Cronos Group Inc (CRON) Q4 2018 Earnings Conference Call Transcript

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Cronos Group Inc. (NASDAQ: CRON)Q4 2018 Earnings Conference CallMarch 26, 2019, 8:30 a.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, please stand by. Cronos Group's Fourth Quarter and Full Year 2018 Earnings Conference Call, will begin momentarily. Thank you for your patience, and please, continue to stand by.

Good morning. My name is Michelle, and I will be your conference operator today. I would like to welcome everyone to Cronos Group's Fourth Quarter and Full Year 2018 Earnings Conference Call. Today's call is being recorded.

At this time, I would like to turn the call over to Anna Shlimak, Investor Relations. Please, go ahead.

Anna Shlimak -- Investor Relations and Communications

Thank you, Michelle. And thank you for joining us today to review Cronos Group's fourth quarter and full year 2018 financial and business. I am joined by our Chairman, President and CEO, Mike Gorenstein and our CFO, William Hilson.

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

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

Management, can give no assurance that any forward-looking statements will prove to be correct. Forward-looking statements during this call speak only as of the original date of this call, and we undertake no obligations to update or revise any of these statements except as required by applicable law. Management refers to the cautionary statement and risk factors included in the company's most recent MD&A and Annual Information Form by which any forward-looking statements made during this call are qualified in their entirety. We will now make prepared remarks, and then, we will move to a question-and-answer session.

With that, I'll turn the call over to Mike.

Michael Gorenstein -- Chairman, Chief Executive Officer, President

Thank you, Anna, and good morning, everyone. During my remarks today, I'd like to do a year-end review. I think it's important to look back and reflect on all that we accomplished in just one year, as both our company and the industry move at such a fast pace.

2018, was a highly productive year for Cronos Group, with many notable company and industry milestones achieved. This past year, saw the legalization of cannabis for adult use, making Canada, the first G-7 country to legalize adult-use cannabis nationally. We are proud to be a participant in this emerging market.

As I mentioned before, the Canadian government's leadership in implementing a federally legal framework is the reason we chose to operate in Canada. When we set out on this journey 3 years ago, we knew the value of operating in a legal environment would allow us to learn, build, and create a company that has the potential to be a global industry leader. We take pride in leading the industry forward responsibly, and are motivated to create meaningful products that excite our consumers, and bring happiness in an improved quality of life.

The growth opportunities in the cannabis industry are vast, with our differentiated brands, global footprint, growing production capacity and supply chain, commitment to cannabinoid innovation, and a strategic investment from Altria Group, Cronos Group, is well positioned to realize these opportunities.

To set the stage for our earnings call today, I want to briefly review the four aspects of our strategy. At Cronos Group, we are establishing an efficient global production footprint and supply chain, developing a diversified global sales and distribution network, we are creating and monetizing disruptive intellectual property, and growing a portfolio of iconic brands that resonate with consumers.

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

The Cultivations Building 4, runs under a perpetual harvest cycle, similar to a manufacturing facility. Like other large-scale agricultural facilities, we expect that with each cycle, our yields will continue to improve as we dial in controls. We are very proud of this facility, our Peace Naturals campus, as a whole, and what we were able to build in such a short period of time.

While yield in cost-per-gram has been the standard unit cost metric for the cannabis industry to-date, we think this is starting to evolve. We still think that COGS will be an important measuring stick, but by that, I mean cost of goods sold, not cost of grams sold. Efficiency, in downstream processing and packaging in categories such as pre-rolls, will be a differentiator in an area we will increasingly focus on. And as value added products come online, the relevant cannabis cost will shift from grams of cannabis flower to milligrams of cannabinoid. And we've already seen the shift begin in the proposed tax regulations in Canada from weight of dried flower, to active ingredient.

With this shift in mind, we will continue working to optimize our supply chain toward final products. As supply catches up to demand, we believe that having experienced large-scale agricultural expertise and labor management practices will be extremely important. This is why our approach to further scaling at capacity involves taking our genetics, growing methodologies, and best practices that we developed at Peace Naturals, our center of excellence, and in creating co-manufacturing relationships with sophisticated agricultural operators around the world. We are confident and committed to our cultivation partnerships.

