Cronos Group Inc (CRON) Q4 2018 Transcript of Conference Call – The Motley Fool

Cronos Group Inc. (NASDAQ: CRON)
Q4 2018 Results Conference Call
March 26, 2019, 8:30 am ET

content:

• Prepared notes
• Questions and answers
• Call the participants

Prepared notes:

Operator

Ladies and gentlemen, stay tuned. The Cronos Group's fourth quarter and 2018 earnings conference call will begin in a few moments. Thank you for your patience and, please, continue to stay by your side.

Hello. I'm calling Michelle and I will be your conference operator today. I welcome everyone to the Cronos Group's fourth quarter and year 2018 earnings conference call. The call of today is being recorded.

At this point, I would like to give Anna Shlimak the floor, Investor Relations. Please, go for it.

Anna Shlimak – Investor Relations and Communication

Thank you Michelle. And thank you for joining us today to review Cronos Group's financial and business activities for the fourth quarter and fiscal year 2018. Mike Gorenstein, President and Chief Executive Officer, and William Hilson, Chief Financial Officer, join me.

Earlier this morning, Cronos Group issued a new press release announcing its financial results, which are all classified in our SEDAR and EDGAR profiles. This information, as well as the prepared remarks, will also be published on our website under Investor Relations.

Before giving Mike the floor, I would like to remind you that our discussion during this conference call will include forward-looking statements based on assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from actual results. . projected in the forward-looking statements.

Management can not guarantee that forward-looking statements will prove to be accurate. The forward-looking statements contained in this appeal are valid only at the original date of this appeal. We assume no obligation to update or revise these statements except as required by applicable law. Management refers to the cautionary statement and risk factors included in the Company's most recent MD & A and Annual Information Form, which fully describe the forward-looking statements made in this call. We will now make some prepared remarks, and then we will go to a question and answer session.

With that, I make the call to Mike.

Michael Gorenstein – Chief Executive Officer, President

Thank you Anna and hello everyone. In my speech today, I would like to make a final assessment. I think it's important to look back and think about everything we've accomplished in just one year, as our society and our sector evolve at such a rapid pace.

2018 was a very productive year for the Cronos Group, which has gone through many important milestones. Last year, cannabis for adult use was legalized, making Canada the first G7 country to legalize cannabis for adult use at the scale national. We are proud to participate in this emerging market.

As I have already mentioned, the Canadian government's leadership in establishing a federal legal framework is why we chose to operate in Canada. When we embarked on this path, three years ago, we knew that the interest of operating in a legal environment would allow us to learn, build and create a business that has the potential to grow. To be a world leader in the sector. We are proud to advance the industry responsibly and are motivated to create meaningful products that excite our consumers and bring happiness to a better quality of life.

The growth opportunities in the cannabis sector are vast: our differentiated brands, our global footprint, our production capacity and supply chain, our commitment to innovation in cannabinoids and a strategic investment in Cannabinoids. Altria group, from the Cronos group, are well positioned to realize these opportunities.

To set the stage for our call for today's results, I would like to briefly review the four aspects of our strategy. Within the Cronos Group, we build an efficient global supply chain and supply chain, we develop a diversified global sales and distribution network, we create and monetize disruptive intellectual property and we develop a portfolio of iconic brands that affect consumers.

During this call, we will discuss each of these strategic pillars and provide an update on what we will do to grow our business globally. I will start with our expansion of production. In August 2018, Peace Naturals, our center of excellence, received approval from Health Canada to grow cannabis in an additional building: Building 4. This 286,000 square foot facility is GMP-certified and is growing. gradually produce cannabis. The facility produced its first harvest in December 2018 and we still expect all flower rooms to be populated in the first half of 2019.

Crop 4 operates on a perpetual harvest cycle, similar to a manufacturing facility. Like other large agricultural facilities, we expect that at each cycle, our returns will continue to improve as we call controls. We are very proud of this facility, our Peace Naturals campus as a whole, and what we have been able to build in such a short time.

While the cost per gram return is the standard measure of unit cost for the cannabis industry to date, we believe this is starting to change. We still think that the COGS will be an important measuring instrument, but by that I mean the cost of the products sold, not the cost of the grams sold. Efficiency, in downstream processing and packaging in categories such as pre-cylinders, will be a differentiating factor in a field on which we will be focusing more and more. And as value-added products come online, the corresponding cost of cannabis will change from grams of cannabis flower to milligrams of cannabinoids. And we have already seen the beginning of the change in proposed tax regulations in Canada, from the weight of dried flowers to the active ingredient.

Keeping this change in mind, we will continue to optimize our supply chain to finished products. As supply catches up with demand, we believe that it will be extremely important to have expertise in agriculture and hand management practices. Works on a large scale. That's why our approach to further strengthening our capacity involves taking our genetics, growth methodologies, and best practices from Peace Naturals, our center of excellence, and creating collaborative relationships. -manufacturing with sophisticated agricultural operators around the world. We are confident and committed to our cultivation partnerships.

In Canada, we launched a joint venture, Cronos GrowCo, with an investor group led by Bert Mucci, a leading large-scale greenhouse operator in Canada. As discussed in our previous call for results, Cronos GrowCo is currently building a purpose-built 850,000 square foot greenhouse, which is expected to produce up to 70,000 kilograms of cannabis a year. The construction of the greenhouse has begun and we plan to complete the greenhouse superstructure in the second half of 2019. In the same way that we put building 4 on line, we expect this greenhouse to become operational in phases. , in 2020.

We are also making progress on our international production footprint. First, let's talk about our joint venture with Cronos Israel, with the Israeli agricultural collective Kibbutz Gan Shmuel. Cronos Israel focuses on the production, manufacture and distribution of medical cannabis and is under construction. We anticipate that the construction of the 45,000 square foot greenhouse will be completed in the first half of 2019 and that construction of the manufacturing facility will be completed in the second half of 2019.

