It's been pretty much all downhill for Cronos Group (NASDAQ:CRON) over the last couple of months. Analysts have piled on with negative views of the Canadian marijuana stock. As of the market close on Wednesday, Cronos' shares were nearly 35% down from the high levels set in early March.

But Cronos delivered a seemingly stellar first-quarter update on Thursday before the market opened. The company reported Q1 revenue of $6.5 million in Canadian dollars ($4.83 million), up 120% year over year and well above the consensus analysts' estimate of CA$4.9 million. Cronos even surprised everyone with a profit, posting earnings in the first quarter of CA$427.8 million, or CA$0.48 per diluted share. Analysts expected a net loss of CA$0.03 per share.

You might think that investors would have reacted positively to Cronos Group's better-than-expected Q1 results. Nope. The stock fell nearly 10% in early trading Thursday. Here's why Cronos' Q1 update didn't generate any excitement.

Magnifying glass on top of a marijuana leaf

Image source: Getty Images.

Higher sales don't mean impressive sales

Let's first give credit to Cronos for defying expectations with its top-line performance. Analysts had been quite negative about the company's first-quarter prospects, primarily due to concerns that the overall Canadian adult-use recreational market was stuck in neutral during the first few months of 2019.

Cronos apparently didn't buy into all that negativity, though. CEO Mike Gorenstein said that the company "performed in line with our expectations" in the first quarter.

One major driver of Cronos Group's revenue growth was higher CBD oil sales. CBD oils generated 23% of net product revenue in Q1, versus only 9% in the prior-year period. These higher sales helped boost Cronos' net revenue by 15% over the fourth quarter of 2018.

But higher sales don't always mean impressive sales. The reality is that CA$6.5 million really amounts to chump change. And while Cronos' revenue increased, the growth rate is certainly slowing. 

The company continues to face challenges with capacity. Also, Cronos doesn't yet have supply agreements for the adult-use recreational marijuana market with all Canadian provinces. It does have agreements with five provinces representing 58% of the Canadian population, but several of the company's peers (including some smaller ones) have a larger addressable market right now.

A huge asterisk with the surprising profit

I'm not sure if anyone expected Cronos Group to announce a profit in the first quarter. I even predicted earlier this week that investors could "bank on the company delivering yet another big loss on the bottom line." As it turned out, I was flat-out wrong.

However, there's a huge asterisk with Cronos' surprising profit. Yes, it posted Q1 earnings of CA$427.8 million. But the company had a CA$436.4 million gain on revaluation of derivative liabilities. Without this gain, Cronos would have reported a net loss, as nearly everyone expected.

There's also more to the story with this big gain that helped boost Cronos Group's bottom line. Those derivative liabilities that were revalued were the warrants owned by Altria that were included in the tobacco giant's big deal with Cronos that closed in March. Any changes in the value of Cronos stock impacts the valuation of these warrants. And as the valuation of the warrants changes, it directly impacts the company's net income. 

When the Altria deal closed on March 8, 2019, the warrants were valued at CA$2.1 billion. At the end of the first quarter, though, the warrants were valued at only CA$1.66 billion because Cronos stock had fallen. The bottom line here is that Cronos Group's profit wasn't a good thing at all because it came totally from the company's share price dropping.

The best news from the Q1 update

There was one piece of good news from Cronos' Q1 update that no one should have any qualms about -- its cash position. Thanks to the Altria deal, Cronos ended the first quarter with cash and cash equivalents of more than CA$2.1 billion. That's a nice change from the CA$32.6 million on hand at the end of 2018.

Expect Cronos to start putting some of that cash to use pretty quickly. And maybe, just maybe, the company will be able to convince some skeptics that it deserves a spot at the table among the major players in the cannabis industry.