In Canada, we launched a joint venture, Cronos GrowCo, with a group of investors led by Bert Mucci, a leading Canadian large-scale greenhouse operator. As discussed during our previous earnings call, Cronos GrowCo is constructing an 850,000 square foot purpose-built greenhouse, which is expected to produce up to 70,000 kilos of cannabis, annually. Construction of the greenhouse has begun, and we expect to complete the superstructure of the greenhouse in the second half of 2019. And similar to how we're bringing Building 4 online, we expect this greenhouse to become operational in phases, in 2020.

We are also making progress on our international production footprint. First, turning to our joint venture of Cronos Israel, with the Israeli agricultural collective, Kibbutz Gan Shmuel. Cronos Israel, is focused on the production, manufacture and distribution of medical cannabis, and is in full construction. We anticipate the construction of the 45,000 square-foot greenhouse will be complete in the first half of 2019, and construction of the manufacturing facility will be complete in the second half of 2019.

Cronos, holds an effective 90% economic equity ownership across the entities in Cronos Israel. In January, 2019, the Israeli government approved the export of medical cannabis from Israel, which will allow license holders to export to countries that have explicitly approved the import of medical cannabis. We intend to pursue the licensing for, and export of medical cannabis products from Cronos Israel, to our European and global distribution partners, once production operations are up and running.

In 2018, we also brought our production model to Latin America. Cronos, announced a JV with a leading Columbian agricultural services provider, with over 30 years of research and expertise, managing industrial scale horticultural operations. This partnership, establishes the newly formed entity, NatuEra in Columbia, that will: develop, cultivate, manufacture, and export cannabis-based medical and consumer products for the Latin-American and global markets. NatuEra, was granted a license to cultivate non-psychoactive cannabis plants to produce seeds for planting and the manufacture of derivative products.

We understand that many investors are modeling cannabis companies off of capacity. However, our business model is not to be the former. We think that there will be value created across many verticals in the cannabis industry's value chain, including cultivation, and wholesale supply, research and development, branded product manufacturing, marketing, and retail. We see tremendous opportunity across the whole industry, but recognize that we can't be all things to all people. Rather, we will focus on areas where we see long-term sustainable value like, developing and marketing innovative-branded products, and then, work with experts in the other verticals.

This focus has proven successful in analogous industries such as consumer packaged goods, and pharmaceuticals. And we think it will prove successful in the cannabis industry, as well. In other words, you can expect our focus to be on making the cheese rather than raising and milking the cows.

Moving on, to distribution. Canada, became the first G-7 country to legalize cannabis sales for adult use. Cronos, participated in the launch of this new market through our 2 adult-use brands: COVE, and Spinach. Currently, these brands are distributed in Ontario, British Columbia, Nova Scotia, Prince Edward Island, and Saskatchewan.

As our production capacity grows, we intend to expand distribution into additional Canadian provinces and territories. In 2018, we also announced to join venture with MedMen Enterprises to create MedMen Canada. The private retail landscape is evolving and changing, so we continue to review and analyze the situation as it develops in each province. We think this is a valuable relationship with a large recognizable brand.

Additionally, this year, we announced that Cronos GrowCo entered a supply agreement with Cura Cannabis. Cura, signed a 5-year take-or-pay supply agreement to purchase a minimum of 20,000 kilos of cannabis annually, from the date they received those licenses. We believe, partnering with companies like Cura and MedMen set Cronos Group up for strong relationships as new and large markets opened and regulations evolve.

Internationally, Cronos Group made strides in 2018 to expand its global reach, with a distribution agreement, supplies in medical market in Poland. In June, 2018, we entered into a 5-year exclusive distribution partnership with Delfarma, a pharmaceutical wholesaler, with a distribution network of over 5,000 pharmacies, and more than 200 hospitals to supply Peace Naturals brand cannabis products. We also have a 5-year exclusive distribution agreement with Pohl-Boskamp, an international European pharmaceutical manufacture and distributor for the German market, which was signed in 2017.

We see Europe and Asia Pacific to be extremely important markets for the future, but in the near-term, it is our belief that the development of pharmaceutical foreign factors and delivery systems for medical cannabis will play a crucial role in growing the prescription and patient base in these markets. We are in the process of pursuing regulatory pathways for additional non-combustible products with our partners, at Pohl-Boskamp, who have expertise in the registration of new drugs in Germany.