Cronos has an effective economic interest of 90% in all Cronos entities in Israel. In January 2019, the Israeli government approved the export of medical marijuana from Israel, which will allow licensees to export to countries that have explicitly approved the import of medical cannabis. . We intend to continue to license and export medical cannabis products from Cronos Israel to our European and global distribution partners once production operations are operational.

In 2018, we also introduced our production model in Latin America. Cronos, announced a joint venture with a major Colombian agricultural service provider, with over 30 years of research and expertise in the management of horticultural operations on an industrial scale. The partnership establishes the new NatuEra entity in Colombia to: develop, grow, manufacture and export cannabis-based medical and consumer products for the Latin American and global markets. NatuEra has obtained a license to grow non-psychoactive cannabis plants to produce seeds for planting and for the production of derived products.

We understand that many investors are modeling cannabis businesses in their capacity. However, our business model should not be the first. We believe that the value chain of the cannabis industry will create value in many vertical sectors, including culture, wholesale supply, research and development, manufacturing of branded products , marketing and retail. We see tremendous opportunities across the industry, but recognize that we can not give everything to everyone. Instead, we will focus on areas in which we perceive long-term sustainable value, such as the development and commercialization of innovative branded products, and then work with experts from other sectors.

This approach has been proven in similar sectors such as consumer products and pharmaceuticals. And we think that will also succeed in the cannabis industry. In other words, you can expect our goal to be to make cheese rather than raising and milking cows.

Let's move on to distribution. Canada became the first G-7 country to legalize cannabis sales for adult use. Cronos, participated in the launch of this new market through our two brands for adult use: COVE and Spinach. At present, these brands are distributed in Ontario, British Columbia, Nova Scotia, Prince Edward Island and Saskatchewan.

As our production capacity increases, we intend to expand distribution to other Canadian provinces and territories. In 2018, we also announced our intention to partner with MedMen Enterprises to create MedMen Canada. The private retail sector is changing and changing, so we continue to review and analyze the situation as it evolves in each province. We think it's a valuable relationship with a great recognizable brand.

In addition, this year we announced that Cronos GrowCo has signed a supply agreement with Cura Cannabis. Cura, has signed a five-year "à la carte" purchase agreement for the purchase of at least 20,000 kilograms of cannabis a year, as of the date of receipt these licenses. We believe that a partnership with companies such as Cura and MedMen has allowed the Cronos group to build strong relationships as new markets and regulations open up.

Internationally, the Cronos Group has made considerable efforts in 2018 to extend its global reach, through a distribution agreement, to the medical products market in Poland. In June 2018, we entered into a five-year exclusive distribution partnership with Delfarma, a pharmaceuticals wholesaler, with a distribution network of more than 5,000 pharmacies and more than 200 hospitals to provide pharmaceutical products. of cannabis brand Peace Naturals. We have also signed a five-year exclusive distribution agreement with Pohl-Boskamp, ​​a European pharmaceutical manufacturer and an international distributor for the German market, signed in 2017.

We believe that Europe and Asia Pacific are extremely important markets for the future, but in the short term we are convinced that the development of foreign pharmaceutical factors and medical cannabis distribution systems will play a role. crucial in the growth of prescriptions and patients. based on these markets. We are looking for regulatory pathways for other non-combustible products with our partners in Pohl-Boskamp who have expertise in registering new medicines in Germany.

We are taking a calculated approach by committing our current offering, as we want to ensure that we support our direct client clients, our provincial and private retail partners, our international partners and end consumers in all these markets. As new distribution channels open up, we need to find a balance between supporting our existing global footprint and responding to the demands of the newly created channel. At this point in our business, we are very aware of this delicate balance, as our offering expands to meet the growing demands of our global distribution.

In our last call for results, we discussed at length the pillar of our IP strategy. As our business and society evolve, this pillar will continue to play an extremely important role in creating and creating value for our business.

I want to reiterate the strategy. We are committed to creating, monetizing and creating a divide around disruptive intellectual property. Within the Cronos Group, we seek to build the most innovative cannabinoids company in the world, where we develop and research effective processes to efficiently produce and formulate the full spectrum of cannabinoids, not just THC and CBD. We use the plant as a model for learning, then to create differentiated active principles by reconstituting cannabinoids and terpenes in combinations with specific psychoactive effects and / or therapeutic benefits.

We will then formulate these active ingredients to optimize bioavailability and customize them for the appropriate delivery systems, based on the product, its effects, its use case and its commercialization process. One way to achieve this goal is to establish a strategic partnership with Ginkgo Bioworks, announced in early September. We believe that this historic partnership in R & D is likely to disrupt the sector. For the benefit of new followers in the history of Cronos, I would like to briefly explain the importance of this announcement and the power of partnership with an unparalleled company like Ginkgo.

Our goal with Ginkgo is to produce cannabinoids in cultivation on a commercial scale. This includes not only THC and CBD, but also a rare cannabinoid that is economically impractical or nearly impossible to produce with high purity and scale through traditional cultivation and extraction. To return to our strategy, at Cronos we believe that rare cannabinoids are essential for product differentiation, but that today they are almost impossible to produce commercially. By using fermentation, Cronos and Ginkgo could significantly reduce the cost of cannabinoid production on a commercial scale and allow the production of rare cannabinoids.

Using this production methodology, we could exploit the existing fermentation infrastructure, rather than incurring heavy capital expenditures to build and manage new cultivation and extraction facilities. In addition, we believe that this technology will allow us to provide product consistency more easily.

The partnership is currently focused on 8 cannabinoids. Ginkgo will design microorganisms that can scale these cannabinoids using fermentation. The partnership is aligned to encourage each party. The common shares of Cronos will be issued in favor of Ginkgo, when each of the 8 cannabinoids can be produced at less than $ 1,000 per kilogram of pure cannabinoid on a scale greater than 200 liters. In total, 14.7 million shares will be issued in tranches for each cannabinoid. In addition, Cronos will fund research and development and smelting costs, which are expected to increase to approximately $ 22 million over the life of the partnership.

