ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis together with our consolidated financial statements and the related notes to those statements, which are included in Item 8 of this Annual Report. This discussion contains Forward-Looking Statements that involve risks and uncertainties. As a result of many factors, such as those set forth in Item 1A “Risk Factors,” of this Annual Report and elsewhere in this Annual Report, our actual results may differ materially from those anticipated in these Forward-Looking Statements.
Business Overview
Cronos Group is an innovative global cannabinoid company with international production and distribution across five continents. We are committed to building disruptive intellectual property by advancing cannabis research, technology and product development and are seeking to build an iconic brand portfolio. Cronos Group’s brand portfolio includes PEACE NATURALSTM, a global wellness platform; two adult-use brands, COVETM and SpinachTM; and three U.S. hemp-derived consumer products brands, Lord JonesTM, Happy DanceTM and PEACE+TM.
Strategy
Cronos Group seeks to create value for shareholders by focusing on four core strategic priorities:
•growing a portfolio of iconic brands that responsibly elevate the consumer experience;
•developing a diversified global sales and distribution network;
•establishing an efficient global supply chain; and
•creating and monetizing disruptive intellectual property.
Business Segments
Cronos Group reports through two segments: “United States” and “Rest of World.” These two segments represent the geographic regions in which the Company operates and the different product offerings within each geographic region. On September 5, 2019, as a result of the Redwood Acquisition, the Company established the United States segment, which includes only the results of Redwood since the date of acquisition. Redwood manufactures, markets and distributes U.S. hemp-derived supplements and cosmetic products through e-commerce, retail and hospitality partner channels in the United States (“U.S.”) under the brands Lord JonesTM and Happy DanceTM.
Recent Developments
In December 2019, an outbreak of a novel strain of coronavirus, COVID-19, was identified in Wuhan, China. Since then, COVID-19 has spread across the globe, including the U.S., Canada and Israel, and other countries in which the Company or its affiliates operate (including Australia and Colombia) and was recognized as a pandemic by the World Health Organization. The COVID-19 pandemic has resulted in a sharp contraction in many areas of the global economy and increased volatility and uncertainty in the capital markets. In response to the pandemic, the governments of many countries, provinces, states, cities, and other geographic regions took preventative or protective actions, including closures of certain businesses, mandatory quarantines, limits on individuals’ time outside of their homes, travel restrictions and social distancing or other preventative measures. Such measures were eased or lifted in varying degrees by different governments of various countries, states and cities throughout 2020, but the continued spread of COVID-19 and increased infection rates has caused, and may continue to cause, some jurisdictions to roll back reopening plans that had been underway and re-impose quarantines, border closures, closure of certain businesses and stay-at-home orders. It is possible that jurisdictions in which the Company or its affiliates operate may reintroduce more stringent preventative or protective actions which could result in further closures of businesses. Governments in certain countries such as the U.S., Canada, and those in Europe have responded to the acute economic and market consequences with certain monetary and fiscal policy actions.
Impact on operating results
During the second quarter of 2020, the effects of the COVID-19 pandemic on retail stores and the increase of costs in production and sales in the U.S. had a material impact on the rate of growth of revenue in the U.S. segment, with revenue for the segment remaining flat from the first quarter of 2020. As a result of these impacts and the expectation of future impacts, for the three months ended June 30, 2020, the Company recorded $35 million of impairment charges on its U.S. reporting unit and $5 million on the Lord JonesTM brand (refer to Note 11 of the Company’s consolidated financial statements for more information regarding intangibles assets and goodwill).
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The continued negative impact on the Company’s results has been as expected during the three months ended December 31, 2020 and no further impairment charges were recorded to the U.S. reporting unit or brands as a result. The Company expects revenue growth and operating results in the U.S. segment to continue to be negatively impacted as retail closures are expected to continue as a result of the pandemic.
Revenue and the growth in revenue in the Rest of World segment was not materially impacted by the effects of COVID-19 during the year ended December 31, 2020. However, prolonged closures of retail stores due to government mandated lockdowns as well as the changes in consumer purchasing behavior in Canada during the COVID-19 pandemic are expected to have a negative impact on the Company’s short-term revenue growth in Canada.
In both segments, there were no material increases in the current expected credit loss in connection with COVID-19. The Company continues to closely monitor the effects of COVID-19 on its operating results.
Production and supply chain
The Company’s global production facilities currently remain operational. To comply with governmental orders or other health and safety requirements, the Company has: (i) reduced the number of personnel working on-site at its production facilities to only the roles that are necessary to be performed on-site, (ii) implemented work-from-home policies for other employees whose work can be performed off-site, and (iii) implemented other additional health and safety measures such as, among other things, enhanced hygiene and sanitation procedures, modified work schedules and social distancing protocols at its production facilities. Further, as recommended by certain jurisdictions in which it operates, the Company has implemented a documented COVID-19 prevention plan in these locations. The Company has and will continue to act in accordance with guidance from local, federal, and international health and governmental authorities, such as any government-mandated requirements for people to wear facemasks in all indoor communal spaces or at businesses, and is prepared to make additional operational adjustments, as necessary. Although the Company’s production facilities currently remain operational, governmental requirements, guidance and health and safety requirements continue to evolve as governmental and health authorities respond to the spread of the virus. Reopening plans in certain jurisdictions have been and may be further reversed, suspended or delayed and quarantines may be re-imposed. The Company’s production facilities may experience further temporary closures or quarantines if governmental or health authorities make changes to the businesses and workforces allowed to remain operational, which would result in reduced production or suspension of production if such closures or quarantines are mandated. In addition, to the extent the Company’s employees contract the virus, depending on the employee’s job duties and access to facilities, the Company’s ability to keep production and manufacturing facilities open may be impacted for health and safety reasons.
The impacts of certain closures or other restrictions on the conduct of business operations at the facilities of third-party manufacturers, suppliers and other vendors in the Company’s supply chain have not been significant to date but remain uncertain. Earlier closures at manufacturers in China in 2020 had resulted in delays of deliveries of batteries and cartridges for cannabis vaporizers and personal protective equipment, such as masks and gowns used in Cronos Group’s manufacturing facilities certified in accordance with Good Manufacturing Practices (“GMP”), from such manufacturers in China. Most delays have been ameliorated as manufacturers are now operational in China but other vendors or suppliers in the Company’s supply chain have been, and in the future could potentially be, impacted. Closures or other restrictions on the conduct of business operations on third-party manufacturers, suppliers or vendors may cause disruption in Cronos Group’s supply chain. As a result of a rise in infection rates late in the fourth quarter of 2020 and in the first quarter of 2021 in the U.S., certain contract manufacturers that manufacture U.S. hemp finished products for our U.S. business have experienced temporary closures or reductions in their operations leading to shortages of finished product available via the e-commerce channel. We expect these closures or reductions to ease and product shortages to be ameliorated as the spread of COVID-19 and infection rates decline. The Company has experienced delays in shipping and expects that the increased global demand on shipping and transport services, which has created challenges to container availability and port capacities, in addition to customs and border control policies put in place in response to the COVID-19 pandemic that require shipments to undergo a quarantine period, may cause the Company to experience further delays in the future which could impact the Company’s ability to obtain materials or deliver products in a timely and cost efficient manner. In addition, work-from-home policies for certain employees and the effects of the Company’s work-from-home policies may negatively impact productivity, disrupt access to books and records and disrupt the Company’s business. Even if the Company’s production facilities continue to remain open, mandatory or voluntary self-quarantines and travel restrictions may limit the Company’s employees’ ability to access facilities, and this, together with impacts on the Company’s supply chain and the uncertainty produced by the rapidly evolving nature of the COVID-19 pandemic, may result in reduced or suspended production.
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Customers
Retailers in the U.S. and Canada have been required to close at times or have curtailed their operations (such as reduced opening hours, reduced staff, limiting brand partner visits, and reduced traffic in stores) due to the implementation of health and safety measures. The slowdown or disruption faced by retailers, in addition to quarantine measures and travel restrictions, impacts the ability of customers to be able to access the Company’s products. These restrictions on retail stores are mandated by, and differ across, each state, province or territory and continue to change and evolve, which creates uncertainty in forecasting customer demand and sales velocity. In the U.S., while online sales have continued despite facing pressure, certain beauty and other retailers have temporarily closed physical boutiques. State specific limitations on retail capacity has also reduced the ability of larger retailers to offer in-store brand education for the Company’s products. In Canada, retailers have implemented a combination of measures from closing stores, offering curbside delivery (to the extent permitted by a province) and online sales only, reduced store opening hours and a reduction in the number of customers permitted in stores in light of social distancing measures. Suspensions of the ability of private retailers to offer click-and-collect or curbside delivery in certain provinces in Canada may further impact customer demand for products. Provincial purchasers have also similarly, among other things, reduced staff on-site leading to a decrease in delivery time slots for producers to deliver products or reduced frequency or size of their purchase orders. While various provinces in Canada have continued to increase the number of retail stores during the COVID-19 pandemic, we expect that the expansion of retail stores in various provinces in Canada will be delayed or slowed down in light of continued increases in COVID-19 cases. We anticipate that uncertainty created by these measures on forecasting customer demand and sales will continue as long as such measures are in place. Demand for the Company’s products could also be negatively impacted should the effects of COVID-19 lead to changes in consumer behavior, including as a result of a potential decline in the level of demand for vaporizer products or in discretionary spending as result of a general economic slowdown.
Macroeconomic impacts
The impacts of these current restrictions and measures on certain strategic projects continue to be uncertain. While facility design and expansion projects and product development initiatives are currently expected to proceed as planned, requirements and restrictions on the operation of businesses and workforces continue to evolve as governmental and health authorities respond to the spread of the virus and changes may result in delays or suspensions if authorities require such activities to be suspended.