We take a calculated approach in committing our current supply, as we want to ensure we support our direct-to-patient clients, our provincial and private retail partners, our international partners, and the end-consumers in all of these markets. As new distribution channels open, we must balance supporting our existing global footprint, and meeting the demands of the newly created channel. At this stage of our business, we are very cognizant of this delicate balance, while our supply ramps to meet the growing demands of our global distribution.

On our last earnings call, we spent a lot of time discussing the intellectual property pillar of our strategy. As our business and company evolve, this pillar will continue to be incredibly important in creating and driving value for our business.

I want to reiterate the strategy. We are dedicated to creating, monetizing, and building a moat around disruptive intellectual property. At Cronos Group, we seek to build the world's most innovative cannabinoid company, where we develop and research efficient processes to effectively produce and formulate the full spectrum of cannabinoids, not just THC and CBD. We are using the plant as a blueprint in order to learn and then, create differentiated active ingredients by reconstituting cannabinoids and terpenes in combinations that have specific psychoactive effects and/or therapeutic benefits.

We'll then formulate those active ingredients to optimize bioavailability and customize them for the appropriate delivery systems, depending on the product, its effect, use case, and its commercialization pathway. One of the ways that we will accomplish this goal is through our strategic partnership with Ginkgo Bioworks, which we announced in early September. We believe this landmark R&D partnership has the potential to disrupt the industry. For the benefit of new followers to the Cronos story, I'd like to briefly explain the significance of this announcement, and the power of partnering with an unparallel company like Ginkgo.

Our objective with Ginkgo is to produce cultured cannabinoid at commercial scale. This not only includes THC and CBD, but also a rare cannabinoid that are economically impractical or near-impossible to produce at high purity and scale through traditional cultivation and extraction. And going back to our strategy, we, at Cronos, believe that rare cannabinoids are key to product differentiation, but today, are nearly impossible to produce commercially. By using fermentation, Cronos and Ginkgo could materially reduce the cost of cannabinoid production at commercial scale, and enable the production of rare cannabinoids.

Using this production methodology, we could leverage existing fermentation infrastructure, rather than incurring heavy capex to build and manage new cultivation and extraction facilities. Additionally, we believe this technology will make it easier for us to deliver product consistency.

The partnership is currently focused on 8 cannabinoids. Ginkgo, will design microorganisms which can produce these cannabinoids at scale using fermentation. The partnership is aligned to incentivize each party. Cronos common shares will be issued to Ginkgo, when each of the 8 cannabinoids can be produced for less than $1,000 per kilo of pure cannabinoid at a scale of greater than 200 liters. In total, 14.7 million shares will be issued in tranches based on each cannabinoid. In addition, Cronos will fund R&D and foundry expenses, which are expected to be approximately $22 million over the term of the partnership.

In November, 2018, Ginkgo, received the relevant licenses to conduct cannabinoid research, from the DEA, and also, from the Massachusetts Department of Public Health. We think, it will take up to September 2020, and 2021; 3 years from the time the deal was announced, in September, 2018, to reach the equity milestones for the target cannabinoids.

Upon reaching these milestones, Cronos, will have the exclusive right to use and commercialize the key patented intellectual property related to the production of the target cannabinoids, perpetually and globally. We know that flower and pre-rolls will continue to be desirable and significant consumer products. We believe the production of derivative products will be achieved using cultured cannabinoids.

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

Dr. Meiri, heads the laboratory of cannabis and cancer research, with vast experience in cannabis and endocannabinoid research. Dr. Fuchs, heads the Laboratory of Stem Cell Biology and Regenerative Medicine, with years of experience in the biology of the skin and its pathologies. Whether the research and development leads to products that consumers will need a prescription to buy, an adult ID purchase, or can be bought anywhere, being able to educate consumers on the advantages of our differentiated products will be very important. And that's where our brands come in. To that end, I'd like to talk about our adult-use brands.

We are focusing on providing consumers with premium, high-quality products, whether it's flower or oil, which are available in the market today, or in the future, through our derivative product offerings. We launched 2 consumer brands in the Canadian adult-use market in October, 2018. Our brand, COVE, is focused on the premium consumer. And Spinach, a light-hearted, playful brand, is geared toward the mainstream market. Our brands are tailored to offer authentic experiences, for the respective consumer targets.

