenue recognition and the identified internal-control weaknesses have been fully remediated, independently tested and accepted by regulators.
- Whether revenue growth can translate into positive gross margins given market price compression, inventory valuation and supply-contract terms.
- Cash burn, investment and loan commitments, and the actual liquidity runway as operating needs and pandemic impacts evolve.
- Updates on the shareholder litigation, regulatory reviews and any further restatements or proceedings.
- Progress and licensing for Cronos Israel, Natuera and Ginkgo initiatives, alongside potential Altria-related dilution and derivative remeasurement volatility.