In November 2018, Ginkgo received the necessary authorizations for cannabinoid research from the DEA and the Massachusetts Department of Public Health. We think it will take until September 2020 and 2021; Three years from the announcement of the transaction, in September 2018, to reach the milestones in equity for the target cannabinoids.

Once these milestones are achieved, Cronos will have the exclusive right to use and commercialize the main patented intellectual property rights related to the production of target cannabinoids at perpetual and global levels. We know that flowers and pre-rolls will remain desirable and important consumer products. We believe that the production of derivatives will be carried out using cannabinoids in culture.

In the fourth quarter, we also entered into a research agreement with the Technion Foundation for Research and Development to explore the use of cannabinoids and their role in the regulation of health and skin disorders. The preclinical studies will be conducted by Technion over a period of 3 years and will focus on 3 skin conditions: acne, psoriasis and wound healing. The research will be led by professors Dedi Meiri and Yaron Fuchs, faculty members of Technion, two of the world's leading researchers in the field of cannabis and stem cell research.

Dr. Meiri, head of the Cannabis and Cancer Research Laboratory, has extensive experience in research on cannabis and endocannabinoids. Dr. Fuchs leads the laboratory for stem cell biology and regenerative medicine, with many years of experience in the field of skin biology and its pathologies. Whether research and development results in products for which consumers will need a prescription, purchase for an adult card, or can be purchased anywhere, it will be very important to be able to educate consumers about the benefits of our differentiated products. And that's where our brands come in. To that end, I'd like to talk about our brands for adult use.

We focus on providing consumers with top-quality, high-quality products, both flowers and oils, available on the market today or in the future through our derivative offerings. In October 2018, we launched two consumer brands in the Canadian adult market. Our brand, COVE, is focused on the high end consumer. And Spinach, a cheerful and playful brand, addresses the traditional market. Our brands are designed to deliver authentic experiences, for the respective consumption targets.

As the product offering in Canada begins to evolve with upcoming regulatory changes, we believe that it will be easier to differentiate brands through derivative products, which will create a more personalized experience for consumers.

Our goal in 2018 of establishing an effective global production footprint, developing our global sales and distribution network, creating disruptive intellectual property and developing our family of brands, ultimately led to the search for a major strategic partner and an investor in the Altria group.

To close the year, we announce the conclusion of a subscription agreement with Altria. Our contract with Altria closed on March 8^th. Altria's $ 2.4 billion investment in the Cronos Group represents a milestone for our company and a relationship with which we are extremely proud to commit ourselves. The investment of Altria represents a stake of about 45% in the Cronos group. They also have an additional 10% acquisition mandate, which will generate approximately $ 1.4 billion Canadian to the Cronos group.

The mandate can be exercised over the next 4 years. We expect this investment to lead to significant growth and value creation for our company. The investment provides not only additional access to financial resources, but also the ability to accelerate and develop product development, as well as marketing capabilities globally. With the equivalent of investment, our board of directors has grown from 5 to 7 members.

The board of directors now includes three directors: Jim Rudyk, chief financial officer of Roots, who will act as lead director, and Jason Adler, co-founder and managing partner of Gotham Green Partners, and myself, his President. In addition, we welcome four new directors: KC Crosthwaite Jr., Altria's Director of Strategy and Growth, Bronwen Evans, Independent Consultant, Murray Garnick, Senior Legal Advisor, Altria and Bruce Gates, Former Senior Vice President external affairs at Altria.

Earlier this month, we also announced an expansion of our management team. Jerry Barbato, most recently Senior Director of Corporate Strategy at Altria, will join the Cronos Group on April 15th. Jerry will assume the role of CFO Billy Hilson. In addition to leveraging Jerry 's 20 years of experience in strategic planning, financial analysis and brand management, we hope that his direct knowledge of Altria will help us to fully capitalize on our partnership with him. Billy will assume a new role as Cronos Group Sales Manager and will further enhance the company's business strategy and research initiatives.

Many of you may not know it, but Billy is primarily a scientist. He holds a Bachelor of Science in Molecular Genetics and a Master of Science in Biochemistry. And more than 15 years experience of multinational pharmaceutical companies. As our company and operations evolve from culture to formulation, we hope that Billy's scientific and pharmaceutical knowledge and relationships in these areas will further strengthen the company's business strategy and R & D initiatives. These appointments demonstrate our commitment to a top management team with the skills and experience to support our next phase of growth and development.

As we work to transform what was once an idea into reality, we would like to thank our partners and shareholders for their support. It was an incredible 2018 year, filled with many achievements, many firsts in the industry and businesses, and I can already say that this year has had a similar beginning. We ended the year with an ideal partner in Altria and look forward to the many opportunities this relationship with Cronos Group will create in the coming year.

With that, I leave the floor to Billy to begin his last formal discussion on the financial results of this quarter and fiscal year 2018 as CFO. However, I am sure that it will make appearances on these calls in the future in order to explain the commercial importance of some of the interesting innovations of our pipeline.

William Hilson – Financial director

Thank you, Mike, and good morning everyone. The figures I am revealing to you today are in our financial statements. We continued to report revenue growth in the fourth quarter and December 31, 2018. The Company reported net revenues of $ 5.6 million compared to $ 1.6 million for the same quarter and fiscal 2017 This is an increase of 248%. Revenues increased 49% qoq. This increase is attributable to deliveries to the Canadian adult market, including strong pre-roll sales, which accounted for 14% of net revenues in the fourth quarter. And the growth of cannabis oil revenues, which accounted for about 24% of net income in the fourth quarter.

