Originally published November 12, 2019
Cronos released their third quarter fiscal 2019 results today
I am getting more and more disappointed with disclosure. Last Q they removed medical, this Q they won’t disclose wholesale. And they buy a brand and don’t disclose GM% on those sales despite the $380 million price tag.
Cronos continues to emphasize “asset light” and being able to purchase and sell into wholesale market in “opportunistic fashion”. So much so, they dropped their capacity table from MDA and are re-purposing cultivation assets as they take extra capacity offline and turn the buildings into R&D and production.
Having visited the campus, the older buildings have been re-purposed more than once in their past history (some were barns at one point). B4 is the big facility which also housed cultivation and production and was purpose built.
It appears they are working on the amount of provision they will take for taking those cultivation assets offline, and they have a rough estimate of $15 million to hit in Q4 F2019.
On the Cronos Mucci JV, from MDA:
“The Company expects to complete the greenhouse structure in the fourth quarter of 2019 and expects the greenhouse to become operational in phases in the second half of 2020.”
This has moved a few times. My notes indicate it was:
- First half 2019 GH finished, 2nd half 2019 manufacturing
- Last Q, 2nd half 2019 finished and operating in phases 2020
- Now, finished 4Q F2019 and 2nd half of 2020 operating
Given their sales ramp… this is not showing as a pressing need, especially considering they are decommissioning cultivation assets.
They are running a different race (something we say repeatedly about them), and it is tough to see early results, as most is predicated on building around brands that are yet to be deployed in 2.0. Cove and Spinach are rarely talked about on social media, so brand isn’t showing stickiness. I saw Mike at Lift Awards and he broke out the metered vape for me to try that they have developed. It was interesting, and showed a lot of data, but it wasn’t the place to do any sort of product review.
They are spending money like someone with lots of cash in the bank (cough, cough… Canopy), as evidenced by SGA, R&D and Marketing ramps.
Now, let’s open up the financials and the Management Discussion and Analysis and get to the Q at hand.
Income Statement Drivers and Implied Breakeven: Trend Analysis
To set the table….
Cronos was asked repeatedly on the conference call to break out what was being sold recreationally and what was being wholesaled. I didn’t hear any detailed answers to those questions. Last Q they stopped reporting a medical and recreational split. So, we are losing data texture. That does not please me.
Dry cannabis sales increased 30% or by $2.4 million in the Q. Dried is 95% of the mix. Given revenue per gram decreased by 43% QoQ, or by $2.64/gram to $3.55/gram, one can certainly assume that a substantial amount of dried flower was sold to extractors in the Q.
Oil, which constitutes only 5% of sales mix, down from 17% last Q, dropped 44% or by $0.9 million in the Q. Revenue per gram remained stable with a +2% increase to $7.87/gram.
They acquired Lord Jones on September 5, 2019 and, as such, those results from that point in time contributed to Sales, CoGS and Opex for the Q. That looked to add $0.9 million in sales for the Q. Hefty price tag for a small contributor. More on that later.
KGs sold went doubled to 3,142 KGs up from 1,584 KGs last Q.
We run an “Implied Harvest” where Harvest is a plug figure based on the rest of the data fields being provided. This implied harvest went up to 9,333 KGs from 5,032 KGs last Q. Given they had 81,874 plants on the floor last Q, with estimate of 56 grams/plant, they could have only harvested 4,600 KGs from those plants. I would have to conclude that their inventory also contains substantial 3rd party purchases which, without disclosure, is impossible to separate. We can guess it was 4,733 KGs. Given Oil increases in inventory… I would say that is where it is re-entering their balance sheet and as Cannabinoid Concentrate.
I don’t know how this happened, but international dry cannabis revenue went negative for the Q at -$0.2 million.
Gross Margin: Peer and Trend
Gross Margin decreased 12% QoQ largely owing to increase reliance on wholesale, this reduced significantly their revenue per gram, putting pressure on % GM.
In absolute terms, GM decreased by $0.2 million to $5.3 million, despite the sales increase. From this I would guess that medical and rec sales retreated significantly and wholesale GM $ was not sufficient to increase GM$ QoQ.
