All right, our clock is starting here. You guys are in track two. The sponsors again are Crowe 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.
Thanks for having me.
For those who didn't hear my introduction earlier, I'm Bill Kirk. I cover cannabis, beverages, and food retail at Roth MKM. So Mike, let's start, I guess, big and broad. You know, 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?
Sure. So I think, you know, first of all, big and broad, but I just wanna, you know, differentiate two things. So if you look at overall, 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 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.
We've actually seen, rather than price compression with flower, there's actually opportunities to increase price. So it's been pretty rapid, and I think there's two main factors for that. You know, 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 lab shopping and sort of inflating THC results, and that product was selling. There was a big push from Health Canada and from the provinces to put an end to that. We've seen that actually end over the last few months, and so a lot of the product that was selling before at 30% THC, maybe now is actually testing at 20%, and it's not getting sold. It's out of the market. 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 that's started to shift, I think you're seeing more supply come out of the market, so a pretty big shift in Canada.
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. Has the value side, or, you know, the people who are just selling for cash considerations rather than margin, you know, opportunities, has that value side stabilized at all yet?
You know, 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 just 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.
And one more maybe on the, like, 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?
Yeah, I think a lot of it is you had, you know, either capital market incentives or just the overall view that all that mattered was market share. And so when you looked at M&A, you had companies that weren't seeing, you know, lining up their brands and saying like: "Is this gonna cannibalize my brand?" Part of that is these are all commoditized, you know, supply houses, and there are very few brands. What are you getting that's gonna 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 looked at their assortment, and 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. Now, 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, it's why you haven't seen us buy brands in Canada, but we've focused on a single brand. We did recently launch Lord Jones, which is, you know, much different than Spinach, so different consumer, very differentiated products. But yeah, I think it comes down to whether or not you're selling a brand or a commodity.
Well, I mean, let's start with some of those differentiated products you offer. So for Spinach, a huge market share in gummies and edibles, and I think you've said it's now number one in flower. So what makes Spinach as a brand resonate so well, maybe from a marketing perspective or even a product perspective?
Yeah, 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, you know, an extra $0.50 for something that is just a better experience.
So starting with, you know, from the product lineup 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. Flower, you know, it's funny, like, if you ever heard us talk about flower a few years ago, it's almost accidental. We cared much more about genetics. We've been breeding genetics for, you know, 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 SKUs in Canada and Israel. We launched in Germany, went right to the top. We expect the same from Australia.
So, you know, 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, you know, be a lifestyle brand in cannabis because the consumers really are focused on what is the product.
You mentioned the borderless products. That's been a difficult thing for a lot of different type of CPG companies, you know, 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?
Yeah, I think it's Spinach Sourz, also the Chocolate Fusions, which will be available in stores soon. But, you know, we launched and sold out in about a month ago. The further you get from flower, the easier it is to differentiate, and I think it's also important that you can transport it. So it's hard to replicate flower 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, you know, ingredients that meet the same spec everywhere. And I think that's, you know, 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, then flower.
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, you know, dollar amount, but also type of cost savings, and then what is left?
So yeah, this, this past year in 2023, we overachieved, ended up, $30 million in cost savings. That was really spread out. A lot of G&A, you know, some came from R&D. We're sort of towards the end of the R&D cycle. You know, overall OpEx, COGS, and I think we about $5 million-$10 million this year, I think, you know, 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, you know, 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.
On the kinda 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?
Yeah, look, I think it's, I've been in it for, I get... It's crazy to think it's been, what, 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, 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 torture yourselves in these different ways, and you try and get really creative, but, you know, the value doesn't really come out.
M&A is already hard enough as it is, right? If a company is worth something, they're usually not selling without a premium. So what is it you have? What's your natural advantage? Can I run it better than you? Are there costs I can take out? You know, is there, is it, can I expand it from their platform to my platform? And if you're not able to do that, it's, it's often difficult. So, you know, what changes? I think you're seeing Europe open up, but Schedule III, what that ultimately looks like, what happens in the U.S., that's really, you know, one side of what we're waiting for. And the other is, we're happy to, you know, 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, you know, 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 US, has held a lot of that back. But I would expect it, it will come, and we will see brands that are great fits for us.
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?
Yeah. I mean, when, you know, 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, you know, there may be assets on the production side, or there may be investments we need to make distribution side. You know, we made an investment in a MSO PharmaCann, which I think helps us get sort of instant distribution. But ultimately, I don't wanna compete with my customers.
I wanna keep the focus on what we do best: innovating, making great differentiated products, you know, putting them in stores. 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 get a full three-tier, you know, so there's a lot of different things that make me hesitant there, but mostly, I think it's focused, picking, you know, the areas that work best for us and going from there.
And let's do the U.S. regulatory conversation a little bit. How are you handicapping the possibilities, right? So say, let's just frame it as before the election. What do you think is possible out of the U.S. administration before the election?
Yeah, I think, and I'm usually pretty conservative with these things, but I think it's, it's pretty likely that we see at least some form this year of a push to implement Schedule III. 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 gonna 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 in 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, you know, numbers, but I would say I'm more optimistic.
I've seen more happening here than, you know, we ever have in cannabis, and I think it's, I think it's likely. Now, what that looks like is another question. You know what? There's gonna be a lot of details around that, what the opportunities are, what the restrictions are, but I think things are, are pushing forward.
