Cronos Group Inc. (CRON) Q1 2019 Earnings Call Transcript

For those who are new to the Cronos story, I like to start each call by briefly reviewing the four key aspects of our strategy. At Cronos Group, we are establishing a global production footprint, which we believe will be instrumental in creating an efficient supply chain for the future. We are developing a diversified global sales and distribution network. We are creating disruptive intellectual property and further we are growing a portfolio of iconic brands and products that resonate with consumers. During this call, we'll do a quick update on each aspect of our strategy and what we were able to achieve since our fourth quarter earnings call.

In the Canadian market, our wholly owned licensed producer and center of excellence Peace Naturals and specifically Building 4, our state-of-the-art, purpose-built 286,000 square foot indoor facility is continuing to come online. As many in the industry have noted, the time it takes to get licenses and approvals has increased. We are awaiting licenses in the last remaining flower rooms in Building 4. We still expect all flower rooms to be populated in the first half of 2019 and we are constantly working on dialing in efficiencies and improvements in yields toward full run rate capacity in the facility's future.

We're also seeing progress with our production joint venture in Colombia. In March 2019, a wholly owned subsidiary of NatuEra received a license from the Colombian Ministry of Justice and Law to cultivate psychoactive cannabis. In addition to its existing licenses to cultivate and manufacture non- psychoactive cannabis and products. This license will allow for the cultivation and the manufacture of derivative products. Although we received this license for psychoactive cannabis, our initial focus will be more heavily weighted toward growing hemp and CBD base production.

We are in the process of working on the design of the production facilities with our partners and we'll provide more information on the status of this facility as soon as we have more definitive designs to share. We continue to expand our distribution footprint in the Canadian market for the adult-use channel. In January 2019, Cronos Group secured listings with a number of private retailers in the Saskatchewan province. Together with our currently established distribution in Ontario BC, Nova Scotia and Prince Edward Island, we have secured listings in five provinces, which represent approximately 58% of the Canadian population.

As our Canadian production capacity grows and comes online, we intend to strategically increase distribution within existing markets and expand into additional provinces and territories in Canada in a calculated methodical manner. We want to make sure we can adequately supply our current footprint on an ongoing basis before expanding in new markets. In January, the Israeli government approved the export of medical cannabis from Israel. This law will allow medical cannabis license holders who meet specific quality certifications to explore medical cannabis.

We intend to pursue export of medical cannabis products from Israel once production operations have commenced at our facility. As a reminder, Cronos Israel is Cronos Group's joint venture with the Israeli agricultural collective, Kibbutz Gan Shmuel. Cronos Israel is focused on the production, manufacturing and distribution of medical cannabis. The greenhouse manufacturing areas of Cronos Israel are in full construction mode. We anticipate that the construction of the 45,000 square foot greenhouse will be completed in the first half of 2019 and construction of the manufacturing facility will be completed in the second half of 2019. Cronos holds an effective 90% economic equity ownership across the entities in Cronos Israel. This week, we also launched Cronos Device Labs, an impressive R&D facility with certain assets purchased from Altria Israel to accelerate our development of disruptive intellectual property. Cronos Device Labs is focused on supporting the development of next-generation vaporizer products. The state-of-the-art facility will serve as our global R&D center for vape technologies. The experienced team of 23 people is comprised of product designers, mechanical, electrical and software engineers and analytical and formulation scientists with extensive experience in vaporizer development. We know that the vaporizer space is one of the fastest growing and evolving categories with many consumers migrating to this convenient, non-combustible consumption method.

At the same time, the category remains in its infancy with few products that are specifically tailored for cannabinoids. These products are even less developed in delivering full spectrum effects in a consistent and controlled manner. At Cronos, we are using the plant as a blueprint to learn and then create differentiated active ingredients. We will do this by reconstituting cannabinoids and terpenes in combinations that have specific psychoactive effects and/or potential therapeutic benefits. We then formulate those active ingredients to optimize bio-availability and customize them for the appropriate delivery systems, depending on the product.

And Cronos Device Labs is specifically designed for doing just that in the vaporizer category. This new initiative is expected to significantly enhance our technology and development capabilities, and ultimately we believe allow us to deliver expanded consumer product offerings, specifically tailored to cannabinoid use. We know that vaporizers will be an important product category, and one that we're committed to leading through innovation, research and product development.

To conclude this call, I wanted to talk about our efforts and responsibility and our commitment to consumers and all of our key stakeholders on this important topic. In April, our adult-use cannabis brand Spinach partnering with Arrive Alive DRIVE SOBER and foodora to encourage responsible sober driving. Every dollar raised goes directly to the campaigns' road safety initiatives. The campaign works with the police services, public health units, schools, community groups and businesses to help spread the message of safe and sober driving through resource sharing, public campaign and awareness events and Spinach is committed to advocating for responsible adult-use to raise awareness about impaired driving.

We are confident that we are positioning the company for long-term success by investing in innovation and responsibility and ultimately in our business. Our strategy is focused on long-term sustainable growth and we believe what we are building will continue to resonate with consumers and will generate long-term shareholder value.

With that, I'll turn it over to Jerry to provide a discussion of this quarter's financial results.

Jerry Barbato -- Chief Financial Officer

Thanks, Mike, and good morning everyone, I'm excited to be part of my first Cronos Group Earnings Call. Both our press release and MD&A includes comparisons of our financials to the same period in 2018. Currently, we believe the best way to evaluate our business and the industry is a comparison on a sequential quarter basis. The industries have gone through substantial change since the first quarter of 2018, primarily driven by the opening of the Canadian adult-use market. With that said, I will focus the majority of my comments discussing the first quarter's performance versus the fourth quarter of 2018.

We also believe adjusted EBITDA is one measure along with the fourth quarter of 2018. We also believe adjusted EBITDA is one measure along with net revenue, kilograms sold and average selling price to evaluate the operating performance of the business. Adjusted EBITDA removes the impact of items that may distort underlying business trends and results. We have included a reconciliation of net income to adjusted EBITDA in our MD&A and our press release.

The company reported an adjusted EBITDA loss of $8.9 million in the first quarter of 2019. The loss increased by 13% from the fourth quarter of 2018, primarily due to increased operating expenses, partially offset by a increase in net revenue. The company reported net revenue of $6.5 million in the first quarter of 2019, an increase of 15% from the fourth quarter of 2018.

This increase is primarily due to two factors, first, dry flower wholesale revenue in the fourth quarter, which carries no excise tax reduction for 2019. The sequential growth continues to be impacted by the supply constraints in the market.