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Cronos released their fourth quarter results today.
I had a direct message land in my twitter box today that really sums this up nicely…”I almost want Cronos to come out with a PR saying ‘we did nothing this quarter, but we still have our money! Please legalize soon, Biden’ and that’s it.”
We are six quarters of negative gross margin in a row and we are still waiting on biosynthesis or for Cronos to something with Altria’s money. Groundhog Day.
And I could not write this if I tried: In F2019 Cronos does a biomass boomerang. Gets caught as a whistleblower tells their auditor. Ends up spending USD $10 million in fees to deal with the restatements (lawsuit still pending), which was more than the fluffed sales of CAD $7 million. And this Q they write down extracts likely remaining from the biomass boomerang. Perfect conclusion.
And as it pertains to biosynthesis…even IF they get minor cannabinoids at a lower price, how will they market them with current Health Canada and FDA regulations? They will not know what the minor cannabinoids do without ten years of scientific testing and validation. Do they just slap a catchy brand or product names on them that suggest the possible effect? I just do not know how they move the product IF they can overcome the patent and other hurdles.
Ohhh. And here is a Material Weakness identified in the audit opinion:
- In our opinion, because of the effect of the material weakness, described below, on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
- Inventory verification: Management failed to properly design and execute sufficient procedures to verify inventory quantities. Specifically, while inventory counts were performed in the fourth quarter, (i) the aggregate value of items excluded from the count exceeded the Company’s materiality threshold, and (ii) human error in count execution, data transposition and reconciliation analysis resulted in inaccurate adjustments.
Wondering if this led to the $15 million inventory writedown this Q. I am going to guess… YES!
What I said at Fiscal 2019 YE:
- If you are investing in Cronos for biosynthesis “September 2021” should be the date you have circled. That is a long time to wait on any meaningful development.
Three more quarters.
- Net sales increase of 15% was good
- Flower sales increase of 40%, 2.0 sale decrease of 22% 2nd QoQ decline since launch, USA Sales down 25%
- GM negative for 5th Q in a row. And looks to be under pressure until they sell higher priced inventory in vault.
- SGA 230% of sales
- Net Income of USD 69 million of which $105 million was gain on derivatives
- Adj EBITDA decreases further to USD -31 million
- Lots of cash still
- Net sales increase of 50% was very good
- Flower sales increase of 45%, 2.0 sale decreased, USA Sales increase 114%
- GM negative for 6th Q in a row. And looks to be under pressure until they sell higher priced inventory in vault.
- SGA 194% of sales
- Net Loss of USD 61 million which was bolstered by $51 million gain in f/x translation offset by a gain on revaluation of derivative of $53 million, and
- Adj EBITDA decreases further to USD -39 million (Note: CRON, to their credit, does not back out inventory writedowns. I did thus my number is better than theirs.)
- Lots of cash still
Now, let us open up the financials and the Management Discussion and Analysis and get to the Q at hand.
Where needed for peer comparison purposes, I have applied an f/x rate of 1.31:1 CAD/USD.
Income Statement Drivers and Implied Breakeven: Trend Analysis
To set the table….
Sales increased 50% +$6 million to USD 17 million (CAD 22 million) from USD 11 million last Q.
- Flower sales increase of 45% is good to see with steady increase this fiscal period after a 40% increase the preceding Q
- 2.0 sale is a weird one. I get there by taking 100% of extract sales and backing out what is sold in USA (as that would all be extracts) and I get a negative number for the Q of -USD 1.6 million. I see no provisions or returns. So IDK??
- USA Sales increased by 114% to $3.5 million as covid restrictions and a move to more online helped Lord Jones volumes.
- I can not isolate Canadian sales nor exports to Israel.
Improvement in Flower sales is encouraging. They no longer even mention how much flower they grow anymore. So not sure if this is their flower or sleeved flower.
They indicate that Grow Co JV with Mucci in Kingsville completed in Nov/20 and they are awaiting license. Originally this was to complete 1st half 2019 and product 2nd half 2019, then it was to open in phases in 2020. So, it is almost two years late.
What I said last few Qs: Iconic brands still be determined.
We will go with that again.
Income Statement Drivers and Breakeven Sales: Peers
In this peer set Cronos is first, a million or so ahead of FIRE.
Gross Margin: Peer and Trend
Gross Margin is negative for 6th consecutive Q. I cannot recall ever seeing that before. For the Q, and without any impairment this Q, GM was $0.1 million or 0.8%. Think about that.
With the impairments of $15 million it is -87%.
USA generated $1.8 million in GM or 52% an improvement from $1.0 million and 8% last Q. Rest of World generated -$14 million GM in the Q a slide from -$2.2 million last Q.
Total GM was -$15 million and this from their presser is not encouraging to those hoping for much improvement soon:
- The Company incurred an inventory write-down in Q4 2020 of $15.0 million, on dried cannabis and cannabis extracts, primarily driven by cannabis product price compression in the Canadian market. The Company may incur further inventory write-downs due to pricing pressures in the marketplace.
