Cronos Group Inc. (CRON) Roth MKM 36th Annual ROTH Conference (Transcript)

Cronos Group Inc. (NASDAQ:CRON) Roth MKM 36th Annual ROTH Conference March 18, 2024 11:30 AM ET

Company Participants

Mike Gorenstein - Chairman, President and CEO

Conference Call Participants

Bill Kirk - ROTH MKM

Bill Kirk

All right, our clock is starting here. You guys are in track two. The sponsors, again, are Crow and Pillsbury Law. Go see them outside of the sponsor booths. For our next fireside, we have Mike Gorenstein, CEO, Chairman of Cronos Group. We're happy to have you, Mike, so thanks for being here.

Mike Gorenstein

Thanks for having me.

Bill Kirk

And for those who didn't hear my introduction earlier, I'm Bill Kirk. I cover cannabis, beverages, and food retail at Roth MKM.

Question-and-Answer Session

Q - Bill Kirk

So Mike, let's start, I guess, big and broad. In Canada, cannabis has gone through a multi-year period of oversupply, overproduction relative to demand. Where does that dynamic, that supply-demand dynamic sit today? And how can it improve from there?

Mike Gorenstein

Sure, so I think first of all, big and broad, but I just want to differentiate two things. So if you look at overall numbers, you'll see something probably different than what you start hearing recently from producers and retailers, which is, there's still a lot more product and overall supply than demand. However, most of that product is not fit for sale and is either expired or too low potency. I think what we are now seeing for the first time after all the supply rationalization is that, that balance is starting to shift. I don't know if I'm ready to say there's a shortage, but you're seeing for product that are in sort of the tier that consumers are willing to pay for, it's not nearly as available as it was. And we've actually seen rather than price compression with flour, there's actually opportunities to increase price.

So it's been pretty rapid and I think there's two main factors for that. The first is, we've had this kind of, I'd just say, like lab testing issues where you had a lot of the smaller producers were

The other one that's pretty big is the CRA, it's the Canadian IRS effectively. They actually started enforcing and saying, producers need to pay their taxes. That's been another thing that there's been unsustainable supply in the market, people selling below their cost because effectively they weren't paying taxes. Now that started to shift. I think you're seeing more supply come out of the market. So, pretty big shift in Canada.

Bill Kirk

I mean, that sounds great, right? That has been a big problem for a long time, and it was most obvious at some of those value price points, right, if you will, right? That was where a lot of the competition was. As the value side, the people who are just selling for cash considerations rather than margin opportunities. Has that value side stabilized at all yet?

Mike Gorenstein

I think you haven't seen it compress as rapidly as it was. But I don't know that you're seeing upticks by any means in value. It's not really a category we've ever participated in. We don't see it as something that's durable. And as a reminder, the way we look at the market is creating borderless products we can take to other markets as they open up. And I don't know that the value tier is something we've seen as attractive or really transportable. So we've mostly stayed out of it. But you've seen certainly there's a level where you start hitting a floor and it feels like we're getting pretty close.

Bill Kirk

And one more maybe on the Canadian market. Some of the largest players, they've lost a lot of share. And even with doing rather large M&A at the same time, why do some of those large players struggle to maintain their share? And is that fragmentation of the cannabis industry, does that kind of continue?

Mike Gorenstein

Yes, I think a lot of it is, you had either capital market incentives or just the overall view that all the matter was market share. And so, when you looked at M&A, you had companies that weren't seeing, lining up their brands and saying, is this going to cannibalize my brand? Part of that is, if these are all commoditized supply houses and there are very few brands, what are you getting that's going to ultimately be accretive? And within a year, they are at the same market share they originally were at. They probably did that analysis after they bought them and then they cut the brands out or you just saw retailers look at their assortment. You don't get the same leverage you normally would get in CPG if you don't have differentiated products.

So I think it's kind of what you would predict. And I think there are opportunities that will change. The more we learn about consumers, the better we're able to meet their needs. You do start getting sticky products, sticky brands, differentiation. For us, that's why you haven't seen us buy brands in Canada. We've focused on a single brand. We did recently launch Lord Jones, which is much different than Spinach, so different consumer, very differentiated products. But yes, I think it comes down to whether or not you're selling a brand or a commodity.

Bill Kirk

Well, let's start with some of those differentiated products you offer. So for Spinach, huge market share in gummies and edibles, and I think you've said it's now number one in flour. So what makes Spinach as a brand resonate so well, maybe from a marketing perspective or even a product perspective?

Mike Gorenstein

Yes. Look, I think it definitely starts with product, right? If you look at Spinach SOURZ, they are very different than other gummies in the market. And there's a lot of different factors that differentiate it. So you've got the flavor profiles are different, having two different types of flavors and actually when you eat the whole gummy together, it's an arc where you get a third mixed flavor, sort of like a fusion. Being able to keep the texture really great, it's just much different than a normal gummy and I think that's resonated. And when every gummy is the same if you have something that's different that people enjoy, they'll pay an extra $0.50 for something that is just a better experience.

