Earlier this week, Cronos Group (TSX: CRON) (NASDAQ: CRON) quietly announced that they would delay the filing of their full annual report as a result of a revenue recognition review being conducted by forensic accountants. At the time, Cronos indicated that it was related to bulk resin purchases and the sale of product through wholesale channels. Upon further inspection, it appears it might be related to an agreement signed with Medipharm Labs (TSX: LABS).
Back in May of 2019, Medipharm Labs and Cronos Group entered into a significant private label contract manufacturing agreement. Under the terms of the agreement, Cronos would be required to purchase, at minimum, $30 million worth of private label cannabis concentrate over a period of 18 months. The agreement, referred to as a “take or pay” arrangement, could potentially increase to $60 million over a period of 24 months.
The agreement itself essentially stated that Medipharm Labs would supply Cronos Group with $30 million in private label cannabis concentrate products. Under a second agreement announced concurrently, Cronos subsidiary Peace Naturals would also be supplying undisclosed amounts of bulk cannabis product to Medipharm that would then be processed through a tolling agreement on a fee for service basis.
Fast forward several months, and Cronos Group is now filing an incomplete annual report due to “a continuing review .. of several bulk resin purchases and sales of products through the wholesale channel and the appropriateness of the recognition of revenue from those transactions.” Despite the filed annual report being incomplete, there are two noteworthy passages that are included within the filed text.
“Third-Party Supply and Manufacturing Agreements. [..] In May 2019, the Company entered into a take-or-pay supply agreement with MediPharm for cannabis resin. MediPharm will supply the Company with approximately C$30.0 million of cannabis resin over 18 months from the date of the agreement, and, subject to certain renewal and purchase options, potentially up to C$60.0 million over 24 months from the date of the agreement.”
For the year ended December 31, 2019, we had three major customers, Ontario Cannabis Store (the cannabis control authority and sole wholesaler and distributor of cannabis in Ontario), Radient Technologies Inc. and MediPharm, sales to each of which are expected to equal or exceed 10% of the Company’s consolidated 2019 net revenues. The Company’s arrangement with MediPharm is described above.”
First, it’s noteworthy that two of three major customers of Cronos Group are that of extractors, given the context for the delay in filing the firms complete annual report. No agreements between Cronos Group and Radient Technologies (TSXV: RTI) are publicly available.
Second, it’s also interesting that the company recognizes Medipharm Labs as both a major customer, as well as a major supplier. The result, is that forensic auditors are likely determining whether the sale of wholesale product to Medipharm can constitute as revenue, as it appears that the same product was potentially then sold back to Cronos via the supply agreement – which essentially amounts to a tolling arrangement rather than that of a product sale. Given that Medipharm makes up at least 10% of Cronos revenues, the impact could be significant.
During the nine month period ended September 30, 2019, Cronos Group recognized revenues of C$31.1 million, of which C$16.9 million, or 54.6% was from that of three major customers, which the annual report reveals as being the OCS, Radient Tech, and Medipharm Labs. Further breakdowns on a major customer basis are not available.
While it can’t be guaranteed that this is the source of contention with Cronos accounting department, based on the data provided within Monday’s filings, there’s a likelihood that it is in fact related to this. It should also be noted that it will likely have no impact on Medipharm Labs’ figures from our point of view, as it does not change the amount that they charged to Cronos Group for the services provided, even if it took more of a tolling format than that of a genuine product supply arrangement.
Cronos Group last traded at $5.46 on the Nasdaq.
Information for this briefing was found via Sedar, Medipharm Labs and Cronos Group. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.
As the founder of The Deep Dive, Jay is focused on all aspects of the firm. This includes operations, as well as acting as the primary writer for The Deep Dive’s stock analysis. In addition to The Deep Dive, Jay performs freelance writing for a number of firms and has been published on Stockhouse.com and CannaInvestor Magazine among others.