In addition, a recession or market correction resulting from the spread of COVID-19 would likely materially affect the Company’s business and the value of its common shares. Collectively, the effects of the COVID-19 pandemic have adversely affected the Company’s results of operations and, if the effects continue unabated, could continue to do so as long as measures to combat the COVID-19 pandemic remain in effect. At this time, neither the duration nor scope of the disruption can be predicted; therefore, the ultimate impact to the Company’s business cannot be reasonably estimated but such impact could materially adversely affect the Company’s business and financial results.
Liquidity and capital resource impact
Despite the impacts of the COVID-19 pandemic, the Company believes that its significant cash on hand and short-term investments will be adequate to meet liquidity and capital requirements for at least the next twelve months. The impact of reduced interest rates has inhibited the Company’s ability to generate interest income in the short-term, but this has not, and is not expected to have, a material impact on the liquidity or capital resources of the Company.
2020 Business Highlights
Cronos Fermentation
In the second quarter of 2020, Cronos Fermentation successfully fermented CBGA, one of the Company’s target cannabinoids under the Ginkgo Strategic Partnership, at research scale. Cronos Fermentation has and will continue to optimize downstream processing and scale up procedures in advance of receiving the final strains and commercial processing license, both of which are required for commercialization.
Management Appointments
On September 9, 2020, Cronos Group expanded its leadership structure to drive its next phase of growth by appointing Kurt Schmidt as President and Chief Executive Officer. This move coincided with Mike Gorenstein’s appointment to Executive Chairman. Mr. Schmidt brings deep experience in consumer products with decades of leadership experience in the U.S. and overseas.
On August 31, 2020, the Company added Shannon Buggy as Senior Vice President, Global Head of People. With over 25 years of experience, Ms. Buggy has a proven track record of leading and managing global human resources teams and driving excellence in talent acquisition, development, retention, employee relations, compensation, benefits, talent management and labor relations.
On July 20, 2020, Summer Frein was named General Manager USA. Ms. Frein joined Cronos Group in January of 2020; however, she has worked with Cronos Group in various capacities since 2018. Under Ms. Frein’s leadership, the Company plans to further expand
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its U.S. hemp-derived business, including introducing new product formats under both Lord JonesTM and Happy DanceTM, that will target different retail channels and consumers.
Cronos Research Labs
In the third quarter of 2020, Cronos Device Labs expanded its scope for cannabinoid research and the R&D center was renamed to Cronos Research Labs. Cronos Group engages in both understanding the fundamental science behind the interactions of cannabinoids with each other and how those interactions can be leveraged to best deliver on the consumer’s needs. Additionally, the Company partners with leading scientific institutions engaged in fundamental cannabis science to augment and accelerate its internal efforts. Cronos Group’s work spans many aspects of cannabis research from strain development to growing conditions to extraction technology to biosynthesis to product development, all supported by advances in analytical sciences.
Recent Developments
Happy DanceTM
Happy DanceTM continues its expansion by securing its first major U.S. retailer, ULTA BeautyTM. The full collection of Happy DanceTM products is expected to launch online at ULTA.com and in-store at over 550 ULTA BeautyTM locations across the U.S. in the coming weeks. Happy DanceTM was co-founded by actress and New York Times best-selling author Kristen Bell and features an easy-to-use line of clean, vegan and cruelty-free U.S. hemp-derived CBD bath and body products including an All-Over Whipped Body Butter + CBD, Head-to-Toe Coconut Melt + CBD and Stress Away Bath Bomb + CBD.
Cronos Israel
During 2020, Cronos Israel received all certifications and licenses required for the cultivation, production and marketing of dried flower, pre-rolls and oils in Israel and currently has PEACE NATURALSTM dried flower and oils in market. On January 11, 2021, the PEACE NATURALSTM brand was recognized by the Israeli Marketing Association and was given the 2020 Innovation Award for its successful marketing strategy in 2020, which led to increased brand exposure. The marketing campaign gained this accolade for standing out amongst its peers by focusing on the high-quality nature of PEACE NATURALSTM products. In February 2021, Cronos Israel signed a distribution agreement with the largest pharmacy chain in Israel, Super-Pharm, which has over 250 branches in Israel. Cronos Israel continues to build distribution and brand awareness through a growing network of pharmacies.
Natuera
Throughout 2020, Natuera, the Company’s joint venture in Latin America, a fully licensed operation in Colombia for hemp and cannabis derived bulk, consumer, and medicinal cannabinoid products, continued to achieve significant operational milestones. In addition to completing a number of test exports of hemp-derived CBD extract to both the U.S. and the United Kingdom for business development and R&D purposes over the course of 2020, during the fourth quarter of 2020, Natuera completed its first export of hemp-derived CBD extract to the U.S. for commercial purposes.
Cronos GrowCo
In 2020, Cronos GrowCo, the Company’s joint venture in Canada, fully completed construction of its production facility, including all fixtures within the greenhouse and all post-harvest activity areas. In November 2020, Cronos GrowCo obtained a cultivation license for the operations contemplated by the first phase of the project. The Company expects the facility to become operational in phases beginning in the first half of 2021.
2019 Financial Results Compared to 2018
For a discussion of our 2019 financial results compared to 2018, see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, in our Annual Report on Form 10K/A for the year ended December 31, 2019.
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Foreign currency exchange rates
All currency amounts in this Annual Report are stated in U.S. dollars, which is our reporting currency, unless otherwise noted. All references to “dollars” or “$” are to U.S. dollars. The assets and liabilities of the Company’s foreign operations are translated into dollars at the exchange rate in effect as of December 31, 2020, December 31, 2019 and December 31, 2018, as reported on Bloomberg. Transactions affecting the shareholders’ equity (deficit) are translated at historical foreign exchange rates. The consolidated statements of net income (loss) and comprehensive income (loss) and consolidated statements of cash flows of the Company’s foreign operations are translated into dollars by applying the average foreign exchange rate in effect for the reporting period, as reported on Bloomberg.
The exchange rates used to translate from Canadian dollars (“C$”) to dollars is shown below:
(Exchange rates are shown as C$ per $) Year ended December 31,
Consolidated Results of Operations: FY 2020 compared with FY 2019
Summary of financial results - consolidated
(In thousands of U.S. dollars) Year ended December 31, Change
Gross margin (55) % (74) % N/A 19 pp
(i) See “Non-GAAP Measures” for information related to Non-GAAP measure.
Net revenue - consolidated
(In thousands of U.S. dollars) Year ended December 31, Change
(i) Net revenue, before excise taxes, is calculated net of sales returns and discounts as described under Note 4 to the consolidated financial statements.
For the fiscal year 2020 (“FY 2020”), we reported net revenue of $46.7 million, representing an increase of $23.0 million from the fiscal year 2019 (“FY 2019”). This change was primarily due to:
•An increase in sales in the Rest of World (“ROW”) segment in FY 2020 compared to FY 2019, due to the continued growth of the adult-use market in Canada and sales in the Israeli medical market, partially offset by non-recurring wholesale revenue in the Canadian market in FY 2019 and strategic price reductions on various adult-use cannabis products in Canada in FY 2020.
•An increase in net revenue in the U.S. segment of $6.1 million in FY 2020 compared to FY 2019 due to FY 2020 results including a full year of the Redwood business as opposed to 117 days in FY 2019.
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Cost of sales and gross profit (loss) – consolidated
(In thousands of U.S. dollars) Year ended December 31, Change
Gross margin (55) % (74) % N/A 19 pp
For FY 2020, we reported gross loss of $25.8 million, representing an increase in losses of $8.2 million from FY 2019. This change was primarily due to:
•An increase in ROW cost of sales primarily driven by third party purchased flower associated with adult-use products in Canada and a decline in wholesale sales in FY 2020 versus FY 2019.
•Partially offset by increased gross profit in the U.S. segment in FY 2020 compared to FY 2019, primarily due to a full year of gross profit in FY 2020 versus 117 days in FY 2019 and a decrease in inventory write-downs in the ROW segment. We may incur further inventory write-downs due to pricing pressures in the marketplace.
Adjusted EBITDA – consolidated
(In thousands of U.S. dollars) Year ended December 31, Change
(i)See “Non-GAAP Measures” for information related to non-GAAP measures.
For FY 2020, we reported an adjusted earnings (loss) before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) of $(147.3) million, representing a decrease in Adjusted EBITDA of $48.9 million from FY 2019. This change was primarily due to:
•An increase in gross loss as described above.
•An increase in general and administrative costs driven primarily by an increase in salaries and wages as a result of increased headcount in order to support the Company’s growth strategy, increased office and general expenses and increased costs due to a full year of U.S. segment results versus 117 days in 2019.
•An increase in sales and marketing costs, primarily related to brand development as well as increased costs due to a full year of U.S. segment results versus 117 days in the same period in 2019.
•An increase in R&D costs primarily related to the Ginkgo Strategic Partnership and increased spending on product development and developing cannabinoid intellectual property.
Other items affecting the comparability of net income (loss) during FY 2020 and FY 2019 – consolidated
Review costs related to restatement of 2019 interim financial statements
For FY 2020, we reported review costs related to the restatement of 2019 interim financial statements of $9.7 million within the general and administrative line in the consolidated statements of net income (loss). These financial statement review costs include costs related to the restatement of the Company’s 2019 interim financial statements, costs related to the Company’s responses to requests for information from various regulatory authorities relating to such restatement and legal costs defending shareholder class action complaints brought against the Company as a result of the restatement. There were no costs related to the restatement of the Company’s 2019 interim financial statements incurred during FY 2019.
Repurposing charges
For FY 2019, we reported pre-tax charges of $7.3 million related to the Company’s decision to redesign its efforts at the Peace Naturals Campus, which includes impairment costs, inventory write-down, and employee termination benefits. There were no repurposing costs incurred during FY 2020.
Interest income, net
For FY 2020, we reported interest income, net of $18.4 million representing a decrease of $9.6 million from FY 2019 primarily due to the impact of a decrease in interest rates on cash and cash equivalents and short-term investments during FY 2020 compared to FY 2019.