So starting with -- from the product up has been a big driver, right? And I think that has -- because we've done that with all the products, it has made the brand stronger and people then start to expect that from the brand. Flour, it's funny, like, have you ever heard us talk about flour a few years ago? It's almost accidental. We cared much more about genetics. We've been breeding genetics for years. And after about four or five years, you start getting good results. And so we've had at least two real blockbusters come out of that program. And you can see it's not just Spinach, but those are the top skews in Canada and Israel. We launched in Germany, went right to the top. We expect the same from Australia. So it's really bottom up and product based. And this is the point again about differentiation. If you don't have a differentiated product, your brand is not really going to be differentiated. It's very difficult to just be a lifestyle brand in cannabis because the consumers really are focused on what is the product.

Bill Kirk

And you mentioned the borderless products. That's been a difficult thing for a lot of different type of CPG companies, going to different countries and having their brand resonate. What is the best example for you or for the Canadian industry of something that seems like a borderless product right now?

Mike Gorenstein

Yes, I think it's Spinach SOURZ, also the Chocolate Fusions, which will be available in stores soon. We launched and sold in about a month ago. The further you get from flour, the easier it is to differentiate. And I think it's also important that you can transport it. So it's hard to replicate flour to be exactly the same in different facilities. It's doable. But the more you can make it a consistent product, it's a recipe you're making, you can get ingredients that meet the same spec everywhere. And I think that's -- edibles is a great example of that. So if you think about potential for differentiation, I think edibles is sort of the easiest to differentiate and probably pre-rolls and sort of the next-gen pre-rolls coming out, then vapes and flower.

Bill Kirk

Switching gears before we get into some of the other markets. Can you remind everybody, your cost savings program, what has kind of been achieved so far, either by dollar amount, but also type of cost savings, and then what is left?

Mike Gorenstein

So yes, this past year in 2023 we overachieved and ended up $30 million in cost savings. That was really spread out, a lot of G&A, some came from R&D, we're sort of towards the end of the R&D cycle. Overall OpEx, COGS, and about 5 to 10 this year we think is achievable. So I think we're in a good space. And then there's some things that you wouldn't think of necessarily as traditional cost savings, but just overall working capital improvements led us to be up $20 million cash quarter-over-quarter, this Q4. So I think we're in pretty good shape, but always work to do, always something to optimize.

Bill Kirk

And on the kind of capital use side, you've been very patient for a very long time. And if people don't know, I haven't looked this morning, but possibly trading with negative enterprise value, you've been very patient for a very long time. How have you been so patient? And what changes that calculus to be more active with your cash balance?

Mike Gorenstein

Yes, I think it's been in it for, I guess, it's crazy to think, it's been about nine years now I've been doing it. So you have to kind of look through everything, model everything out, project where things are going. And as you've seen most of the M&A and say like almost every M&A deal that's been out there has not been accretive and it's just looking and seeing will this be a good return. I've always resisted pressure to do a deal just to do a deal. A lot of it is regulatory driven. When regulations change we think it unlocks quite a bit of value. Trying to move before that sometimes is just you can tort yourselves in these different ways and you try and get really creative.

But the value doesn't really come out. M&A is already hard enough as it is. If a company is worth something, they're usually not selling without a premium. So what's your natural advantage? Can I run it better than you? Are there costs I can take out? Can I expand it from their platform to my platform? And if you're not able to do that, it's often difficult. So what changes? I think you're seeing Europe open up. But Schedule 3, what that ultimately looks like, what happens in the US, that's really one side of what we're waiting for. And the other is, we're happy to focus on organic growth. I think it serves us well. If we see other brands and products start to differentiate and something that we think would be better to buy versus build ourselves. We'll do that. I think the lack of capital in the industry, the fact that you've got 280E making R&D prohibitively expensive in the U.S. has held a lot of that back. But I would expect it will come and we will see brands that are great fits for us.

Bill Kirk

And you specifically mentioned brands, right? So when you're thinking about M&A, it's brands over, say, a tier of the vertical or even regions?

Mike Gorenstein

Yes, I mean, when I look at this, I think about where does this go long term. And I don't believe this is a vertically integrated industry. It's a consumer industry. We've seen kind of what that looks like. With interstate commerce, I don't think markets that mandate vertical integration will survive structurally. I also don't know that there's an advantage to be able to produce in, say, like New York or Florida when I could produce in Oregon or California for significantly cheaper. So there may be assets on the production side, and there may be investments we need to make distribution side. We made an investment in MSO PharmaCann, which I think helps us get sort of instant distribution.