For the 2018 fiscal year, the company reported net revenues of $ 15.7 million, compared with $ 4.1 million for fiscal 2017. An increase of 285%. Kilograms of cannabis sold increased 198% from 349 kilograms in the fourth quarter of 2017 to 1,040 kilograms in the fourth quarter of 2018. Kilograms sold increased 102% quarter-over-quarter. The increase is due to the growth of cannabis production.

For 2019, we expect that increases from one quarter to the next will gradually decrease in the first half as we increase production and revenue growth accelerates in the second half of the year. . The average selling price for the fourth quarter of 2018 is set at $ 5.39 versus $ 4.62 for the prior year. On a full year basis, the average selling price is set at USD 5.74 for 2018, compared to USD 6.43 for the full year 2017. This decrease is due to the The impact of the excise tax entered into force in October 2018.

As discussed in the last quarter, we believe that gross profit before fair value adjustment provides useful information to understand and evaluate operating performance by excluding non-cash fair value adjustments related to biological assets and inventories sold. .

For the fourth quarter of 2018, gross profit before fair value adjustment of $ 2.5 million compared to $ 0.4 million for the fourth quarter of 2017 represents an increase of 449%. The increase in gross margin before fair value adjustment is largely due to the increase in the number of kilograms sold compared to the same period last year. Gross margins before fair value adjustments were 44% in the fourth quarter of 2018. During the fourth quarter of 2017, the Company reviewed and updated its estimates of cost drivers and allocations, including the evolution of the biological assets model, resulting in higher production and processing costs. and a corresponding lower gross margin of 28% for this quiet quarter, as these changes were not annualized in 2017.

Cost of goods sold, before fair value adjustments per gram or per full unit, was reduced by 13% from $ 3.21 in 2017 to $ 2.80 in relation to 2018. In addition, operating costs decreased by 8% quarter-on-quarter. CoGS unitaire trimestriel de 3,02 USD contre 3,28 USD au troisième trimestre de 2018.

Les charges d’exploitation pour le quatrième trimestre, y compris les salaires et les avantages du personnel hors production, la rémunération à base d’actions, les frais généraux et administratifs, les ventes et le marketing, la recherche et le développement et les charges d’amortissement ont totalisé 12,4 millions de dollars, soit une augmentation de 9,5 millions de dollars par rapport à cette même période. période, l'année dernière.

L’augmentation des charges d’exploitation est imputable à l’augmentation des frais de recherche et développement, à l’acquisition de talents et à l’augmentation des honoraires professionnels et de consultants pour les services rendus dans le cadre de nos diverses initiatives stratégiques, y compris l’investissement Altria.

Pour l'exercice 2018, la société a déclaré des dépenses d'exploitation totales de 29,4 M $, comparativement à 9,3 M $ pour l'exercice 2017, ce qui représente une augmentation de 20 M $. La société a déclaré une perte de BAIIA ajusté de 7,9 millions de dollars au quatrième trimestre de 2018, comparativement à une perte de 1,5 million de dollars au même trimestre de l'exercice 2017. Le BAIIA ajusté pour l'exercice 2018 était une perte de 14,6 millions de dollars, perte de 4 millions de dollars pour l'année 2017 complète.

À mesure que la réglementation évolue et que les règles d'engagement changent sur les marchés sur lesquels nous opérons, les moteurs de notre activité évoluent également. Globalement, les prix de vente moyens baissent en raison du glissement de la composition des revenus nets du marché de la médecine directe au patient, au marché des adultes, où nous vendons aux gouvernements provinciaux et absorbons la taxe d'accise dans les deux canaux. D'autre part, nos coûts de production s'améliorent à mesure que nous mettons en ligne de nouvelles installations et que nous augmentons l'efficacité. Nos dépenses d’exploitation augmentent en raison de l’acquisition de nouveaux talents et, au fur et à mesure que nous commençons à augmenter nos dépenses de manière significative, dans des domaines qui génèrent une valeur durable à long terme, tels que la R & D et le marketing. Nous continuerons d'investir dans notre entreprise et nous nous sommes engagés à le faire à l'avenir.

Au bilan, au 31 décembre, la trésorerie totale s’élevait à 32,6 millions de dollars. Après le 31 décembre 2018, la trésorerie du groupe Cronos s'est améliorée avec la clôture de l'investissement de 2,4 milliards de dollars réalisé par Altria en mars 2019. En plus de fournir une liquidité significative, l'investissement dans Altria nous permet également de tirer parti des opportunités de croissance externe opportunistes, et accélérer les initiatives de croissance organique.

J'aimerais vous donner un aperçu de l'utilisation à court terme des fonds reçus d'Altria, en mars. Au fur et à mesure que nous continuons à développer notre activité pour assurer notre réussite future, nous augmenterons nos investissements en immobilisations liés à la production, en particulier en ce qui concerne nos équipements d’extension et d’automatisation Peace Naturals, nos installations GrowCo et Israël. Comme vous le savez, la réglementation en fonction de la légalisation des produits dérivés, notamment des vaporisateurs et des produits comestibles sur le marché canadien de l'utilisation par les adultes, nécessitera des investissements accrus au cours de l'année 2019.

Enfin, en ce qui concerne les flux de trésorerie, la société a utilisé pour l'exercice 2018 des flux de trésorerie liés aux activités opérationnelles de 9,7 millions USD, contre 5,5 millions USD pour l'exercice 2017. Représentant une augmentation de 4,2 millions USD des flux de trésorerie utilisés. Au cours de l’année 2018, la société a utilisé 121,5 millions de dollars en espèces pour des activités d’investissement. En particulier, des dépenses en capital de 114,4 millions de dollars ont été financées pour financer les efforts d’expansion de Cronos Israel et de Peace Naturals, principalement le bâtiment 4, et la serre Peace Naturals. Et grâce à 6,9 millions d’avances sur nos coentreprises Cronos Australia, Cronos GrowCo et MedMen Canada.