Is Cronos wholesaling and buying back oil inventory?? That is a good question to ask, yet no one asked it. Unlike RTI ACB possible wholesale and repurchase, Cronos, does not to my knowledge, have an investment in an extractor. Given MediPharm is their extractor of choice, and MediPharm carries $54 million in biomass, transactions with Cronos could be done via tolling agreement or outside tolling agreement in sale and buy back.
Cost structure of GM improved largely because wholesale does not have the packaging and production costs that recreational or medical would.
Without the split of revenue and segmentation of financial results we cannot tell any efficiencies Cronos picked up, despite improvements listed above. The fact that Processing Costs is greater than cost of sales shows the distortion.
Larger LP Peer Group: Gross Margin
Cronos’ 42% GM% has them on the lower side of the median of this group, however CGC, TLRY and APHA all have lower margin non-cannabis business units contributing to a lower GM% (CGC might be the exception to that, given their cannabis segment might be the lowest GM in that business).
I want to point out the Gain on Biologicals … as an expense this is usually a negative figure (negative expenses are good for Net Income fluffing), and it usually signifies the GoB on their crop has increased due to more plants. That is not the case here. Plants dropped 8% QoQ and the driving factor was a reduction in anticipated selling price to $3.58/gram from $5.93/gram. That is a 40% reduction in selling price. These two decreases is what flipped a negative number to positive, the selling price being the bigger driver.
Fair Value Increment on product sold increased $11 million to $15 million and were a whopping $4.65/gram up from $2.25/gram. That $4.65/gram FVI/gram is more than their average revenue per gram of $3.75/gram. They had a ton of pulled forward Net Income in their inventory. -As they move to US GAAP watch for the inventory revaluation!}
Their inventory booking cost per gram dropped 33% QoQ. With $40 million in cannabis inventory last Q that would be an approximate writedown of $14 million as a result of management assumptions being too high in previous periods.
When evaluating management, especially when they are playing a long game, things like how aggressively they pull forward profit and it being reversed and their acquisitions are items you can look at.
SGA & SBC: Trend Analysis
Selling expenses is up $0.7 million QoQ but down 4% as percentage of sales to 48%. More marketing efforts were the reason, as they get ready for 2.0. They had their name splashed around the Lift Awards and were shut out on awards. That Selling expense will end up in Q4.
G&A expenses is up $6 million QoQ and is now 168% of Sales up 20% as percentage of sales last Q. Headcount was part of the reason. Their acquisition contributed for one month too. That is a staggering amount of SGA relative to sales since legalization.
SBC was up $1.1 million to $3.1 million.
R&D is up to $3.4 million a $0.3 million increase QoQ.
From MDA, reasons for SGA increase:
“• an increase in professional and consulting fees for services rendered in connection with various strategic initiatives, legal fees, and accounting fees; • higher marketing costs to build and develop our brands; • increased staffing levels across functions including procurement, information technology, sales and marketing, finance, and operations, in line with the Company’s growth strategy; and • R&D expenses related to the Ginkgo Strategic Partnership and Technion research agreement.”
Overall OPEX was $35 million, almost triple sales. Inflection points will likely not occur for several Q’s after 2.0.
SGA & SBC: Peer Comparison
Cronos is only behind Hexo’s latest Q (which was disaster) and 48 North which has minimal sales, in the peer group.
Net Operating Profit before IFRS voodoo was negative $30 million, a slide from negative $21 million last Q. This is almost all Opex driven, save for the small backslide in GM$’s
Implied Breakeven Sales divided by Current Sales:
Cronos would have to add 561% in incremental quarterly sales to achieve +NOP, using present GM% and Opex $s. Last Q they required 380% more quarterly sales to reach +NOP, so they are sliding backwards.
The Other Expenses and Income +$835 million this Q versus $271 million last Q. The vast majority of this the result of the falling share price and the impact of the Altria options. Should share price reverse, these will reverse.
Net Income after tax was +$788 million all from the Altria derivatives.
This is where you hope their long game pays off. As Adj EBITDA deficit is increasing at a large rate. This past Q it was -$24 million, up from -$18 million and -$9 million sequentially. This trend will likely continue into Q1 F2020.
Income Statement Drivers & Implied Breakeven Sales: Trend Analysis
The gap to breakeven sales needed to achieve +EBITDA is now at $58 million and +NOP at $72 million. Both almost doubled QoQ as GM% shrunk and Opex increased.