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Gain on revaluation of derivative liabilities
For FY 2020, we reported a gain on revaluation of derivative liabilities of $129.3 million representing a decrease of $1,147.6 million from FY 2019 primarily driven by a decrease in our share price since December 31, 2019. The Company expects continued changes in derivative valuations as the Company’s share price fluctuates period-to-period. For further information, see Note 14 to the consolidated financial statements in Item 8 of this Annual Report.
Impairment loss on goodwill and intangible assets
For FY 2020, we reported an impairment loss on goodwill and intangible assets of $40.0 million representing an increase of $40.0 million from FY 2019 primarily driven by a $35.0 million impairment charge on the U.S. reporting unit and a $5.0 million impairment charge on the Lord JonesTM brand during the year ended December 31, 2020. For further information, see Note 11 to the consolidated financial statements in Item 8 of this Annual Report.
Gain on disposal of other investments
For FY 2020, we reported a gain on disposal of other investments of $4.8 million representing a decrease of $11.5 million from FY 2019 primarily driven by a decrease in the sale of shares associated with the Whistler Transaction (as defined below) during FY 2020 compared to FY 2019. For further information, see Note 7 to the consolidated financial statements in Item 8 of this Annual Report.
Financing and transaction costs
For FY 2020, we reported financing and transaction costs of $0.04 million representing a decrease of $32.2 million from FY 2019 primarily driven by the increased financing and transaction costs incurred in FY 2019 compared to FY 2020 as a result of the Altria Investment and the Redwood Acquisition. For further information see Note 27 and Note 14 to the consolidated financial statements in Item 8 of this Annual Report.
Income tax expense
For FY 2020, we reported an income tax expense of $1.3 million representing an increase of $1.3 million from FY 2019 primarily driven by changes in valuation allowance, partially offset by a decrease in the fair value gain on financial liabilities.
Results of Operations by Business Segment: FY 2020 compared with FY 2019
Summary of financial results – ROW
(In thousands of U.S. dollars) Year ended December 31, Change
Gross margin (81) % (96) % N/A 15 pp
(i)See “Non-GAAP Measures” for information related to non-GAAP measures.
Net revenue – ROW
(In thousands of U.S. dollars) Year ended December 31, Change
For FY 2020, we reported net revenue of $37.2 million, representing an increase of $16.8 million from FY 2019. This change was primarily due to:
•An increase in sales due to the continued growth of the adult-use market in Canada and sales in the Israeli medical market, partially offset by non-recurring wholesale revenue in the Canadian market in FY 2019 and strategic price reductions on various adult-use cannabis products in Canada in FY 2020.
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Cost of sales and gross profit (loss) – ROW
(In thousands of U.S. dollars) Year ended December 31, Change
Gross margin (81) % (96) % N/A 15 pp
For FY 2020, we reported gross loss of $30.0 million, representing an increase in losses of $10.5 million from FY 2019. This change was primarily due to:
•An increase in cost of sales primarily driven by third-party purchased flower associated with adult-use products in Canada and a decline in wholesale sales in FY 2020. The Company anticipates that gross margin will continue to fluctuate as price and mix change from quarter-to-quarter.
•Partially offset by an increase in net revenue from FY 2019, as described above and a decrease in inventory write-downs. We may incur further inventory write-downs due to pricing pressures in the marketplace.
Adjusted EBITDA – ROW
(In thousands of U.S. dollars) Year ended December 31, Change
(i)See “Non-GAAP Measures” for information related to non-GAAP measures.
For FY 2020, we reported Adjusted EBITDA of $(98.3) million, representing a decrease in Adjusted EBITDA of $13.5 million from FY 2019. This change was primarily due to:
•An increase in ROW gross loss from FY 2019, as described above.
•An increase in R&D costs primarily related to the Ginkgo Strategic Partnership and costs related to increased spending on product development and cannabinoid intellectual property.
•An increase in general and administrative costs from FY 2019 driven by an increase in salaries and wages as a result of increased headcount to support the Company’s growth strategy and increased office and general expenses.
•An increase in sales and marketing costs primarily related to building and developing our brands and products in the Canadian adult-use market.
Summary of financial results – U.S.
(In thousands of U.S. dollars) Year ended December 31, Change
Gross margin 44 % 56 % N/A (12) pp
(i)See “Non-GAAP Measures” for information related to non-GAAP measures.
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Net revenue – U.S.
(In thousands of U.S. dollars) Year ended December 31, Change
For FY 2020, the U.S. segment reported net revenue of $9.5 million, representing an increase of $6.1 million from FY 2019. The increase was primarily due to:
•An increase in sales due to a full year of U.S. segment results in FY 2020 as opposed to 117 days in FY 2019.
•The growth in existing product lines and introductions of new U.S. hemp-derived CBD products during FY 2020. A significant amount of the U.S. segment’s FY 2020 revenue was earned during the fourth quarter as a result of increased sales in the direct-to-consumer channel driven by holiday sales.
Cost of sales and gross profit – U.S.
(In thousands of U.S. dollars) Year ended December 31, Change
Gross profit margin 44 % 56 % N/A (12) pp
For FY 2020, the U.S. segment reported gross profit of $4.2 million representing an increase in gross profit of $2.3 million from FY 2019. This was primarily due to:
•The increase in net revenue, as described above.
•Partially offset by an increase in cost of sales primarily driven by a full year of U.S. segment results in FY 2020 as opposed to 117 days in the same period in 2019.
Adjusted EBITDA – U.S.
(In thousands of U.S. dollars) Year ended December 31, Change
(i)See “Non-GAAP Measures” for information related to non-GAAP measures.
For FY 2020, we reported an Adjusted EBITDA of $(28.0) million, representing a decrease in Adjusted EBITDA of $26.3 million from FY 2019. This change was primarily due to:
•Sales and marketing costs incurred in relation to the introduction of new U.S. hemp-derived CBD products.
•Increased general and administrative costs driven by increased headcount to support the Company’s growth strategy across a variety of functions.
•Partially offset by an increase in gross profit from FY 2019, as described above.
Liquidity and Capital Resources
We believe that our existing cash and cash equivalents and short-term investments will be sufficient to fund our business operations and capital expenditures over the next twelve months.
Liquidity
Our primary need for liquidity is to fund operations and capital expenditures. Our ability to fund operations and capital expenditures depends on, among other things, future operating performance and cash flows that are subject to general economic conditions and financial and other factors, including factors beyond our control.
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Historically, we have primarily funded our operations through equity financing. In March 2019, Altria closed a C$2.4 billion (approximately $1.8 billion) investment in us, pursuant to which we issued to certain wholly owned subsidiaries of Altria 149,831,154 of our common shares and one warrant, as further discussed under “Altria Strategic Investment” herein. As of February 23, 2021, we had a cash and cash equivalents balance of $1.1 billion and $0.2 billion in short term investments to fund operations and capital expenditures.
Capital resources
As of December 31, 2020, we had $1.1 billion in cash and cash equivalents and $0.2 billion in short term investments. As of December 31, 2020, the Company had no external financing.
Contractual obligations
As of December 31, 2020, the Company had the following contractual obligations:
(In thousands of U.S. dollars) Payments Due by Period
Total Less Than 1 Year 1-3 Years 4-5 Years After 5 Years
Long-term debt obligations $ — $ — $ — $ — $ —
Capital (finance) lease obligations 59 39 20 — —
Other long-term liabilities 8,962 8,962 — — —
Finance lease obligations relate to equipment leases maturing in June 2022. Operating lease obligations relate to land, buildings, vehicles, and office space in Canada, the U.S. and Israel. Purchase obligations include commitments for capital expenditure, information technology services, and other professional services. Other long-term liabilities relate to commitments for research and development such as Ginkgo foundry access fees, as well as undrawn but committed loans to our joint ventures.
Summary of cash flows
(In thousands of U.S. dollars) Year ended December 31,
FY 2020 cash flows vs FY 2019 cash flows
Operating activities.
During FY 2020, we used $142.5 million of cash in operating activities as compared to $130.3 million in FY 2019, representing an increase of $12.2 million in cash used. This change is primarily driven by an increase in operating expenses in FY 2020 partially offset by increased revenues in FY 2020.
Investing activities.
During FY 2020, we received $20.2 million of cash in investing activities, as compared to $603.3 million of cash used during FY 2019, representing an increase of $623.5 million in net cash provided. This change is primarily driven by the Redwood Acquisition in FY 2019 for cash consideration of $224.3 million, as well as a $395.3 million increase from FY 2019 from the net effect of the purchase of and proceeds from maturity short-term investments.
Financing activities.
During FY 2020, cash used in financing activities was $5.5 million, as compared to $1,856.9 million of cash provided by financing activities in FY 2019, representing a net increase of $1,862.4 million. This change is primarily driven by proceeds from the strategic investment from Altria of $1,809.6 million as well as the proceeds from exercises Top-up Rights of $67.1 million by Altria partially offset by the $16.0 million repayment of the construction loan payable.
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Non-GAAP Measures
Cronos Group reports its financial results in accordance with Generally Accepted Accounting Principles in the United States (“US GAAP”). This Annual Report refers to measures not recognized under US GAAP (“non-GAAP measures”). These non-GAAP measures do not have a standardized meaning prescribed by US GAAP and are therefore unlikely to be comparable to similar measures presented by other companies. Rather, these non-GAAP measures are provided as a supplement to corresponding US GAAP measures to provide additional information regarding our results of operations from management’s perspective. Accordingly, non- GAAP measures should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with US GAAP. All non-GAAP measures presented in this Annual Report are reconciled to their closest reported GAAP measure. Reconciliations of historical adjusted financial measures to corresponding US GAAP measures are provided below.