Au cours de l'exercice 2018, les flux de trésorerie générés par les activités de financement se sont élevés à 154,6 millions de dollars principalement dus, le produit net provenant de l'opération d'achat de janvier 2018 et de l'opération d'achat d'avril 2018, et en raison des avances de dette de 15 millions de dollars. Après la fin de l’exercice, la société a remboursé l’intégralité de ses créances et une partie du produit de l’investissement Altria.

Ceci conclut mon examen des données financières pour la fin du trimestre, le 31 décembre 2018 et l'exercice 2018. J'aimerais terminer l'appel en souhaitant la bienvenue à Jerry dans l'équipe. Nous élargissons notre équipe de direction en ajoutant une ressource extraordinaire. Et même si ces appels de résultats me manqueront, j’attends avec impatience mon nouveau rôle. Au fur et à mesure que l'entreprise évolue et que nous passons d'une phase de croissance à l'autre, nous comprenons que la création de notre pilier stratégique de la propriété intellectuelle nécessitera le déploiement de ressources de R & D, ainsi que l'alignement de la science et du monde des affaires pour trouver et exécuter la meilleure commercialisation. voie pour notre produit. Cette intersection est non seulement une excellente opportunité pour moi, mais également un chapitre très excitant pour le groupe Cronos.

…

Merci tout le monde. Et maintenant, ouvrons la ligne aux questions.

Questions et réponses:

Opérateur

Mesdames et Messieurs, si vous souhaitez poser une question, appuyez sur * 1. Si vous avez répondu à votre question et que vous souhaitez vous retirer de la file d'attente, vous pouvez appuyer sur la touche #. Nous vous demandons de bien vouloir vous limiter à une question et à un suivi. Encore une fois, si vous souhaitez poser une question, appuyez sur * 1.

Notre première question vient de Tamy Chen, de BMO Capital Markets. Votre ligne est ouverte.

Tamy Chen – BMO Marchés des capitaux – Analyste

Merci et bonjour à tous. Je viens tout d'abord de poser une question d'ordre administratif. Pouvez-vous divulguer la répartition de votre volume vendu entre REC, Canada Medical et toute exportation internationale?

Michael Gorenstein – Président Directeur Général, Président

Merci. Lorsque nous examinons la manière dont nous prévoyons divulguer les informations, je pense qu’il convient de garder quelques points à l’esprit. Premièrement, nous sommes toujours dans une situation où nous essayons de gérer la manière dont nous répartissons entre les patients en médecine, les provinces, les partenaires de vente au détail privés et les partenaires internationaux confrontés à une situation de grave pénurie. Mais nous envisageons l’avenir car nous pensons qu’il devient plus important d’éclater dans les canaux. Mais je pense que nous allons le garder tel que divulgué pour le moment.

Tamy Chen – BMO Marchés des capitaux – Analyste

D'accord merci. And my next question is, on your pricing, I know you disclosed the average price, which would have both REC and medical. But particularly on the REC side, could you provide some more color on the pricing dynamics? Because, I would've thought maybe your indoor product and its premium position, particularly, the COVE brand — are you getting premium pricing in the REC market in Canada, at this point?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Sure, it's a great question. I think this goes back to what I was sort of talking about in the prepared remarks about how we're breaking down unit pricing versus using a weight. So, I think what you're seeing is most reflect of the breakdown between oil and flower. And when we think of the market we're in today, and the current excise tax regime, you're essentially incentivized not to sell as much oil because, the excise tax, depending on the input that you use can be quite punitive. So, I think that we are still positioned in the premium space, but you're seeing a much bigger SKU toward flower than you are toward oil.

Tamy Chen — BMO Capital Markets — Analyst

Okay, got it. And if I could just squeeze in one more. I'm just wondering, you haven't made much public announcements, thinking about the whole U.S. hemp CBD market. Is this an area you're actively considering? How are you assessing this market and trying to position the company to enter this opportunity, potentially?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Our original strategy and vision for Cronos was to come up to Canada, develop a turnkey solution that we could ultimately bring down to the U.S. once steadily legal, and that really hasn't changed. I think relationships certainly matter in the cannabis industry, and we feel that we've done a great job of building strong relationships both with U.S. cannabis industry stakeholders, and with other strategic partners, sort of along the value chain, whether that's in cultivation of other regulated crops, general retail distribution.

And ultimately, we think the farm — the great step for the industry. It's going to create a lot of opportunities, and really encourage the regulators and lawmakers at all levels that are prioritizing CBD, in an effort to provide clarity and opportunities to industry stakeholders like us. I think that it's something that we're going to continue watching very closely, and we probably won't telegraph our strategy sort of as publicly as some others have. But we are absolutely excited about the opportunity.

Tamy Chen — BMO Capital Markets — Analyst

Thank you.

Operator

Our next question comes from Matt Bottomley, of Canaccord Genuity. Your line is open.

Matt Bottomley — Canaccord Genuity — Analyst

Good morning, everyone. Just wanted to go back to the quarter, a couple of quick questions there, just housekeeping items, just to make sure I understand direction; where things are going. You mentioned quickly the oil pricing and some of the punitive elements, depending on how it's manufactured. Can you speak at all to the gross pricing? I noticed, quarter-over-quarter, your oil pricing came down quite a bit from about $9.00 to $5.00. So, is that all excite tax considerations, or is there other pricing considerations there?

Michael Gorenstein — Chairman, Chief Executive Officer, President

I think that's certainly a consideration, on the medical side, absorbing excise tax. But I'd say, also, again, when you're looking at the pricing for oil, we typically aren't — equivalency factor matters a lot, and I think that that factor matters when you think how much weight you're using, whether using trim or flower, certainly, plays a role in your average price per gram, which is why when we're thinking about this, I think, you're going to see things shift toward the unit cost, of say, a tincture of oil rather than the amount of input that was used.