As the product offering in Canada begins to advance with the pending regulatory changes, we believe there will be greater ability to differentiate brands through derivative products, which will create a more uniquely tailored experience for consumers.

Our focus, in 2018, on establishing an efficient global production footprint, developing our global sales and distribution network, creating disruptive intellectual property, and growing our family of brands, has ultimately led to securing a major strategic partner, and investor in Altria Group.

To cap off the year, we announce that we entered into a subscription agreement with Altria. Our deal with Altria closed on March 8th. Altria's $2.4 billion equity investment in the Cronos Group, is a major milestone for our company, and a relationship we are incredibly proud to be embarking on. Altria's investment represents an approximate 45% ownership interest in Cronos Group. And they have also, a warrant to acquire an additional 10% ownership, which will provide Cronos Group with approximately 1.4 billion Canadian, of additional proceeds.

The warrant, is exercisable over the next 4 years. We expect this investment to lead a significant growth and value-creation for our company. The investment, not only provides additional access to financial resources, but also, the ability to accelerate and scale product development, and commercialization capabilities globally. With equivaling of the investment, our board of directors expanded from 5 to 7 members.

The board, now includes 3 existing directors: Jim Rudyk, CFO of Roots, who will serve as a lead director, and Jason Adler, co-founder and managing partner of Gotham Green Partners, and myself, as chairman. Additionally, we welcome 4 new directors: K.C. Crosthwaite Jr., Chief Strategy and Growth Officer of Altria, Bronwen Evans, an Independent Consultant, Murray Garnick, General Counsel of Altria, and Bruce Gates, former SVP of External Affairs, at Altria.

Earlier this month, we also announced an expansion of our management team. Jerry Barbato, most recently, Senior Director of Corporate Strategy at Altria, will join Cronos Group on April 15th. Jerry, will assume the CFO role from Billy Hilson. In addition to benefiting from Jerry's 20 years of experience in strategic planning, financial analysis, and brand management, we expect his firsthand knowledge of Altria to help ensure that we fully capitalize on our partnership with him. And Billy, will move to a new role, as Cronos Group's chief commercial officer, and will be responsible for further enhancing the commercial strategy, as well as research initiatives at the company.

Many of you may not know this, but Billy is first and foremost, a scientist. He has a bachelor of science in molecular genetics, and a master of science in biochemistry. And over 15 years of experience of multi-national pharmaceutical companies. As our company and business develop from cultivation to formulation, we expect Billy's scientific and pharmaceutical knowledge and relationships in those fields to further enhance the commercial strategy and R&D initiatives for the company. These appointments demonstrate our commitment to a premier leadership team with the skills and experience necessary to support our next phase of growth and development.

As we work to transform what was once just an idea into reality, we'd like to thank our partners and shareholders for their support. It was an incredible 2018, filled with many accomplishments, many industry and company firsts, and I can already say that this year is off to a similar start. We ended the year with an ideal partner in Altria, and we look forward to the many opportunities we expect this relationship in Cronos Group to create, in the year to come.

With that, I'll turn it over to Billy to get his last official discussion of this quarter's and full 2018 financial results as CFO. Although, I'm sure he'll be making guest appearances on these calls in the future to explain the commercial significance of some of the interesting innovations in our pipeline.

William Hilson -- Chief Financial Officer

Thanks, Mike, and good morning, everyone. The figures I'm revealing today can be found in our financial statements. We continue to see revenue growth in the fourth quarter, and December 31st, 2018. The company, reported net revenue of $5.6 million versus $1.6 million in the same quarter and fiscal 2017. Representing, a 248%-increase. Revenue increase 49% quarter-over-quarter. This increase, was due to shipments into the Canadian adult-use market, including strong sales of the pre-roll format, which represented 14% of net revenue in the fourth quarter. And growth in cannabis oil revenues, which represented approximately 24% of net revenue in the fourth quarter.

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

As we look to 2019, we see that quarter-over-quarter increases will slowly scale in the first half of the year, as we ramp-up production with momentum for revenue growth building in the second half of the year. Average selling price for the fourth quarter 2018, was $5.39 versus $4.62 the previous year. On a full year basis, the average selling price was $5.74 for 2018, versus $6,43 for the full year 2017. The decrease on a full year basis is due to the impact of the excise tax that came into force in October, 2018.