Adjusted EBITDA
Management reviews Adjusted EBITDA, a non-GAAP measure which excludes non-cash items or items that do not reflect management’s assessment of on-going business performance. Management defines Adjusted EBITDA as net income (loss) before interest, tax expense, depreciation and amortization adjusted for: impairment loss on goodwill and intangible assets, repurposing charges, financing and transaction costs, loss (gain) on revaluation of derivative liabilities, loss (gain) on disposal of investments, share of loss (income) from equity accounted investees, loss from discontinued operations, other loss (income), review costs related to the restatement of the Company’s 2019 interim financial statements, the Company’s responses to the reviews of such interim financial statements by various regulatory authorities and legal costs defending shareholder class action complaints brought against the Company as a result of the restatement (see Part I, Item 3, Legal Proceedings, of this Annual Report for a discussion of the regulatory reviews and shareholder class action complaints relating to the restatement of the 2019 interim financial statements), and share-based payments.
Management believes that Adjusted EBITDA provides the most useful insight into underlying business trends and results and provides a more meaningful comparison of year-over-year results. Management uses Adjusted EBITDA for planning, forecasting and evaluating business and financial performance, including allocating resources and evaluating results relative to employee compensation targets. As a result of the appointment of Mr. Schmidt as President and Chief Executive Officer in September 2020 and a review of how management looks at the business, Adjusted EBITDA is now the primary metric upon which management views the consolidated business performance and results year-over-year.
Adjusted EBITDA by segment
Management also reviews adjusted earnings (loss) before interest, tax, depreciation and amortization by segment (“Adjusted EBITDA by segment”), a non-GAAP measure which excludes non-cash items or items that do not reflect management’s assessment of on-going business performance. Corporate expenses are removed from Adjusted EBITDA by segment. Corporate expenses are expenses that relate to the consolidated business. The Company’s method of allocating corporate expenses is refined periodically. Management defines Adjusted EBITDA by segment as net income (loss) by segment before interest, tax expense, depreciation and amortization adjusted for the same items that are adjusted in consolidated Adjusted EBITDA.
Management believes that Adjusted EBITDA by segment provides useful insight into underlying segment trends and results and provides a more meaningful comparison of year-over-year segment results. Management uses Adjusted EBITDA by segment for planning, forecasting and evaluating business and financial performance, including allocating resources and evaluating results relative to employee compensation targets. As a result of the appointment of Mr. Schmidt as President and Chief Executive Officer in September 2020 and a review of how management looks at the business by segment, Adjusted EBITDA by segment is now the primary metric upon which management views the segment performance and results year-over-year.
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Adjusted EBITDA and Adjusted EBITDA by segment is reconciled to net income (loss) as follows for the years ended December 31, 2020 and 2019:
(in thousands of U.S. dollars) Year ended December 31, 2020
US ROW CorporateExpenses Total
Adjustments
Impairment loss on goodwill and intangible assets 40,000 — — 40,000
Financing and transaction costs 40 — — 40
Gain on revaluation of derivative liabilities — (129,254) — (129,254)
Gain on disposal of other investments — (4,789) — (4,789)
Share of loss from equity accounted investees — 4,510 — 4,510
Loss from discontinued operations — 650 — 650
Adjustments
(in thousands of U.S. dollars) Year ended December 31, 2019
US ROW CorporateExpenses Total
Adjustments
Gain on revaluation of derivative liabilities — (1,276,819) — (1,276,819)
Gain on disposal of other investments — (16,277) — (16,277)
Share of loss from equity accounted investees — 2,009 — 2,009
Loss from discontinued operations — 363 — 363
Adjustments
Adjusted operating loss
Management previously reviewed operating loss on an adjusted basis, which excluded certain income and expense items that management believed were not part of underlying operations. These items typically included repurposing charges and non-recurring charges such as the review costs related to the restatement of the Company’s 2019 interim financial statements, the Company’s responses to the reviews of such interim financial statements by various regulatory authorities and legal costs defending shareholder class action complaints brought against the Company as a result of the restatement (see Part I, Item 3, Legal Proceedings, of this Annual Report for a discussion of the regulatory reviews and shareholder class action complaints relating to the restatement of the 2019 interim financial statements).
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Management did not view these items to be part of underlying results as they may have been highly variable, unusual or infrequent, were difficult to predict or could distort underlying business trends and results. Management believed that adjusted operating loss provided useful insight into underlying business trends and results and provided a more meaningful comparison of year-over-year results. Management used to use adjusted operating loss for planning, forecasting and evaluating business and financial performance, including allocating resources and evaluating results relative to employee compensation targets. As a result of the appointment of Mr. Schmidt as President and Chief Executive Officer in September 2020 and a review of how management looks at the business, adjusted operating loss is no longer a primary metric upon which management views the consolidated business performance and results year-over-year.
(In thousands of U.S. dollars) Year ended December 31,
Adjustments
Review costs related to restatement of 2019 interim financial statements 9,688 —
Repurposing charges — 7,268
Adjusted operating loss by segment
Management previously reviewed operating loss by segment, which excluded corporate expenses, and adjusted operating loss by segment, which further excluded certain income and expense items that management believed were not part of the underlying segment’s operations. Corporate expenses were expenses that relate to the consolidated business and not to an individual operating segment while the income and expense items typically included non-recurring charges such as repurposing charges and review costs related to the restatement of the Company’s 2019 interim financial statements, the Company’s responses to the reviews of such interim financial statements by various regulatory authorities and legal costs defending shareholder class action complaints brought against the Company as a result of the restatement (see Part I, Item 3, Legal Proceedings, of this Annual Report for a discussion of the regulatory reviews and shareholder class action complaints relating to the restatement of the 2019 interim financial statements). Management did not view the income and expense items above to be part of underlying results of the segment as they may have been highly variable, unusual or infrequent, were difficult to predict and could distort underlying business trends and results.
As a result of the appointment of Mr. Schmidt as President and Chief Executive Officer in September 2020 and a review of how management looks at the business, adjusted operating loss by segment is no longer the primary metric upon which management views the segment performance and results year-over-year.
(In thousands of U.S. dollars) Year ended December 31, 2020
US ROW Total Segments Corporate Expenses Total
Adjustments
(In thousands of U.S. dollars) Year ended December 31, 2019
US ROW Total Segments Corporate Expenses Total
Adjustments
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements.
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Critical Accounting Estimates
Estimates and critical judgments by management
The preparation of the consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. These estimates are reviewed periodically and adjustments are made as appropriate in the year they become known. Items for which actual results may differ materially from these estimates are described in the following section.
Refer to Note 2 “Summary of Significant Accounting Policies” within the Consolidated Financial Statements for further information on our critical accounting estimates and policies, which are as follows:
Goodwill and indefinite-lived intangible assets
Goodwill and indefinite-lived intangible assets are not subject to amortization. We test goodwill and indefinite-lived intangible assets for impairment annually, or more frequently if an event occurs or circumstances change that could indicate a potential impairment. We compare the fair value of our reporting units with their carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value.
We believe that the accounting estimate for goodwill and indefinite-lived intangible assets is a critical accounting estimate because of the judgment required in assessing the fair value of each of our reporting units. We estimate fair value through various valuation methods, including the use of discounted expected future cash flows of each reporting unit as well as the use of the relief-from-royalty method on the Lord JonesTM brand. The expected future cash flows for each reporting unit are significantly impacted by current market conditions. If these market conditions and resulting expected future cash flows for each reporting unit decline significantly, the actual results for each segment could differ from our estimate, which would cause goodwill to be impaired. Our accounting for goodwill and indefinite-lived intangible assets represents our best estimate of future events.
Based on our assessments and after considering potential triggering events, including COVID-19, we recognized an impairment loss related to goodwill and indefinite life intangible assets of $35 million and $5 million in the U.S. reporting unit, respectively, in FY 2020. During our annual quantitative impairment test in the fourth quarter of 2020, no further impairment was recorded. Both fair values of the goodwill as well as the Lord JonesTM brand exceeded carrying value by more than 10%. No impairment was recorded in FY 2019 or FY 2018.
Inventory valuation
We value our inventory at lower of cost or net realizable value determined using weighted average cost. Inventory is reflected at the lower of cost or net realizable value considering future demand, market conditions and market prices. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management's assumptions which do not reflect unanticipated events and circumstances that may occur. We record an inventory valuation adjustment for excess, slow moving, and obsolete inventory that is equal to the excess of the cost of the inventory over the estimated net realizable value. We also experience inventory write-downs due to reduced market prices. The inventory valuation adjustment to net realizable value establishes a new cost basis of the inventory that cannot be subsequently reversed. Inventory valuation adjustments are based on inventory levels, expected product life, and estimated product demand. In assessing the ultimate realization of inventories, we are required to make judgments as to future demand requirements compared with inventory levels.
Share-based compensation
We measure the fair value of services received in exchange for all stock options granted based on the fair market value of the award as of the grant date. We compute the fair value of stock options with time-based vesting using the Black-Scholes option-pricing model and recognize the cost of the equity awards over the period that services are provided to earn the award. The Black-Scholes option-pricing model includes assumptions regarding dividend yields, expected volatility, expected option term and risk-free interest rates. The assumptions used in computing the fair value of share-based compensation expense reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. We estimate expected volatility based primarily on historical daily price changes of our stock and peers. The expected option term is the number of years that we estimate that the stock options will be outstanding prior to exercise.