Matt Bottomley — Canaccord Genuity — Analyst

Great. And just a follow-up on maybe just continued penetration into the Canadian REC market. I know you said you'll probably telegraph exact channels in the future. But you're in 5 provinces, currently, and you had — I think I looked quickly but — 11 million of inventory on-hand, at the year-end, 1 and a half of finished goods. So, are you, as a company capacity constrained in order to continue to penetrate into additional markets? And can you give us any color on when you think you'll get into maybe markets like Alberta or Quebec, or some of the other big markets you're not in today.

Michael Gorenstein — Chairman, Chief Executive Officer, President

Sure. I think, when we think of capacity, there's really 2 ways to look at it. So, the first is cultivation capacity, and then, the second, is really the downstream processing, packaging, and other parts of the supply chain. So, I'd say, on the first, we think that we're doing well in terms of being able to access the cultivation capacity. But each time you had province, you're adding complications to the other parts of the supply chain. You have to multiply a set of SKUs each time you add a province because of tax stamps.

So, making sure that we can manage the downstream logistics is really the biggest factor, and when we'll add those provinces. And so, we're in constant dialogue. We understand there are shortages in provinces, but we want to make sure that we can efficiently get product out the door to all partners we — onboard. So, I think you'll see that over time, increase, but we want to make sure that we can get everything right dialed in, in terms of automation before we onboard, and spread across the entire country.

Matt Bottomley — Canaccord Genuity — Analyst

Thanks, Mike.

Operator

Our next question comes from John Zamparo, of CIBC. Your line is open.

John Zamparo — CIBC Capital Market — Analyst

Hey, thanks. Hello. You mentioned the taxation structure a couple of times. I was wondering if you could comment on the draft regulations that you've seen for production and marketing restrictions on derivative products in October. And how do you think that will restrict your ability to operate?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Sure. Well, I'd say, overall, it's certainly a step in the right direction in terms of new formats that are allowed. And I think that there are some pros and cons. I think that there will be a fair amount of flexibility in the vaporizer space, which we're pleased to see. But I do think that the packaging rules for edibles will likely prove challenging, and we'll hope to see some revision or changes there, in the future. And specifically, I'm referring to the way that packaging will work on amount of dosage. I think that that's very different than what we've seen in other markets in the U.S. And also, I think some of the limits on co-manufacturing will limit the amount and the diversity of product format that will be initially available.

John Zamparo — CIBC Capital Market — Analyst

That's helpful, thanks. And my follow-up was on the M&A side. Maybe you could talk a bit about the opportunities and deal flow you're seeing. Are you encouraged by the assets that are available? And what are your thoughts on valuations in the sector?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Sure. I do have a background in M&A, so hopefully, that will come in handy. But the way that I look at it is there are a lot of good assets available. One thing that is always a question is whether the regulations make it feasible for us to capitalize on those opportunities today. I think, we tend to be attracted to assets that aren't always top-of-mind for most other companies. So, we do see a lot of opportunities. But our focus really is on assets that we think will contribute to scalable value, that we can take and transfer across borders, and across regulated channels, whether that's adult use, pharmaceutical, medical, or the general CPG channel. So, I think that there are a lot of opportunities, but I would say that regulations evolving will certainly play a factor.

John Zamparo — CIBC Capital Market — Analyst

Understood. Thank you, very much.

Operator

Our next question comes from Owen Bennett, of Jefferies. Your line is open.

Owen Bennett — Jefferies — Analyst

Good morning, guys. Thanks for taking my question, and hope all well. Just one question for me. On GrowCo, you say it won't become operational until 2020. And with this in mind, I was hoping you could give an estimate as to where you expect annualized, calendar year in 2019 capacity to be out. Thank you.

Michael Gorenstein — Chairman, Chief Executive Officer, President

The question's about GrowCo, or prior to GrowCo?

Owen Bennett — Jefferies — Analyst

No, sir, obviously, that's not becoming operational in 2020, so I just want to get an idea of 2019, where you think annualized capacity will be up.

Michael Gorenstein — Chairman, Chief Executive Officer, President

Sure. So, we think the second quarter of this year, we'll have all of the flower rooms planted in Building 4. From a capacity perspective, once we're able to fill everything up, we'll be able to dial in and ramp-up efficiency. So, from a utilization perspective, I think we'll see that increase throughout the year. And then, we also have Israel, that we expect to be ready for the second half of the year. So, I think that that will factor in among the supply sources that we have.

Owen Bennett — Jefferies — Analyst

Cool, thank you.

Operator

Our next question comes from Vivien Azer, of Cowen. Your line is open.

Steve Schneiderman — Cowen & Co. — Analyst

Hi, this is Steve Schneiderman here for Vivien today. Thanks for taking our question. Mike, well — break out medical versus adult use revenues given the amount of tax. It looks like it's fairly fair to say that there was a sequential decline in medical revenues. While, that wouldn't be unique in this industry. What is your outlook in general for this part of the segment in particular? What are you seeing in terms of the interaction between medical and adult use sales?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Sure. So, first, I just would say we do absorb the excise tax for medical patients. So, the effect of excise tax for us as a company affects us regardless of whether it's medical or recreational. But overall, what we're seeing is it likely is going to be a larger decline in Canada than you saw in some of the U.S. states. While, it's too early to really use, I think, the immediate data we're seeing because of the shortage that you don't have enough supply that — really, where you allocate the supply is where you're going to see the demand. But there are different incentives in the market in Canada than there were in the U.S. states. For one, we haven't seen excise tax really applied to medical patients in the U.S., but we're seeing here, in Canada.

From a regulation and a distribution perspective, there is additional incentives for the government to push demand toward the recreational channel because they play a part in the distribution. So, given that, I would say in the short-to-medium term, we would expect to see that decline faster than how it declined in the U.S. That being said, we do think there's a huge long-term opportunity in what I would say, is more of a pharmaceutical market, where you're able to focus on developing very tailored formulations of specific active ingredients that can target actual therapeutic benefits, different indications. Those will take time to develop, so you'll see that decline. But I think in the coming years, you'll see that market really start to build back up.