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

For Q4 2018, the gross profit before fair value adjustment of $2.5 million, as compared to $0.4 million for Q4 2017 represents a 449% increase. The increase in gross profit before fair value adjustment was largely driven by an increase in kilograms sold over the comparable period, prior year. Gross margins before fair value adjustments was 44% in the fourth quarter of 2018. During Q4 2017, the company reviewed and updated its estimates in cost drivers and allocations, including the evolution of the biological assets model, resulting in higher production and processing costs, and a corresponding lower gross margin of 28% for that discrete quarter, as these changes were not annualized across 2017.

Cost of sales, before fair value adjustments per grams or fully loaded unit COGS decreased by 13% from $3.21, from full year 2017, to $2.80 for full year of 2018. Additionally, unit COGS decreased 8% quarter-over-quarter, with fourth quarter unit COGS of $3.02 compared to $3.28, in the third quarter of 2018.

Operating expenses for the fourth quarter, including salaries and benefits of non-production staff, stock-based compensation, general and administrative, sales and marketing, R&D, and depreciation expenses totaled $12.4 million, representing an increase of $9.5 million, compared to the same period, last year.

The increase in operating expenses, was driven by an increase in research and development expenses, talent acquisition, and an increase in professional and consulting fees for services rendered in connection with our various strategic initiatives, including the Altria investment.

For full year 2018, the company reported total operating expenses of $29.4 million, as compared to $9.3 million, for the full year 2017, representing an increase of $20 million. The company reported an adjusted EBITDA loss of $7.9 million in the fourth quarter of 2018, as compared to a loss of $1.5 million, in the same quarter in Fiscal 2017. Adjusted EBITDA for full year 2018 was a loss of $14.6 million, compared to a loss of $4 million for full year 2017.

As regulations evolve, and the rules of engagement change in the markets that we operate in, so do the drivers of our business. Overall, average selling prices are decreasing due to a shift in net revenue mix from the medical direct-to-patient market, to the adult-use market, where we hold sales of provincial governments, and absorb the excise tax in both channels. On the other hand, our COGS are improving as we bring new facilities online, and increase efficiencies. Our operating expenses are increasing through the acquisition of new talent, and as we begin to increase spend in a significant way, in areas that drive long-term sustainable value, such as R&D and marketing. We will continue to invest in our business, and our committed to doing so in the future.

Turning to the balance sheet, as of December 31st, total cash position amounted to $32.6 million. Subsequent to December 31st, 2018, Cronos Group's cash position improved with a closing of the $2.4 billion Altria investment in March, 2019. In addition to providing as meaningful liquidity, the Altria investment also affords us the flexibility to capitalize on opportunistic external growth opportunities, and accelerate organic growth initiatives.

I would like to provide some insight into the short-term use of funds received from Altria, in March. As we continue to scale the business for future success, we will increase our capital investments related to production, specifically, as it relates to our Peace Naturals facility expansion and automation equipment, GrowCo, and Israel facilities. As you are aware, depending regulations related to the legalization of derivative products include vaporizers and edibles in the Canadian adult-use market, will require increased investment as we work our way through 2019.

Finally, turning to cash flows, for the full year 2018, the company used $9.7 million of cash in operating activities, as compared to $5.5 million, in Fiscal 2017. Representing an increase of $4.2 million in cash used. During the full year 2018, the company used $121.5 million of cash in investing activities. Primarily, $114.4 million in capital expenditures to fund expansion efforts at Cronos Israel and Peace Naturals, mainly Building 4, and the Peace Naturals greenhouse. And due to 6.9 million advances to our Cronos Australia, Cronos GrowCo, and MedMen Canada joint ventures.

During Fiscal 2018, cash provided by financing activities was $154.6 million primarily due, $136.5 million in net proceeds from the January 2018 Bought Deal, and the April 2018 Bought Deal, and due to the $15 million in debt advances. Subsequent to year-end, the company repaid all of its outstanding debt obligations in full, with a portion of the proceeds from the Altria investment.