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Valuation of derivative liabilities
Derivative liabilities consist of the Altria Warrant, Pre-emptive Rights, and certain Top-up Rights. We measure derivative liabilities at fair value at each reporting date until settlement with the re-measurement gain or loss being recognized immediately in net income (loss) and comprehensive income (loss). We calculate fair value of the derivative liability using the Black-Scholes model. Significant assumptions are used in the valuation of derivative liabilities, including the volatility of the share price of our Company and our peers, expected dividend yield, expected term and expected risk-free interest rate. The assumptions used in computing the fair value of derivative liabilities reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. Sensitivity is performed on various inputs, refer to Note 14 “Derivative Liabilities” in Item 8 of this Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest rate risk
Interest rate risk is the risk that the value or yield of fixed-income investments may decline if interest rates change. Fluctuations in interest rates may impact the level of income and expense recorded on the cash equivalents and short-term investments, and the market value of all interest-earning assets, other than those which possess a short-term to maturity. During the year ended December 31, 2020, the Company had net interest income of $18.4 million (December 31, 2019 – $28.0 million). A 10% change in the interest rate in effect on December 31, 2020 and December 31, 2019, would not have a material effect on (i) fair value of the cash equivalents and short-term investments as the majority of the portfolio has a maturity date of three months or less, or (ii) net interest income. Management continues to monitor external interest rates and revise the Company’s investment strategy as a result.
During the year ended December 31, 2020, the Company’s average variable interest rate fell 1.49%, which resulted in a decrease of net interest income, of $15.7 million in the period. During the year ended December 31, 2019, the Company’s average variable interest rate did not materially change.
Currency rate risk
Currency rate risk is the risk that the fair value of, or future cash flows from, the Company’s financial instruments will significantly fluctuate due to changes in foreign exchange rates. The Company is exposed to this risk on advances to joint ventures denominated in A$. The Company is further exposed to this risk through subsidiaries operating in Israel and the U.S. as the Company’s functional currency is in Canadian dollars. The Company does not currently use foreign exchange contracts to hedge its exposure to currency rate risk. As such, the Company’s financial position and financial results may be adversely affected by the unfavorable fluctuations in currency exchange rates.
As of December 31, 2020, the Company had foreign currency gain on translation of $15.0 million (December 31, 2019 – $37.7 million). A 10% change in the exchange rates for the foreign currencies would affect the carrying value of net assets by approximately $170.8 million as of December 31, 2020 (December 31, 2019 – $174.9 million).
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Reports of KPMG LLP, Independent Registered Public Accounting Firm 67
Consolidated Balance Sheets 71
Consolidated Statements of Net Income (Loss) and Comprehensive Income (Loss) 72
Consolidated Statements of Changes in Shareholders’ Equity (Deficit) 74
Consolidated Statements of Cash Flows 76
Notes to Consolidated Financial Statements 77
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Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors Cronos Group Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Cronos Group Inc. (the Company) as of December 31, 2020 and December 31, 2019, the related consolidated statements of net income (loss) and comprehensive income (loss), changes in shareholders’ equity (deficit), and cash flows for each of the years in the three‐year period ended December 31, 2020, and the related notes (collectively, the consolidatedfinancial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and December 31, 2019, and the results of its operations and its cash flows for each of the years in the three‐year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 26, 2021, expressed an adverse opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the Audit Committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Evaluation of sufficiency of audit evidence over inventory
As discussed in Note 5 to the consolidated financial statements, inventory consists of raw materials; dry cannabis and cannabis extracts work-in-progress; dry cannabis and cannabis extract finished goods; and supplies and consumables. The Company’s total inventory as of December 31, 2020 was $44,002 thousand. The accuracy of inventory quantities is dependent upon the performance of an annual physical count and appropriately recording adjustments to inventory quantities in the Company’s inventory process. The Company has also identified a material weakness related to inventory as of December 31, 2020.
We identified the evaluation of the sufficiency of audit evidence over the accuracy of inventory quantities as a critical audit matter. Evaluating the sufficiency of the audit evidence obtained required especially subjective auditor judgment because of the material weakness described above.
The following are the primary procedures we performed to address this critical audit matter. We applied auditor judgment to determine the nature and extent of procedures to be performed over inventory. We increased the number of inventory samples selected to perform certain procedures compared to those we would have selected if the Company’s internal controls were operating effectively at year end. We performed independent test counts of inventory quantities. We compared the results of our independent test counts to the Company’s inventory records. We confirmed with third parties a selection of inventory quantities held by them. We evaluated the overall sufficiency of audit evidence obtained by assessing the results of procedures performed.
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Evaluation of the impairment analysis for goodwill in the U.S. reporting unit and the Lord JonesTM brand indefinite life intangible asset
As discussed in Note 2(k) to the consolidated financial statements, goodwill and indefinite life intangible assets are not amortized but are reviewed for impairment annually or more frequently when events or changes in circumstances indicate that fair value of the reporting unit has been reduced to less than its carrying value. As discussed in Note 11 to the consolidated financial statements, the Company had $178,414 thousand of goodwill in the U.S. reporting unit and an indefinite life intangible asset of $59,000 thousand from the Lord JonesTM brand. The Company recorded $35,000 thousand of impairment charges on the goodwill recorded in the U.S. reporting unit and $5,000 thousand of impairment charges on the Lord JonesTM brand indefinite life intangible asset in the year ended December 31, 2020.
We identified the evaluation of the impairment analysis for goodwill in the U.S. reporting unit and the Lord JonesTM brand indefinite life intangible asset as a critical audit matter. The evaluation of the Company’s key assumptions used in the discounted cash flow valuation model, including the growth rates, the discount rates, and forecasted royalty income from the Lord JonesTM brand indefinite life intangible asset, required a high degree of auditor judgment.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Company’s impairment process, including a control related to the determination and assessment of the reasonableness of key assumptions used in the discounted cash flow valuation model. We evaluated the key assumptions used in the discounted cash flow valuation model, including comparing forecasted growth rates against external analyst expectations for the industry in the United States. We also performed sensitivity analysis on the forecasted growth rates and forecasted royalty income to assess the impact on the Company’s fair value estimate. We compared a selection of royalty rates of comparable entities used by the Company to determine the royalty rate used in the discounted cash flow valuation model to publicly available information. We involved valuation professionals with specialized skills and knowledge who assisted in:
•evaluating the discount rate, by comparing it against the internal rate of return and comparing the weighted average cost of capital to a range that was independently developed using publicly available market data for comparable entities.
•evaluating the royalty rate, which was applied to estimate forecasted revenues, to calculate forecasted royalty income, using industry knowledge and consideration of comparable brand royalty rates and qualitative factors specific to the brand.
/s/ KPMG LLP
Chartered Professional Accountants, Licensed Public Accountants
We have served as the Company’s auditor since 2018.
Vaughan, Canada
February 26, 2021
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Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors Cronos Group Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited Cronos Group Inc.’s (the Company) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, because of the effect of the material weakness, described below, on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and December 31, 2019, the related consolidated statements of net income (loss) and comprehensive income (loss), changes in shareholders’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements), and our report dated February 26, 2021 expressed an unqualified opinion on those consolidated financial statements.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. A material weakness related to the following has been identified and included in management’s assessment:
Inventory verification: Management failed to properly design and execute sufficient procedures to verify inventory quantities. Specifically, while inventory counts were performed in the fourth quarter, (i) the aggregate value of items excluded from the count exceeded the Company’s materiality threshold, and (ii) human error in count execution, data transposition and reconciliation analysis resulted in inaccurate adjustments.
The material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2020 consolidated financial statements, and this report does not affect our report on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A(b)(i) of the Form 10-K). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Chartered Professional Accountants, Licensed Public Accountants
February 26, 2021
Vaughan, Canada
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CRONOS GROUP INC.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019
Cronos Group Inc.
Consolidated Balance Sheets
As of December 31, 2020 and 2019
(In thousands of U.S. dollars)
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As of December 31,
Assets
Current assets
Current portion of loans receivable 7,083 4,664
Investments in equity accounted investees 19,235 557
Liabilities
Current liabilities
Accounts payable and other liabilities $ 42,102 $ 35,301
Current portion of lease obligation 1,322 427
Due to non-controlling interests 2,188 1,844
Commitments and contingencies(iii)
Shareholders’ equity
Accumulated other comprehensive income 42,999 27,838
Total equity attributable to shareholders of Cronos Group 1,711,364 1,749,883
Non-controlling interests (3,196) (853)
(i)Net of current expected credit loss allowance of $74 as of December 31, 2020 (December 31, 2019 – $136)
(ii)Refer to Note 14 in the notes to the consolidated financial statements.
(iii)Refer to Note 20 and Note 21 in the notes to the consolidated financial statements.
(iv)Authorized for issuance as of December 31, 2020: unlimited (December 31, 2019 – unlimited).
(v)Shares issued as of December 31, 2020: 360,253,332 (as of December 31, 2019: 348,817,472)
See notes to consolidated financial statements.
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Cronos Group Inc.
Consolidated Statements of Net Income (Loss) and Comprehensive Income (Loss)
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S dollars, except share and per share amounts)
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Year ended December 31,
Operating expenses
Repurposing charges — 5,328 —
Other income (expense)
Gain on revaluation of derivative liabilities(i) 129,254 1,276,819 —
Impairment loss on goodwill and intangible assets (40,000) — —
Financing and transaction costs (40) (32,208) —
Income tax expense 1,347 — —
Loss from discontinued operations (650) (363) (894)
Net income (loss) attributable to:
Net income (loss) per share
Weighted average number of outstanding shares
(i)Refer to Note 14 in the notes to the consolidated financial statements
(ii)In computing diluted earnings per share, incremental common shares are not considered in periods in which a net loss is reported, as the inclusion of the common share equivalents would be anti-dilutive.
See notes to consolidated financial statements.
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Cronos Group Inc.
Consolidated Statements of Net Income (Loss) and Comprehensive Income (Loss)
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S dollars, except share and per share amounts)
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Year ended December 31,
Other comprehensive income (loss)
Gain on revaluation and disposal of other investments, net of tax — — 3
Comprehensive income (loss) attributable to:
See notes to consolidated financial statements.
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Cronos Group Inc.