We have a lot of pre-clinical results that are available and a lot of early indications that there is promise, but we still have a lot of work to do to be able to get those into a more formalized and traditional medical channel.

Steve Schneiderman — Cowen & Co. — Analyst

Great. So, moving on to Israel, with the upcoming election, it seems that adult-use cannabis is seemingly becoming increasingly topical over there. To the extent, a pro adult-use candidate is elected, how does that change the opportunity for the Israeli business?

Michael Gorenstein — Chairman, Chief Executive Officer, President

I'd say, this is something we're seeing in a lot of markets, where the conversation is certainly shifting toward recreational cannabis. I think we have a huge regulatory tailwind globally. But we set ourselves up in the IP that we develop for the recreational market, as transferrable. And a big reason for us to start setting up these manufacturing regional hubs is it ensures that whether it's a traditional ethical pharma market, a health and wellness, or sort of a market like you're seeing start to develop with the pharma bill, or an adult-use market will be well-positioned to capitalize on the opportunity. So, it's something that we would be very excited for, and we think that would certainly be an exciting market for us.

Steve Schneiderman — Cowen & Co. — Analyst

Great. Final one for me, as it relates to Cronos GrowCo. Can you please elaborate on the structure of that venture, and what Cronos' specific capital commitments for the construction of the facility is going to be?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Yeah. So, it's a 50/50 joint venture with equal contributions from each of the partners. And I'd say that the ultimate capital contribution will really be a function of the amount of leverage that's used in order to fund it. Obviously, we feel that to go back to that old metric that I don't love about funded capacity, we feel that regardless of whether we are able to access debt, that it's something that we will be able to fund, but it is our expectation that we'll be able to use some leverage. And then, we would think of it as really sort of a third-party from there, where we are purchasing product, and then, depending on the channel, either selling it as flower, processing it into pre-rolls, or using it to serve in derivative products such as vaporizers and edibles.

Steve Schneiderman — Cowen & Co. — Analyst

And just to clarify, would that be — third-party from the JV, or is that just on a go-forward basis, once that GrowCo is completed?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Yeah. From the JV. Our model really does assume that cannabis will follow the same principles as economics we see in other industries, where supply catches up with demand. One of the ways that we can ensure that we'll have an efficient supply chain, and can use contract growers is by essentially building them with leaders ourselves. So, we think it's going to be a great way for us to make sure we don't sacrifice quality in for flower-base products especially, we can have the genetics that we know grown in a way that we're used to. But that's really the model that we'll follow in most countries, is how do we find a way to — there aren't existing contract growers we can give our genetics to, how do we build up that infrastructure? And when we can find experts like Mucci, at GrowCo, we're very excited about being able to bring them in early, and work with them.

Steve Schneiderman — Cowen & Co. — Analyst

And just to clarify, how much is the actual projected cost of the facility?

Michael Gorenstein — Chairman, Chief Executive Officer, President

It's not something we've disclosed. So, we'll give updates as capital contributions are made. But we haven't given any forward-looking items on that.

Steve Schneiderman — Cowen & Co. — Analyst

Great. Thanks, Mike.

Operator

Our next question comes from Martin Landry, of GMP Securities. Your line is open.

Martin Landry — GMP Securities — Analyst

Hi. Hello. Just wondering, now that your partnership with Altria is closed, could you talk about what are the near-term goals that you want to achieve with the help of Altria?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Sure. So, I think, first and foremost, when we think of ourselves still as an aggressive growth company. So, talent acquisition is one of the key priorities. We think that that's really what's going to be the differentiator over the next few years. Product development and R&D is, I think, after human capital, is the biggest priority. When we think about Canada, the value that we see is having the opportunity to develop the processes and products that ultimately will be spread globally. So, making sure that we accelerate that innovation whether through organic investment, or through external ventures is going to continue to be a key priority. And then, preparing and making sure that we setup a framework to be a leader in responsibility is something we think we'll be required to make sure that we are able to participate in what we hope to be a very long-term sustainable industry.

Martin Landry — GMP Securities — Analyst

That's helpful. Now, that edibles are going to be allowed this fall, in Canada, I'm wondering, what's your readiness to tackle this market? Is it fair to expect that you're going to have edible products on the shelves this fall, in Canada?

Michael Gorenstein — Chairman, Chief Executive Officer, President

I'd say we are hopeful, but one thing that is likely out of our control is how the regulations are really finalized and implemented, how will retailers be ready. There's a lot of work, I think, that still needs to go in. So, I think that — again, I'd say, we're very hopeful. But as we've seen, there can and usually are delays when you try and bring on these types of regulatory frameworks quite quickly.

Martin Landry — GMP Securities — Analyst

Yeah. And is it fair to say that with Altria's partnership with you, that there could be something that could be brought, like a vape pen, or brought to the Canadian market with their help?

Michael Gorenstein — Chairman, Chief Executive Officer, President

I think, we look at the cannabinoid category as a very unique and distinct category from nicotine. We both have Altria as a partner, and access to the resources that Altria has. We think that the leading and winning device will be specifically tailored to cannabinoid formulations, and to target very nuanced cannabis consumer needs to-date. And so, that's something that we're working on, on bringing a proprietary product to market. But we will, and are excited to benefit form years of expertise and infrastructure at Altria, in that regard.

Martin Landry — GMP Securities — Analyst

Thank you.

Operator

Our next question comes from Graeme Kreindler, of Eight Capital. Your line is open.