Income Statement Drivers & Implied Breakeven Sales: Peer Comparisons
Hexo and Cronos share the distinction of the highest breakeven sales level needed to hit +NOP.
Sales gap to +EBITDA Cronos is the 2nd highest gap in their Peer Group.
+EBITDA Large Peer Group
On an incremental basis, Cronos needs to add 454% more in quarterly sales, up from double last quarterly results, to achieve +EBITDA.
As we said last Q: “But with guidance of increased Opex going forward a pure doubling will not be enough.”… rinse, repeat for next few Q’s.
Balance Sheet Items of Note:
- Cash is King and they have lots of it at $2.0 Billion down $330 million QoQ. Insert Dr. Evil gif.
- A/R increased up only $0.7 million. Someone is getting cash terms for wholesale unlike the ACB wholesale..
- Biological Assets: decreased $8 million to $2 million
- Last Q we wrote: “While they now have 81,874 plants on the floor versus 67,635 last Q, the projected yield per plant dropped significantly from 91 grams to 56 grams. No mention as to why, but it could be they are growing smaller plants with a shorter cradle to grave for oil. This dropped their Projected Yield from Bio Assets to 4,585 kgs from 6,155 kgs last Q. I kind of wish someone asked a Q around this in the CC, but with little prep time between earnings drop and the call I can understand why it wasn’t asked.
- This time … their plants dropped by 8% to 75,649 but Selling price dropped from $5.93/gram to $3.58/gram. This 40% decrease knocked inventory down by $14 million based off just last Q inventory closing totals.
- Inventory increased $8 million of which $3.6 million is new Infused Finished Goods and Cannabinoid Concentrates, making their debut These latter two items are not accounted for in KG or KG equivalents in inventory totals.
- I do caveat that Cronos does not disclose their Harvests and also purchases from 3rd parties, which are not disclosed. So, the “Implied” Harvest [below] is likely off by the KGs they sleeved from 3rd parties.
- It is nice to see the Implied Harvest to Sold delta growing, as this gives them more product to sell in Q4 F2019. But it is strange they need to purchase from 3rd parties when their Bio Assets would yield more than their KGs sold, including wholesale, in the Q. Sleeving from 3rd party will keep negative pressure on GM%.
- Also encouraging is the increase in Finished Goods Inventory [below] despite the strong sales AND despite a writedown in value. This is a sign that their throughput and/or sleeving was greater than sales. FG remains relatively small to this Q Sales.
“Gas in the Tank”
Sold v Harvest & Sales v Inventory
- As per above Cronos is Selling versus Implied Harvest at a 34% rate this Q and 31% last Q. I can see why they are taking cultivation assets offline as inventory is +4 times sales.
- 50% of Inventory is now oil at $28 million despite oil being 4% of sales mix. This is their stockpile for 2.0.
- PPE was up $20 million to $216 million.
- With the Lord Jones acquisition Goodwill and Intangibles increased $367 million from a $380 purchase price. Tangible non leased tangible assets accounted for only $11 million of that purchase price or less than 3%. That is quite price tag for an asset that generated less than $1 million in revenue for the month.
- Accounts Payable increased $27 million to $58 million. Only $4 million in A/P came from Redwood Lord Jones acquisition.
- Derivative Liability is up $788 million as discussed in Other Income section of Income Statement.
This is a tough Q to read without any disclosure on wholesale revenue. My gut says that Rec and Medical revenue backslid considerably based on reading the absolute GM tea leaves.
Sales are up 24% but how much of that is a base of medical and rec they can grow versus “opportunistic” wholesale? Opportunistic wholesale means “we had product we didn’t think we could sell in the foreseeable future that we sold for what we could get for it now, before the price drops further.” This fits in the narrative of reducing cultivation capacity as they cannot sell their capacity.
They will take a provision for that action next Q.
The Opex ramp is afforded by the Altria investment and cash. It will take time to see if they are able to justify the ramp in sales that won’t happen largely until next year. Canopy made a similar ramp of investment and Opex (and in biomass producing assets) that have yet to turn the corner. We will see if Cronos fairs differently, as they shed biomass cultivation capacity and come more of a CPG company.
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.