Consolidated Statements of Changes in Shareholders’ Equity (Deficit)
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S dollars, except number of share amounts)
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Share issuance costs — (7,577) — — — — (7,577)
Contribution by non-controlling interests — — — — — 287 287
Other comprehensive income (loss) — — — — (12,328) (6) (12,334)
Share issuance costs — (3,722) — — — — (3,722)
Vesting of restricted share units — — 889 — — — 889
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Cronos Group Inc.
Consolidated Statements of Changes in Shareholders’ Equity (Deficit)
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S dollars, except number of share amounts)
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Restricted share units settled 414,088 — — — — —
Vesting of restricted share units — — 8,176 — — — 8,176
Taxes withheld on vesting of restricted share units — — (2,148) — — — (2,148)
Top-up Rights exercised — 3,265 — — — — 3,265
See notes to consolidated financial statements.
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Cronos Group Inc.
Consolidated Statements of Cash Flows
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S dollars)
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Year ended December 31,
Operating activities
Items not affecting cash:
Gain on revaluation of derivative liabilities (i) (129,254) (1,276,819) —
Impairment on goodwill and intangible assets 40,000 — —
Provisions for inventory and doubtful accounts 3,741 136 —
Share of loss from investments in equity accounted investees 4,510 2,009 723
Non-cash sales and marketing 2,863 410 —
Income tax expense 1,347 — —
Non-cash repurposing costs — 4,439 —
Other non-cash operating activity expense (income) (123) (243) (9)
Investing activities
Proceeds from (purchase of) short-term investments, net 95,404 (299,923) —
Investments in equity accounted investees — (1,658) (480)
Acquisition of Redwood — (224,295) —
Other non-cash investing activity expense (income) — 415 (231)
Financing activities
Advance to non-controlling interests (1,019) — —
Repayment of lease obligations (2,414) (919) —
Withholding taxes paid on equity awards (2,148) (915) (16)
Proceeds from Altria Investment — 1,809,556 —
Proceeds from exercise of Top-up Rights — 67,051 —
Proceeds from exercise of warrants and options 116 1,455 2,612
Proceeds from share issuance — — 115,510
Proceeds from construction loan payable — — 11,583
Repayment of construction loan payable — (15,971) —
Advance under Credit Facility — 48,715 —
Repayment of Credit Facility — (48,309) —
(i)Refer to Note 14 in the notes to the consolidated financial statements
See notes to consolidated financial statements.
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Cronos Group Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S. dollars, except for gram and share amounts)
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1. Background
Cronos Group Inc. (“Cronos Group” or the “Company”) is incorporated in the Province of British Columbia and under the British Columbia Business Corporations Act with principal executive offices at 111 Peter St. Street, Suite 300, Toronto, Ontario, M5V 2H1. The Company’s common shares are currently listed on the Toronto Stock Exchange (“TSX”) and Nasdaq Global Market (“Nasdaq”) under the ticker symbol “CRON.”
Cronos Group is an innovative global cannabinoid company, with international production and distribution across five continents. The Company is committed to building disruptive intellectual property by advancing cannabis research, technology and product development and is seeking to build an iconic brand portfolio. Cronos Group’s brand portfolio includes PEACE NATURALSTM, a global wellness platform; two adult-use brands, COVETM and SpinachTM; and three U.S hemp-derived consumer products brands, Lord JonesTM, Happy DanceTM and PEACE+TM.
Cronos Group has established four strategic joint ventures in Canada, Israel, and Colombia. Cronos Israel (as defined herein) is consolidated for financial reporting purposes. The Company also holds approximately 31% of the issued capital of Cronos Australia Limited (“Cronos Australia”) and accounts for its investment in Cronos Australia under the equity method of accounting. For additional discussion regarding the joint ventures and strategic investment, see Note 6.
2. Summary of Significant Accounting Policies
(a)Basis of presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the dates of the consolidated financial statements and the reported amounts of net revenues and expenses during the reporting periods. The accounting policies adopted in the preparation of the consolidated financial statements were effective as of January 1, 2020.
(b)Segment structure
The Company undertook a realignment of its management structure along geographic regions in September 2019. As a result, effective September 2019, the Company’s results are reported through the following operating segments: United States and Rest of World. Prior period amounts contained in these consolidated financial statements have been adjusted to conform to the new segment presentation. Refer to Note 29 for additional information.
(c)Basis of consolidation
The accompanying consolidated financial statements include the accounts of the Company, and all entities in which the Company has a controlling voting interest or is the primary beneficiary of a variable interest as of and for the fiscal years ended December 31, 2020, December 31, 2019 and December 31, 2018. The Company assesses control under the variable interest entity (“VIE”) model to determine whether the Company is the primary beneficiary of that entity’s operations. If an entity is not deemed to be a VIE, the Company consolidates the entity if the Company has a controlling voting interest. Subsidiaries are fully consolidated from the date on which control is transferred to the Company. They are deconsolidated from the date that control ceases. Investments in which the Company has the ability to exercise significant influence over the operating and financial policies of the investee, but does not have control, are accounted for under the equity method of accounting.The Company consolidates the financial results of the following entities, which the Company controls:
Cronos Israel G.S. Cultivation Ltd.(i) Israel February 4, 2018 70%
Cronos Israel G.S. Manufacturing Ltd.(i) Israel September 4, 2018 90%
Cronos Israel G.S. Store Ltd.(i) Israel June 28, 2018 90%
Cronos Israel G.S. Pharmacy Ltd.(i) Israel February 15, 2018 90%
(i)These Israeli entities are collectively referred to as “Cronos Israel.”
(ii)“Ownership interest” is defined as the proportionate share of net income to which the Company is entitled; equity interest may differ from ownership interest as described herein.
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Cronos Group Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S. dollars, except for gram and share amounts)
Table of Contents
In the consolidated statements of net income (loss) and comprehensive income (loss), the net income (loss) and comprehensive income (loss) are attributed to the equity holders of the Company and to the non-controlling interests. Non-controlling interests in the equity of Cronos Israel are presented separately in the shareholders’ equity (deficit) section of the consolidated balance sheets and consolidated statements of shareholders’ equity (deficit). All intercompany transactions and balances are eliminated upon consolidation.
(d)Use of estimates
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Significant estimates and assumptions include, among other things, valuation of derivative liabilities, fair value of assets and liabilities assumed in business combinations, impairment of goodwill, inventory write-downs, valuation allowance on deferred income tax assets and uncertain tax liabilities. Actual results could differ from those estimates.
(e)Revenue recognition
The Company’s contracts with customers for the sale of dried cannabis, cannabis oil, cannabinoid-derived products and U.S. hemp-derived personal care products consist of one performance obligation. The Company has concluded that revenue from the sale of these products should be recognized at the point in time when control is transferred to the customer, which is on shipment or delivery, depending on the contract. Revenue is recognized at the transaction price, which is the amount of consideration to which the Company expects to be entitled in exchange for transferring promised goods to a customer.
Net revenue before excise taxes from sale of goods, as presented in the consolidated statements of net income (loss) and comprehensive income (loss), represents revenue from the sale of goods less expected price discounts, and allowances for customer returns. Net revenue before excise taxes excludes excise taxes, which the Company pays as principal and excludes duties and taxes collected on behalf of third parties. Excise taxes are a production tax classified as government remittances payable, which when applicable, become payable when a product is delivered to the customer and are not directly related to the value of revenue.
The Company treats shipping and handling activities as a fulfillment cost, classified as cost of sales. Accordingly, the Company accrues all fulfillment costs related to the shipping and handling of consumer goods at the time of shipment. Within the Company's Rest of World segment, dried cannabis sales outside of Canada may include profit sharing arrangements with distributors which give rise to variable consideration. If the consideration in a contract includes a variable amount, the Company estimates the amount of consideration to which it will be entitled in exchange for transferring the goods to the customer. The variable consideration is estimated as the most likely amount, based on the Company’s historical information, at contract inception.
The Company’s payment terms vary by customer and product type. For individual consumer sales, payment is due prior to the transfer of control.
The Company elected to treat the costs incurred to obtain a contract, primarily related to sales commissions, as an expense in the period incurred and not an asset to be capitalized, as the amortization period of the related asset would be less than one year. Accordingly, the Company will expense the costs to obtain a contract in the period incurred.
(f)Investments
Variable interest entities (“VIE”)
A VIE is an entity having either a total equity investment that is insufficient to finance its activities without additional subordinated financial support or equity investors at risk that lack the ability to control the entity’s activities. Variable interests are investments or other interests that will absorb portions of a VIE’s expected losses or receive portions of the VIE’s expected residual returns. The Company evaluates whether it is the primary beneficiary of each VIE it identifies on an ongoing basis and considers the impact of any reconsideration events. The primary beneficiary is the party that has both the power to direct the activities that most significantly impact the VIE and holds a variable interest that could potentially be significant to the VIE. To make this determination the Company considers both quantitative and qualitative factors regarding the nature, size and form of its involvement with the VIE. The Company consolidates the VIE when it is determined that it is the primary beneficiary of the VIE.
Equity method investments
The Company accounts for investments in companies over which it has the ability to exercise significant influence but does not hold a controlling financial interest, using the equity method. Under the equity method, the Company records its proportionate share of income or losses in the consolidated statements of net income (loss) and comprehensive income (loss). If the current fair value of an investment falls below its carrying amount, this may indicate that an impairment loss should be recorded. Any impairment losses recognized cannot be reversed in subsequent periods.
78
Cronos Group Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S. dollars, except for gram and share amounts)
Table of Contents
(g)Inventory
Inventory is comprised of raw materials, finished goods and work-in-progress such as pre-harvested cannabis plants, by-products to be extracted, oils, gel caps, tinctures, and boxes. The costs of growing cannabis, including but not limited to labor, utilities, nutrition and irrigation, are capitalized into inventory until the time of harvest.
Inventory is stated at the lower of cost and net realizable value, determined using weighted average cost. Cost includes expenditures directly related to manufacturing and distribution of the products. Primary costs include consumables (insect control, fertilizers, soil), packaging, shipping, direct labor, overhead, supplies and small tools, and the depreciation of manufacturing equipment and production facilities determined at normal capacity. Manufacturing overhead and related expenses include salaries, wages, employee benefits, rent, utilities, security, and property taxes.