Graeme Kreindler — Eight Capital — Analyst

Hi, good morning. Thanks for taking my question. I just wanted to ask, with respect to the pre-roll segment, I noticed that was around 14% of the revenues in the quarter. Is this a segment that you think has a lot of long-term value for the company? And is there any sort of existing work or future work that could be done leveraging the partnership with Altria with respect to that vertical?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Absolument. We've seen, certainly, in tobacco, if you're looking for a comp, that over time, I guess, you'd call it the pre-rolled segment, as well, became very popular relative to loose flower or loose leaf. And we think that there's a lot of innovation that really can be leveraged. So, it's a big focus of ours. We think, as far as differentiation in branding, something with a lot of opportunity, and we think whether that's an advantage in the actual form factor, in the presentation, or in efficiency and production, that that will arguably be a bigger differentiator than just cultivation.

Graeme Kreindler — Eight Capital — Analyst

And are you making any investments right now, trying to leverage any of the technology that Altria might have in terms of assembly lines, or packaging, making that more efficient?

Michael Gorenstein — Chairman, Chief Executive Officer, President

Absolument. A big focus for us is downstream processing, and pre-rolls. When we talk about downstream processing, especially for flower-base products, it's a major focus. So, I'd say that that is a clear yes, and we have a lot of people to work with who got quite a bit of experience. Really, while, you may think of just Marlboro, there's a big expense across a lot of other rolled and automated formats where we think that there's a lot of opportunity.

Graeme Kreindler — Eight Capital — Analyst

Thanks. My other question here, is just more big-picture. As we're entering, you're getting closer to derivative products coming online in the Canadian adult-use market. Sort of, next gen products, with respect to what you guys are doing on R&D, is there any sort of expertise, again, with Altria, and their experience dealing with federal regulators? Are they working at all with Canadian regulators, with respect to some of the products you're looking to come online? Are we still kind of too early days for that?

Michael Gorenstein — Chairman, Chief Executive Officer, President

We've been able to increase our regulatory bench range, I'd say. The bigger focus is really on making sure that we have certain technologies ready, and are able to, whether that's leverage the rare cannabinoids in formulations, and tailor them to the devices, or be able to find different ways of optimizing bioavailability, case-masking, speed of onset for oral ingestible, I think that's really the focus. And then, what we need to do, not just for Canada, but for other markets to be able to collect data to get regulators comfortable. And we think having that dataset will become increasingly important over time.

Graeme Kreindler — Eight Capital — Analyst

That's it for me. Thank you.

Operator

Our next question comes from Rob Wertheimer, of Melius Research. Your line is open.

Rob Wertheimer — Melius Research — Analyst

Hi. Hello. There was announcement out of a team at Berkeley on U.S.-based production of cannabinoids during the quarter, I think. And I just wanted to see if you saw that as support for the path that you guys are taking, whether there's any intellectual property threat, or your general comments.

Michael Gorenstein — Chairman, Chief Executive Officer, President

I think it's great to see others that are working on it and are having success. I think there's always this funny situation in entrepreneurship where if you look at a space, and you don't have competitors, then that's not always a good sign; it may mean that no one else saw an opportunity. But when you look at a space, and you've got groups from MIT and Berkeley, or the ones that are focusing on it, it's reassuring that even though it's not crowded yet, but there's huge opportunity. I think as far as the actual pathways and enzymes, I don't want to dig too deep into the phase that we're using, but we think that there's very different pathways as far as the specifics. So, we don't really see it as a threat. We do see that it is a area where focus will increasingly shift to as people start to understand the opportunity.

Rob Wertheimer — Melius Research — Analyst

That's a very helpful answer. Thank you. Can you give us any sense of the cost per kilogram that you're targeting there? I don't know, as the greenhouse-based or even field crop-based cost fall. You know, are they approaching at all what you can see is possible for primary cannabinoids? I wish — maybe not targeting THC, CBD. And then, is it always going to be a case, if that works, if the targeted cost, that that will be far lower. Is there a definitive cost — you can continue to see even though as costs fall, and get out the — on the regular plant-based production.

Michael Gorenstein — Chairman, Chief Executive Officer, President

Sure. So, that's speaking to our specific cost target. I would say that Ginkgo, felt comfortable in staking their compensation on being able to achieve cost of less than $1,000 a kilo for the actual active ingredient, not for the flower.

Rob Wertheimer — Melius Research — Analyst

Not for the flower, exactly, yes.

Michael Gorenstein — Chairman, Chief Executive Officer, President

As far as competing with field crops, I think it really will be dependent on the market as far as feasibility. So, I think if you're in a climate like Canada, it would be extremely difficult, even outdoors, to produce at the same level.

The innovation we'd have to see would be likely using some type of transgenic, or a really sophisticated marker-assisted selection to have a field crop be able to compete from a specific cannabinoid production cost. I think CBD, would have the best chance because it crystalizes easier, you kind of have genetics already developed, and it's probably the easiest pathway biosynthetically to produce.

The biggest advantage we see is certainly on the rare cannabinoids, but when we think of the purity advantage, being able to have an CGMP manufacturing, and ultimately, precision. When you start factoring in using chromatography columns, when you're extracting, it gets very, very expensive if you want to reconstitute, and have the same type of consistency you would have with fermented products.

Rob Wertheimer — Melius Research — Analyst

Great. Thank you.

Operator

This, concludes our Q&A Session. I'd like to turn the call back over to Mike Gorenstein, for any closing remarks.

Michael Gorenstein — Chairman, Chief Executive Officer, President

Thank you, everyone, for joining. I hope you join us in a few months.

…

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.

Duration: 60 minutes

Call participants:

Anna Shlimak — Investor Relations and Communications

Michael Gorenstein — Chairman, Chief Executive Officer, President

William Hilson — Financial director

Tamy Chen — BMO Capital Markets — Analyst

Matthew Bottomley — Canaccord Genuity — Analyst

John Zamparo — CIBC Capital Market — Analyst

Owen Bennett — Jefferies — Analyst

Steve Schneiderman — Cowen & Co. — Analyst

Martin Landry — GMP Securities — Analyst

Graeme Kreindler — Eight Capital — Analyst

Rob Wertheimer — Melius Research — Analyst

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