But ultimately, I don't want to compete with my customers. I want to keep the focus on what we do best, innovating, making great differentiated products, putting them in stores. And I think it'd be just a distraction to try and move from that model. We also haven't seen a fully legal system. You could get the liquor rules. You could get a full 3 tier. So there's a lot of different things that make me hesitant there. But mostly, I think it's focused picking the areas that work best for us and going from there.

Bill Kirk

And let's do the U.S. regulatory conversation a little bit. How are you handicapping the possibilities? So say, let's just frame it as before the election. What do you think is possible out of the US administration before the election?

Mike Gorenstein

Yes, I think -- and I'm usually pretty conservative with these things, but I think it's pretty likely that we see at least some form this year of a push to implement Schedule 3. I think there will be legal challenges, so I don't know that it necessarily gets across immediately, but I think that's one of the reasons they're going to push to get it done before the election. I think given where polling numbers are, given how much interest there is in young voters and black voters, how it's polled with those two groups, I think that's something that they probably need to campaign on as an accomplishment versus a promise, and getting that done early will help.

I'm always hesitant to give numbers, but I would say I'm more optimistic. I've seen more happening here than we ever have in cannabis. And I think it's likely. Now, what that looks like is another question. There's going to be a lot of details that are around that, what the opportunities are, what the restrictions are. But I think things are pushing forward.

Bill Kirk

How do you prepare for that kind of expectation? Including how wide the potential actual legislation could be?

Mike Gorenstein

Look, I'd say we've been preparing for a long time. We've been, again, patient. You could say like, discipline planning. Things you want is you want to have a balance sheet that gives you flexibility. We have no debt. We have $860 million in cash. We have other investments that we could get additional cash from. And we have a great portfolio of products. I think ultimately, regardless of what the system is, having quality differentiated products is going to be what wins. And so having that is important. And then picking our spots, we've got mapped out what different possibilities are, what the best way would be to enter is. But regardless, it's looking out not what it'll be over the next two years after rescheduling or some change makes, but what's it going to look like five, 10, 20 years out.

Bill Kirk

What would your dream scenario be? What is the structure you're like, that's it. That's the one that's perfect for us?

Mike Gorenstein

The dream is a regulatory system that lets us access consumers and compete like a normal industry. So being able to set up a national supply chain, have interstate commerce, have some certainty. One of the things that's tough in cannabis is, you have to change every six months when the regs change. But getting a normal rollout would be, I think that's where it eventually goes. Sooner than later would be great. That's what we've been prepared for. We're ready to move no matter what the opportunity is. But I think that's what you need. If you talk about the illicit market, the best way to be able to compete with them is, give us the ability to leverage scale to be consistent. To optimize, get our costs down, pass it on to consumers. And I think we take share from the illicit market and make the industry successful.

Bill Kirk

How would you compare the illicit market in the U.S. to what you faced in Canada? How would you compare those two?

Mike Gorenstein

I think they're pretty similar. It's just -- states are very different. So I would say California, pretty similar to Canada. If you go further southeast though, the illicit market is much more in the shadows. It's really based off the policies enforcement. New York, California, generally the blue states, similar politics to Canada, you're going to see similar illicit market activity. And I think that's something just to watch. The more relaxed enforcement is, you'll see illicit market pop up until there's something that either you've got the legal market taking share from it, or you've got the government enforcing.

Bill Kirk

And then on some other opportunities internationally, news out of Germany a couple weeks ago that they're pursuing legalization, what does that market look like when that day comes, and when does that day come?

Mike Gorenstein

Yeah, I think the news being about legalization is a little bit misleading. It's -- there's no real effect from the change that was made. And I don't know that there's actually a line of sight into when an adult use legalization would happen. That's really about decriminalizing these kind of caregiving clubs that they grow attached to the cafe or place where people use. It's not really high quality product. It's not something that we think is going to be really in demand. I think it's more about just the overall sentiment towards cannabis in Germany. What I think does matter, what we're excited about is sort of near-term what's happening is being able to market cannabis. It's been treated as a narcotic, very strict in Germany. As you may know, Germans definitely follow laws. And you can go to jail for marketing cannabis before this change three weeks ago. So I think that opens it up and lets us get to patients a lot more effectively.

Bill Kirk

And does the ability for doctors to write prescriptions, does that change locally now? Is there a larger willingness to go write them?

Mike Gorenstein

I think there's a larger willingness, because when it's not a narcotic, a lot of doctors are hesitant with narcotics. They want to see, you've tried all these other medicines first. So yes, there's certainly a lot of fear post-opioid epidemic on what you're prescribing. There is a little bit of a -- still even in the U.S., there's always a hesitance because cannabis, people -- most doctors are used to time when it was fully illegal. And it's a shock to them. So yes, I think the more you have public sentiment and government endorsing it, the easier it is and the more it opens things up.