Net realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. At the end of each reporting period, the Company performs an assessment of inventory obsolescence to measure inventory at the lower of cost and net realizable value. Factors considered in the determination of obsolescence include slow-moving or non-marketable products. During the year ended December 31, 2020, we incurred significant inventory write-downs driven by pricing pressures in the marketplace and will continue assessing pricing pressures on the value of inventory at the end of each reporting period. See Note 5.
(h)Definite life intangible assets
Intangible assets are recorded at cost less any accumulated amortization and accumulated impairment losses. Intangible assets acquired through a business combination are measured at fair value at the acquisition date.
The Company capitalizes certain costs incurred in connection with its enterprise software, which include external direct costs of materials and services consumed in developing or obtaining internal-use software, payroll and payroll-related costs for employees who are directly associated with and who devote time to the development of the software for the function intended. All other costs are expensed as incurred.
Intangible assets with finite useful lives are amortized over their estimated useful lives using the following methods and rates:
Method Rate
Software Straight-line 5 years
Enterprise resource planning (“ERP”) software Straight-line 5 years
Health Canada licenses Straight-line Useful life of corresponding facilities
Israeli codes(i) Straight-line Useful life of corresponding facilities
(i) The preliminary licenses granted to Kibbutz Gan Shmuel (the Cronos Israel joint venture partner) by the Medical Cannabis Unit of the Israeli Ministry of Health in early 2017 (the “Israeli codes”) were transferred by non-controlling interests to Cronos Israel in exchange for equity interests in the Cronos Israel entities specified above.
Amortization begins when assets become available for use. The estimated useful life, amortization method, and rate are reviewed at the end of each reporting period, with the effect of any changes in estimate being accounted for on a prospective basis.
(i)Property, plant & equipment
Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:
Rate
Building 15 to 25 years
Furniture and equipment 5 to 7 years
Computer equipment 5 years
Leasehold improvements Lesser of term of lease and useful life
Equipment under finance lease Lesser of term of lease and useful life
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Cronos Group Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S. dollars, except for gram and share amounts)
Table of Contents
When assets are disposed of, the cost and accumulated depreciation are removed from the respective accounts and any related gain or loss is recognized. Maintenance and repairs are charged to expense as incurred. Significant expenditures, which increase productivity or extend the useful life of the asset, are capitalized.
Interest incurred relating to construction or expansion of buildings is capitalized to construction in progress. The Company ceases the capitalization of interest when construction activities are substantially completed and the facility is available for use. At this point, construction in progress is transferred to the appropriate asset class. Available for use is defined as the point at which the related building receives the requisite regulatory licenses to (i) possess cannabis, (ii) obtain dried cannabis, fresh cannabis, cannabis plants or cannabis plant seeds by cultivating, propagating and harvesting cannabis, and (iii) produce cannabis, other than obtaining it by cultivating, propagating, or harvesting. Depreciation commences at the point the assets are available for use.
(j)Leases
The Company enters into leases in the normal course of business, primarily for the land-use rights, office premises, and equipment used in the production of its products. At the inception of a contract, the Company assesses whether a contract is, or contains, a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The Company performs an analysis over the classification of the lease agreement as either an operating lease or finance lease.
A right-of-use asset and the related lease obligation associated with the lease are recorded at the inception of the lease. The right-of-use asset’s recorded amount is based on the present value of future lease payments over the lease term at the commencement date plus any initial direct costs incurred. If the rate implicit in the lease is not readily determinable for the Company’s operating leases, an incremental borrowing rate is generally used based on information available at the lease commencement date to determine the present value of future lease payments. Subsequent changes to these lease payments due to rate updates are recorded as lease expense in the period incurred. Leases with a term of 12 months or less are not recorded on the balance sheet as a lease.
The right-of-use asset is subject to impairment testing whenever events or changes in circumstances indicate the carrying value of the asset may not be recoverable. The leased asset is amortized over the shorter of the lease term or its estimated useful life if title does not transfer to the Company, while the leased asset is depreciated in accordance with the Company’s depreciation policy if the title is to eventually transfer to the Company.
The Company’s lease agreements generally exclude non-lease components. As a result, non-lease components are accounted for separately for all classes of assets and expensed as incurred. In addition, the Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. For finance leases, from the commencement date to the earlier of the end of the useful life of the right-of-use asset or the end of the lease term, the right-of-use asset is amortized on a straight-line basis and the interest expense is recognized on the lease liability using the effective interest method. For operating leases, lease expense is recognized on a straight-line basis over the term of the lease and presented as a single charge in the consolidated statements of net income (loss) and comprehensive income (loss).
(k)Impairment of long-lived assets
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The Company groups assets at the lowest level for which cash flows are separately identifiable, referred to as an asset group. The Company prepares projected undiscounted cash flow analyses for each asset or asset group. If the sum of the undiscounted cash flow is less than the carrying value of the asset or asset group, an impairment loss is recognized equal to the excess of the carrying value over the fair value, if any. Impairment losses on assets held for sale are based on the fair value, less costs to sell.
Goodwill and indefinite life intangible assets are not amortized. Goodwill and indefinite life intangible assets are reviewed for impairment annually or more frequently when events or changes in circumstances indicate that fair value of the reporting unit has been reduced to less than its carrying value. The Company performs an impairment test annually in the fourth quarter by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered to be impaired. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The Company determined that it has two reporting units: the U.S. reporting unit and the Rest of World reporting unit.
80
Cronos Group Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S. dollars, except for gram and share amounts)
Table of Contents
(l)Repurposing charges
The Company’s repurposing charges primarily include employee termination benefits and refurbishment costs. The recognition of repurposing charges requires the Company make certain judgments and estimates regarding the nature, timing, and amount of costs associated with the planned activity. To the extent actual results differ from estimates and assumptions, a revision to the estimated liabilities, requiring the recognition of additional repurposing charges or the reduction of liabilities already recognized may be required. At the end of each reporting period, the Company evaluates the remaining accrued balances to ensure these balances are properly stated and the utilization of the reserves are for their intended purpose in accordance with planned activity.
(m)Capital stock
Capital stock is presented at the fair value at the time of issuance of the shares issued. Costs related to the issuance of shares are reported in equity, net of tax, as a deduction from the issuance proceeds.
(n)Foreign currency
The Company’s functional currency is the Canadian dollar (“C$”). Prior to the year ended December 31, 2019, the Company reported its financial results in C$, however following the change in the Company’s status from foreign private issuer to a United States (“U.S.”) domestic issuer, the financial results are now reported in U.S dollars (“dollars” or “$”). Functional currencies for the entities in these consolidated financial statements are their respective local currencies, including C$, Australian dollars (“A$”) and Israeli New Shekel (“ILS”). The assets and liabilities of the Company’s foreign operations are translated into dollars at the exchange rate in effect as of December 31, 2020 and 2019. Transactions affecting the shareholders’ equity (deficit) are translated at historical foreign exchange rates. The consolidated statements of net income (loss) and comprehensive income (loss) and the consolidated statements of cash flows of the Company’s foreign operations are translated into dollars by applying the average foreign exchange rate in effect for the reporting period. The cumulative translation adjustments (“CTA”) resulting from translating the consolidated financial statements into their dollar reporting currency are recorded in other comprehensive income (loss).
Monetary assets and liabilities denominated in foreign currencies are translated to the functional currency by applying the foreign exchange rate in effect at the balance sheet date. Revenues and expenses are translated using the average foreign exchange rate for the reporting period. Realized and unrealized foreign currency differences are recognized in the consolidated statements of net income (loss) and comprehensive income (loss).
Transactions in foreign currencies are translated into the functional currency using the exchange rate prevailing at the date of the transaction and are recorded in other comprehensive income. Exchange differences arising from operating transactions are recorded in net income for the period.
(o)Income taxes
The Company uses the liability method of accounting for income taxes, under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when such assets and liabilities are recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the year that includes the enactment date. The Company determines deferred tax assets including net operating losses and liabilities, based on temporary differences between the book and tax bases of assets and liabilities.
A valuation allowance is established to reduce some or all net deferred tax assets to amounts that are more likely than not to be realized. The Company considers all available evidence, both positive and negative including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies, in assessing the need for a valuation allowance.
The Company has a full valuation allowance against its net deferred tax assets, and has concluded, based on the weight of all available evidence, that it is more likely than not that the net deferred tax assets will not be realized, primarily due to the historical net operating losses. The valuation allowance against the net deferred tax assets does not in any way impact the Company’s ability to use future tax deductions such as the Company’s net operating loss carryforwards; rather, the valuation allowance indicates, according to the provisions of Accounting Standards Codification 740, Income Taxes, it is more likely than not that the deferred tax assets will not be realized. The valuation allowance that was established will be maintained until there is sufficient positive evidence to conclude that it is more likely than not that the net deferred tax assets will be realized. The Company’s income tax expense for future periods will be reduced to the extent of corresponding decreases in our valuation allowance. There is uncertainty regarding any future realization of the benefit by the Company of all or part of our net deferred tax assets.
81
Cronos Group Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S. dollars, except for gram and share amounts)
Table of Contents
Judgment is required to determine the recognition and measurement attributes prescribed in the accounting guidance for uncertainty in income taxes. The Company uses a two-step approach for evaluating uncertain tax positions. Step one, recognition, requires us to determine if the weight of available evidence indicates that a tax position is more likely than not to be sustained upon audit, including resolution of related appeals or litigation processes, if any. If a tax position is not considered “more likely than not” to be sustained, no benefits of the position are recognized. If we determine that a position is “more likely than not” to be sustained, then we proceed to step two, measurement, which is based on the largest amount of benefit which is more likely than not to be realized on effective settlement. This process involves estimating our actual current tax exposure, including assessing the risks associated with income tax audits, together with assessing temporary differences resulting from the different treatment of items for tax and financial reporting purposes. If actual results differ from our estimates, our net operating loss and credit carryforwards could be materially impacted in the period which such determination is made.