How, how do you prepare for that kind of expectation, including how wide the potential actual legislation could be?
Look, I'd say we've been preparing for a long time. We've been, you know, again, patient. You could say, like, disciplined planning. Things you want is you wanna 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, you know, get additional cash from. I think we have a great portfolio of products. I think ultimately, regardless of what the system is, having quality differentiated products is gonna be what wins, and so having that is important. And then, you know, picking our spots, we've got, you know, mapped out what different possibilities are, what the best way would be to enter is.
But, you know, regardless, it's looking out, not what it'll be over the next 2 years after a rescheduling or some change makes, but what's it gonna look like 5, 10, 20 years out?
What would your, like, dream scenario be? Like, what is, what is the structure you're like: "That's it. That's the one. That's, that's perfect for us?
Yeah, the dream is a regulatory system that lets us access consumers and compete like a normal industry. So being able to set up a, you know, national supply chain, have interstate commerce, have some certainty. You know, 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... You know, I think that's where it eventually goes. Sooner than later would be great. You know, that's what we've been prepared for. We're ready to move no matter what the, you know, 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, you know, we take share from the illicit market and make the industry successful.
How would you compare the illicit market in the US to what you faced in Canada? How would you kinda compare those two?
I think they're pretty similar. It's just, you know, 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, you know, generally in the blue states, it's similar politics to Canada. You're gonna 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.
And then, on some other opportunities internationally, news out of Germany a couple of weeks ago that they're pursuing legalization. What does that market look like, you know, when that day comes, and when does that day come?
Yeah, I think the news being about legalization is a little bit misleading. It's you know, 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 adult use legalization would happen. That's really about decriminalizing these kind of caregiving clubs, that they grow attached to the cafe or, you know, place where people use. It's not really high-quality product. It's not something that we think is gonna be really in demand. I think it's more about just the overall sentiment towards cannabis in Germany. What I think does matter, and 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, it was three weeks ago. So, I think that opens it up. It lets us get to patients a lot more effectively.
And does the, I don't know, the ability for doctors to write prescriptions, like, does that change locally now? Like, is there a larger willingness to go write them or-
I think there's a larger willingness because when it's not a narcotic... You know, a lot of doctors are hesitant with narcotics. They want to see you've tried all these other, other medicines first. So, yeah, I think there's certainly a lot of fear post, you know, 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, you know, people, most doctors are, you know, used to a time when it was, you know, fully illegal, and, and it, it's a shock to them. So yeah, I think the more you have public sentiment and government endorsing it, the easier it is and the more it opens things up.
Israel's been another big country for you. Can you help us with an update on operations after the attacks in October, I guess? You know, a lot of volatility since, but how are operations in Israel? How's the market changed or not changed?
Yeah, October was definitely a rough month. Most of the country was shut down. You had a lot of stores in the south and 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, you know, if you look at all the inputs that come in, if you look at trade partners, people just... You know, 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, you know, 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-
We can.
Yeah. So, you know, the way the prescriptions are written, taking it out for 15% of the indications and allowing doctors to prescribe it like normal medicine, I think 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 gonna be really, really important. And I think it incentivizes doctors and lets them know it's okay. 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 is gonna be important for patient growth.
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 gonna 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?
Yeah, I mean, 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, you know, we re-entered Australia. We have a stake in the largest cannabis company there, Vitura, so we have 10% there and, you know, using them to distribute. I think there's, you know, really 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, you know, New Zealand, U.K., Czech Republic, Poland, those are really the best opportunities and only the kind of real markets today that I would think make sense to enter.
But it's ultimately what's the fixed cost of entering, you know, 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'd achieve that scale, we're big believers that better beats first. You know, 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, you know, we have the supply to do it, you know, we'll enter. But we're getting back to a point where it's, are we gonna have enough supply, like short term, if we enter all these places?
Products are doing well in all the markets we're in, so making sure we, you know, we're disciplined in how we enter and we don't short ship.
Like, how quickly, with Germany making a change, how quickly are other countries in the EU to do something similar? Like, is that the domino that opens the whole country in a similar way?
It definitely could be. I think the COVID, you know, Ukraine, the Ukraine war, those actually slowed things down that were already moving, so we probably would've been much further on, but I think governments had other priorities. But yeah, you've got the U.K., which I think is still somewhat influential. Germany, I think you'll see more countries move, but a lot of it's also gonna watch the next few months in Germany and see how it goes. And I think what happens in every market, it's kind of the medical terms to adult use in the U.S. states. People wake up and realize, "Wow, the country didn't burn down when, you know, we allowed cannabis. It's amazing. Oh, things look great." And then, you know, they start implementing it.
Germany is definitely, I think, a bellwether and someone to watch. So yeah, I think it's optimism in Europe.
We'll round it out with a rather open-ended one. When we're sitting down next year, like I said, this time next year, what are we talking about? Is it gonna be the same? What's the U.S. doing? What are we talking about?
Oh, well, I think a lot of that's gonna depend on, you know, elections and some other things. I think that you will see you have seen a change in the US, probably be a lot of questions about what that means. You know, there'll likely be some a bill that's being put out that's gonna 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, you know, 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.
Well, that's it for time. Mike, thank you. Appreciate you taking the time with us today.
Thank you.