Bill Kirk

Israel is been another big country for you. Can you help us with an update on operations after the attacks in October, I guess? A lot of volatility since, but how are operations in Israel? Has the market changed or not changed?

Mike Gorenstein

Yes. October was definitely a rough month. Most of the country was shut down. You had a lot of stores in the south end. Sort of cautiously in the north shut down. 10% of the population going in the reserves. Very difficult. It affects not just our supply chain, our distribution, but if you look at all the inputs that come in, if you look at trade partners, people just -- it was very disruptive. But things are starting to normalize, and I'll say stabilize for now. I can't predict where geopolitics go, but October was the worst month.

Things are starting to rebound. And there is a regulatory change that was scheduled in December that, of course, got pushed back. That's now scheduled for July, and we're really excited about that. I think it's a big catalyst that we'd love to see happen. I'm looking at time, probably can't detail all the regulations but...

Bill Kirk

We can.

Mike Gorenstein

So the way the prescriptions are written, taking it out for 15% of the indications and allowing doctors to prescribe it like normal medicine. And that's a really big one, opening up pharmacy distribution. Right now, most of the product goes through these specialized pharmacies, which are essentially dispensaries. Allowing that to go into more pharmacies is going to be really, really important. And I think it incentivize doctors [indiscernible] similar to Germany. It's okay to prescribe any type of endorsement from the government like that. There is a fear, especially in Israel. Last year, a few doctors were arrested for pay-to-play schemes. And so giving them comfort again, I think it's going to be important for patient growth.

Bill Kirk

We have about five minutes left. If there's any questions out in the audience, happy to take those. I can keep going as well. All right, so it's going to be me. So what other countries? And how do you supply some of these countries, right? So are you supplying it all from Canada, some from Canada, a mix between Israel and Canada? Like how do you supply these opportunities from where? And what other countries should we be keeping an eye on?

Mike Gorenstein

Yes. Israel, we have cultivation in Israel, so of course that stays within Israel, but that's not enough to supply Israel, so we do export from Canada. Australia, we re-entered Australia. We have a stake in the largest cannabis company there, Vitura. So we have 10% there and using them to distribute. I think there's a limited number of countries that make sense. I think you'll see us in at least one more country this year. You look at New Zealand, UK, Czech Republic, Poland, those are really the best opportunities and only the kind of real markets today that I would think makes sense to enter.

But it's ultimately, what's the fixed cost of entering? What's the minimum number of units we need to send for it to actually make sense? While they're higher margin, if we're not at a certain scale and we don't think we can achieve that scale. We're big believers that better beats first. We've seen that every market that we push into. So we're not in a rush. I think it's making sure we have the best products and when the market makes sense to enter. And we have the supply to do it, we'll enter. But we're getting back to a point where it's, are we going to have enough supply, like, short term when we enter all these places? Products are doing well in all the markets we're in. So making sure we're disciplined in how we enter and we don't short-ship.

Bill Kirk

How quickly, with Germany making a change, how quickly are other countries in the EU to do something similar? Is that the domino that opens the whole country in a similar way?

Mike Gorenstein

It definitely could be. I think the COVID, I think the Ukraine -- the Ukraine war, those actually slowed things down that were already moving. So we probably would have been much further on, but I think governments had other priorities. But yes, you've got the UK, which you think is still somewhat influential. Germany, I think you'll see more countries move, but a lot of it's also going to watch the next few months in Germany and see how it goes. And I think what happens every market, it's kind of the medical terms to adult use in the US states. People wake up and realize, wow, the country didn't burn down when we allowed cannabis. It's amazing. Things look great. And then they start implementing it. But Germany is definitely a bellwether and someone to watch. So yes, I think it's optimism in Europe.

Bill Kirk

We'll round it out with a rather open-ended one. When we're sitting down next year, so this time next year, what are we talking about? Is it going to be the same? What's the US doing? What are we talking about?

Mike Gorenstein

Well, I think a lot of that's going to depend on elections and some other things. I think that you will see -- you have seen the change in the US. There will Probably be a lot of questions about what that means. There's likely be some a bill that's being put out that's going to have much wider reaching implications than what just rescheduling does and questions about what that'll mean. So there'll always be a talk about what the US is doing, because the profit pool in the US is probably equal to the potential profit pool of the rest of the world for the next 10 years. I'm also cautiously optimistic that Canada will have had some changes, the ones that have been proposed around excise tax that I think makes it a much better market. And I think we'll be looking at what the next countries are in Europe.

Bill Kirk

Well, that's it for time. Mike, thank you. I appreciate you taking the time with us today.

Mike Gorenstein

Thank you.