Queue scary music.
Larger LP Peer Group: Gross Margin
Cronos is dwelling in the basement in the GM% peer group.
SGA & SBC: Trend Analysis
I guess improving SGA and SBC from 300% of sales to 208% is an improvement. BUT…
Selling expense almost doubled, increasing to USD 13.5 million from USD 7.2 million as they launch new Kristen Bell CBD products in USA. Selling expense is 79% of sales. That is large. Hopefully, US sales keep increasing because that is a bigger increase than all of US sales of $3.5 million
G&A increased from $18.9 million to $19.5 million QoQ with
- Internal review costs related to 2019 revenue restatement decreasing to $0.9 million from $1.0 million. The aggregate of the restatement expenses of USD $10 million exceeds the CAD $7.5 million restatement of revenue. Class action lawsuit still pending.
- professional fees decreased by $2.3 million to $2.0 million
- salaries and wages increasing by $3.7 million to $8.3 million. I would imagine the ramping of fermentation facility is part of it.
SBC was USD 2.5million down from USD 7.9 million last Q as they paid some severances in that Q.
R&D was USD 7.4 million up from USD 4.7 million last Q. Much of the R&D is for the new fermentation facility. You will have to wait until September 2021 to see if that bet pays off.
Operational Expenses total USD 44 million an increase from USD 40 million last Q. That is 255% of sales.
SGA & SBC: Peer Comparison
Cronos is the leader in Aggregate SGA and SBC. Not in a good way.
Net Operating Profit was negative USD $58 million, a slide from negative USD 41 million last Q. The decrease in GM of $13 million and increase in Opex by $4 million the reasons.
Other Expenses and Income of note:
- Interest income of USD 3.1 million a decrease from last Q of USD 3.8 million.
- A $53 million loss on derivative liability, a significant reversal of the +$105 million last Q as their stock price increased.
Total Other Expense were $52 million versus income last Q of $111 million.
FX translation gain was $51 million.
Cronos records a Net Income of -$61 million a slide from +USD 68 million last Q.
Implied Breakeven Sales divided by Current Sales:
With a Negative Gross Margin, we cannot determine breakeven sales levels.
After Q2F2020 when Cronos removed the mention of EBITDA from their MDA and earnings release, it has now re-entered.
My EBITDA is better than theirs by $14 million as they did not deduct the $15 million inventory impairment and they add back the legal expenses from the restatement of revenue in F2019. Cute, as legal expenses was self-inflicted, I do not add it back.
Adjusted EBITDA slid to negative CAD 51 million from negative CAD 41 million last Q despite a strengthening of CAD/USD. This is only “surpassed” (in a bad way) by Canopy at negative $68 million. These might cross over in the next Q or two.
+EBITDA Large Peer Group
With a Negative Gross Margin, we cannot determine breakeven sales levels.
Opex burn of negative USD $33 million and investment in non-cash working capital of negative USD 4.8 million.
Balance Sheet Items of Note:
- Cash is King and they have lots of it at USD 1.3 billion down USD 11 million QoQ.
- Inventory was USD 44 million a decrease of USD 12 million QoQ of which 415 million was impairment.
- WIP flower was the second biggest decrease at $5.2 million to $20.5 million
- WIP oil decreased $7.7 million to $5.8 million
Sold v Inventory and CoGS vs Inventory
We modified the graph to a US GAAP model. The lines (from top to bottom) are inventory, Sales and CoGS (excluding writedown).
Cronos has 2.6 Q’s of inventory on hand, an improvement from last Q’s 4.4 turns on hand. The decrease is a result of the $15 million impairment. This has been a steady, but costly, improvement as they try to right size inventory. They wrote down $29 million in inventory during F2020 versus $24 million in F2019.
What I said last Q:
Cronos is a term deposit with a cannabis side business. Until they make a move with the Altria investment, they are likely to remain that way.
The big operational bet remains biosynthesis, which must navigate several patents in order to work. If it does not Cronos will have a big white elephant in the fermentation asset and plenty of money invested in R&D that will be spent.
Without substantial sales growth with a positive gross margin the SGA and R&D expenses will continue to depress operating profitability and EBITDA.
The cost structure of the company resembles a pre revenue company.
Good thing they have plenty of cash as the business is far from profitability, potentially further out than Canopy.
Much of the above remains the same. Groundhog Day.
The sales progress is good to see. They just need so much sales increases and some sort of positive GM to get even close to breakeven.
They now have more cash (USD 1.3 billion) than Canopy (CAD 1.5 billion)
That’s all I have.
The preceding is the opinion of the author and is in no way intended to be a recommendation to buy or sell any security or derivative. The author does not have a position in Cronos and will not initiate one in the next 5 days.
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