This concludes my review of the financials for the quarter-end, December 31st, 2018, and full year 2018. I'd like to end the call by welcoming Jerry to the team. We are expanding our management team by adding a tremendous resource. And as much as I will miss these earnings calls, I am really looking forward to my new role. As the company evolves, and we move from one phase of growth and development to the next, we understand that building our intellectual property strategic pillar will require the deployment of R&D resources, and the alignment of science and business to find and execute the best commercialization pathway for our product. This intersection is not only a great opportunity for me, but a very exciting next chapter for Cronos Group.

...

Thank you, everyone. And now, let's open up the line for questions.

Questions and Answers:

Operator

Ladies and gentlemen, if you'd like to ask a question, please press *1. If your question has been answered, and you'd like to remove yourself from the queue, you may press the # key. We ask that you please limit yourself to one question and one follow-up. Once again, if you'd like to ask a question, please press *1.

Our first question comes from Tamy Chen, of BMO Capital Markets. Your line is open.

Tamy Chen -- BMO Capital Markets -- Analyst

Thanks, and good morning, everyone. I just had a housekeeping question, first. Are you able to disclose the breakdown of your volume sold between REC, Canada Medical, and any international export?

Michael Gorenstein -- Chairman, Chief Executive Officer, President

Thanks. When we look at how we plan on disclosing, I think there's a few things to keep in mind. First, we're still in a situation where we're trying to manage how we allocate between medical patients, provinces, private retail partners, and international partners in a pretty big shortage situation. But we do look in the future as we think it becomes more material to break out in channels. But I think we're going to keep it as it's disclosed for now.

Tamy Chen -- BMO Capital Markets -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Tamy Chen -- BMO Capital Markets -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

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

Tamy Chen -- BMO Capital Markets -- Analyst

Thank you.

Operator

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

Matt Bottomley -- Canaccord Genuity -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Matt Bottomley -- Canaccord Genuity -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

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

Matt Bottomley -- Canaccord Genuity -- Analyst

Thanks, Mike.

Operator

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

John Zamparo -- CIBC Capital Market -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

John Zamparo -- CIBC Capital Market -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

John Zamparo -- CIBC Capital Market -- Analyst

Understood. Thank you, very much.

Operator

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

Owen Bennett -- Jefferies -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Owen Bennett -- Jefferies -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Owen Bennett -- Jefferies -- Analyst

Cool, thank you.

Operator

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

Steve Schneiderman -- Cowen & Co. -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

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

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

Steve Schneiderman -- Cowen & Co. -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Steve Schneiderman -- Cowen & Co. -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Steve Schneiderman -- Cowen & Co. -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Steve Schneiderman -- Cowen & Co. -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Steve Schneiderman -- Cowen & Co. -- Analyst

Great. Thanks, Mike.

Operator

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

Martin Landry -- GMP Securities -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Martin Landry -- GMP Securities -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Martin Landry -- GMP Securities -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Martin Landry -- GMP Securities -- Analyst

Thank you.

Operator

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

Graeme Kreindler -- Eight Capital -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Graeme Kreindler -- Eight Capital -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Graeme Kreindler -- Eight Capital -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Graeme Kreindler -- Eight Capital -- Analyst

That's it for me. Thank you.

Operator

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

Rob Wertheimer -- Melius Research -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Rob Wertheimer -- Melius Research -- Analyst

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

Rob Wertheimer -- Melius Research -- Analyst

Not for the flower, exactly, yes.

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

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

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

Rob Wertheimer -- Melius Research -- Analyst

Great. Thank you.

Operator

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

Michael Gorenstein -- Chairman, Chief Executive Officer, President

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

...

Operator

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

Duration: 60 minutes

Call participants:

Anna Shlimak -- Investor Relations and Communications

Michael Gorenstein -- Chairman, Chief Executive Officer, President

William Hilson -- Chief Financial Officer

Tamy Chen -- BMO Capital Markets -- Analyst

Matthew Bottomley -- Canaccord Genuity -- Analyst

John Zamparo -- CIBC Capital Market -- Analyst

Owen Bennett -- Jefferies -- Analyst

Steve Schneiderman -- Cowen & Co. -- Analyst

Martin Landry -- GMP Securities -- Analyst

Graeme Kreindler -- Eight Capital -- Analyst

Rob Wertheimer -- Melius Research -- Analyst

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