The Company recognizes uncertain income tax positions at the largest amount that is more-likely-than-not to be sustained upon examination by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Recognition or measurement is reflected in the period in which the likelihood changes. Any interest and penalties related to unrecognized tax liabilities are presented within income tax expense in the consolidated statements of net income (loss) and comprehensive income (loss). Accrued interest and penalties are included in accounts payable and other liabilities in the consolidated balance sheets.
(p)Share-based compensation
As described in more detail below, the Company has five share-based compensation plans under which awards have been made: the 2020 Omnibus Plan (as defined below), the 2018 Stock Option Plan (as defined below), the 2015 Stock Option Plan (as defined below), the Employment Inducement Award Plan #1 (the “Employment Inducement Award Plan”) and a cash-settled deferred share unit (“DSU”) plan for non-executive directors.
Share-based compensation consists of equity-settled share-based awards such as stock options and restricted share units (“RSUs”) that are issued to eligible employees, non-executive directors, and non-employees.
Cash-settled deferred share units (“DSUs”) that are issued to non-executive directors are recorded in accounts payable and other liabilities with the fair value adjustment recorded in other income (loss).
Equity instruments granted are initially measured at fair value on the grant date. The fair value of the stock options are determined using the Black-Scholes option pricing model. The fair value of RSUs and DSUs are determined using the market price. This is recognized on a straight-line basis in the consolidated statements of net income (loss) and comprehensive income (loss) over the vesting period for employees, and over the contractual term for non-employees. The fair value of the payout of cash-settled DSUs is determined at each reporting date based on the fair value of the Company’s common shares at the reporting date and is recorded within other liabilities.
The related costs for all equity-settled share-based awards are reflected in additional paid-in capital until the awards are exercised. Upon exercise, shares are issued and the amount previously reflected in the additional paid-in capital is, along with any proceeds paid upon exercise, credited to share capital. Forfeitures are estimated at the time of grant, and the Company revises these estimates in subsequent periods if there is a difference in actual forfeitures and the estimates.
(q)Net earnings (loss) per share
The Company presents basic and diluted net earnings (loss) per share data for its common shares. Basic net earnings (loss) per share is calculated by dividing the profit or loss attributable to common shareholders of the Company by the weighted average number of common shares outstanding during the period. Diluted net earnings (loss) per share is determined by adjusting the profit or loss attributable to common shareholders and the weighted average number of common shares outstanding for the effects of all potentially dilutive common shares that are issuable upon exercise of warrants, stock options and the Altria Warrant (as defined below) as well as the vesting of RSUs outstanding.
(r)Cash and cash equivalents and short-term investments
Cash and cash equivalents are comprised of cash and highly liquid investments that are readily convertible into known amounts of cash with original maturities of three months or less. Cash and cash equivalents include amounts held in dollars, C$ and ILS and security deposits.
82
Cronos Group Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S. dollars, except for gram and share amounts)
Table of Contents
Short-term investments consist of debt securities that (i) have original maturities of greater than three months and (ii) the Company has the ability to convert into cash within one year. Short-term investments are classified as held-to-maturity. Our investments classified as held-to-maturity are recorded at cost. Interest earned on short-term investments is recorded in other receivables on the consolidated balance sheet and interest income on the consolidated statement of comprehensive income (loss). Cash inflows and outflows related to the purchase and maturity of short-term investments are classified as investing activities in the Company’s consolidated statements of cash flows.
(s)Derivative liabilities
For financial instruments that are not designated as hedging instruments or do not qualify for hedge accounting, changes in fair value are recorded in the consolidated statements of net income (loss) and comprehensive income (loss) each period. The Company does not enter into or hold derivative financial instruments for trading or speculative purposes. Derivative liabilities are initially recognized at fair value at the date on which the derivative contract was entered into. Any attributable transaction costs are recognized in net income (loss) as incurred. Subsequent to initial recognition, derivative liabilities are measured at fair value at each reporting date until settlement with the re-measurement gain or loss being recognized immediately in comprehensive income.
For more details on derivative liabilities consisting of the Altria Warrant, Pre-emptive Rights, and certain Top-up Rights, see Note 14.
(t)Fair value measurements
The carrying value of the Company’s cash and cash equivalents, accounts receivable, other receivables, loan receivable, account payables and other liabilities and holdbacks payable approximate fair value, given their short-term nature.
Cronos Group uses a fair value hierarchy, which gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities, noted as Level 1 measurements, and the lowest priority to unobservable inputs, noted as Level 3 measurements. The following are the three levels of inputs used to measure fair value:
•Level 1 – valuation based on quoted prices (unadjusted) in active markets for identical assets and liabilities.
•Level 2 – valuation techniques based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.
•Level 3 – valuation techniques using the inputs for the asset or liability that are not based on observable market data.
The Company’s policy for determining when transfers between levels of the fair value hierarchy occur is based on the date of the event or changes in circumstances that caused the transfer.
(u)Acquisitions
The accounting basis for each acquisition is dependent on whether the integrated set of assets and activities acquired constitutes a business. A business consists of inputs and processes applied to those inputs that have the ability to contribute to the creation of outputs. The cost of acquisition is allocated to the assets acquired on a relative fair value basis. No goodwill is recognized in an asset acquisition. If it is determined that a business is not acquired, the transaction is accounted for as an asset acquisition and the relevant values are finalized prior to the next reporting period. On the other hand, when a business is acquired, the acquisition method of accounting in accordance with Accounting Standards Codification (“ASC”) 805 is applied, which requires that once control of the business is obtained, the assets and liabilities of the acquired business, including amounts attributable to non-controlling interests, be recorded at their respective fair values as of the date of acquisition. Any excess of purchase consideration over the net fair value of tangible and identified intangible assets acquired less liabilities assumed is recorded as goodwill. The costs of business acquisitions, including fees for accounting, legal, professional consulting and valuation specialists, are expensed as incurred. Purchase price allocations may be preliminary and, during the measurement period not to exceed one year from the date of acquisition, changes in assumptions and estimates that result in adjustments to the fair value of assets acquired and liabilities assumed are recorded in the period the adjustments are determined.
For business combinations achieved in stages, the Company’s previously held interest in the acquiree is remeasured at its subsequent acquisition date fair value, with the resulting gain or loss recorded in the consolidated statements of net income (loss) and comprehensive income (loss). For a pre-existing relationship between the Company and acquiree that is not extinguished on the business combination, such a relationship is considered effectively settled as part of the business combination even if it is not legally cancelled. At the acquisition date, it becomes an intercompany relationship and is eliminated upon consolidation.
83
Cronos Group Inc.
Notes to Consolidated Financial Statements
For the years ended December 31, 2020, 2019, and 2018
(In thousands of U.S. dollars, except for gram and share amounts)
Table of Contents
Contingent consideration in a business combination is initially measured at fair value. Subsequently all liability classified as contingent consideration is remeasured at fair value at each reporting period until the contingency is resolved and any change in the fair value following the date of acquisition is recorded in the consolidated statements of net income (loss) and comprehensive income (loss). All equity classified as contingent consideration is not remeasured and its subsequent settlement is accounted for within equity.
(v)Assets held for sale and discontinued operations
In accordance with ASC 205-20 Presentation of Financial Statements: Discontinued Operations, a disposal of a component of an entity or a group of components of an entity is required to be reported as discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results when the components of an entity meet the criteria in paragraph 205-20-45-10. In the period in which the component meets held-for-sale or discontinued operations criteria the major current assets, other assets, current liabilities, and noncurrent liabilities shall be reported as components of total assets and liabilities separate from those balances of the continuing operations. At the same time, the results of all discontinued operations, less applicable income taxes (benefit), shall be reported as components of net income (loss) separate from the net income (loss) of continuing operations.
During the year ended December 31, 2020, OGBC, formerly included within the Rest of World segment, met the criteria for “held-for-sale”. As a result, the Company has reflected amounts relating to OGBC as a disposal group classified as held-for-sale on the consolidated balance sheet and included as part of discontinued operations on the consolidated statement of net income (loss) and comprehensive income (loss) for all periods presented in this Annual Report. OGBC is no longer included in the segment reporting following the reclassification to discontinued operations. The discontinued operations of OGBC are described further in Note 30.
3. New Accounting Pronouncements
(a)Adoption of new accounting pronouncements
On January 1, 2020, the Company adopted ASU No. 2018-13, Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820) (“ASU No. 2018-13”). ASU No. 2018-13 adds, modifies, and removes certain fair value measurement disclosure requirements. The adoption of ASU No. 2018-13 did not have a material impact on the Company’s consolidated financial statements.
On January 1, 2020, the Company adopted ASU No. 2018-15, Intangibles – Goodwill and Other Internal-use-software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU No. 2018-15”). ASU No. 2018-15 amends current guidance to align the accounting for costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing costs associated with developing or obtaining internal-use software. The guidance in ASU No. 2018-15 is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. The adoption of ASU No. 2018-15 did not have a material impact on the Company’s consolidated financial statements.
On January 1, 2020, the Company adopted ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment (“ASU No. 2017-04”). ASU No. 2017-04 eliminates step 2 from the goodwill impairment test and instead requires an entity to measure the impairment of goodwill assigned to a reporting unit if the carrying value of assets and liabilities assigned to the reporting unit, including goodwill, exceeds the reporting unit’s fair value. The guidance in ASU No. 2017-04 is effective for annual and interim goodwill tests completed by the Company beginning on January 1, 2020. The adoption of ASU No. 2017-04 was applied prospectively and the Company follows a one-step model for goodwill impairment.
(b)New accounting pronouncements not yet adopted