Nova Cannabis Inc

TSX:NOVC

Earnings Call Transcript 2022-Q1

[Operator]

Good morning, and welcome to Nova Cannabis First Quarter 2022 Financial Results Conference Call. Yesterday, Nova issued a press release announcing their financial results for the first quarter ended on March 31, 2022. This press release is available on the company's website at novacannabis.ca and filed on SEDAR as well.

The webcast replay of the conference call will also be available on the Nova website. Presenting on this morning's call, we have Marcie Kiziak, Chief Executive Officer; Cam Sebastian, Chief Financial Officer. Before we start that certain matters discussed in today's conference call or answers that may be given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect results are detailed in the company's financial reports and other public filings that are made available on SEDAR. Additionally, all financial figures mentioned are in Canadian dollars unless otherwise indicated, and then we'll move on to analyst questions.

I would now like to turn the call over to Marcie Kiziak.

[Marcie Kiziak, executive]

Good morning, and thank you for joining Nova Cannabis' First Quarter 2022 Earnings Call. This is an exciting time in the growth and evolution of Nova Cannabis. Prior to taking on the CEO role at Nova, I was the company's Chief Operating Officer, where we've launched and rapidly expanded the value by brand and retail footprint as a public company.

Today, we are one of the largest and fastest growing cannabis retailers in Canada with the relationship with Sundial Growers, a vertically integrated leader in the cannabis industry. Since its inception, Nova has stayed laser focused on a simple yet powerful mission to deliver everyday low prices to cannabis consumers. We successfully executed this vision and our thesis on the Canadian cannabis market, and its core consumers is proving out in our financial performance.

Sales for the first quarter of 2022 were $49.8 million, representing a growth of 171% year-over-year. Our relative outperformance reflects the market share gains that we continue to see across the value by store network. During the first quarter, we added 4 stores in Ontario. And since the closing of the Sundial Alcanna acquisition, we've added 2 more stores to bring our total store count to the 80. When you set out to disrupt an industry as we did with Value Buds, a competitive response is expected. We are starting to see more retail closures and further consolidation in the retail landscape, which is precisely what our model was designed to withstand.

Rationalization is healthy for our industry and aligns perfectly with the next phase in our strategy. As we entered this key transition point in the cycle, we've built a solid foundation to start to improve gross margin and store profitability. Cam will speak more about this progress as he discusses the financial results. But today, we are operating profitably at the store level.

At the corporate level, excluding the onetime costs associated with the closing of the Sundial Alcanna transaction, we generated $1.4 million in positive operating profit before depreciation, impairments and other costs in the first quarter. Building on this foundation and balancing growth with a greater profitability and cash flow generation is a key priority for Nova in 2022. Being deeply focused and disciplined in how we operate is a competitive advantage that is deeply embedded in how we do business.

It starts with the master services agreements that we have with Alcanna, which is now with Sundial, and it extends to the additional synergies at the storefront level and support our relationship with Sundial will bring. With the completion of the Sundial Alcanna transaction, we agreed to sell Nova's retail operations in Ontario, [Indiscernible] Ontario to accommodate the AGCO's retail ownership limit for licensed cannabis producers.

We have a buyback option to repurchase these Ontario stores at the original purchase price of $11 million should the regulations change. [Indiscernible], Ontario will operate these Ontario retail stores under the Value Buds banner. We will receive brand licensing and service revenue from these stores. Having a well-capitalized cannabis-focused partner as a majority shareholder, is a tremendous asset for Nova's growth prospects going forward.

Sundial has already committed additional capital to Nova by increasing the maximum available under revolving credit facility from $5 million to $10 million. We'll be deploying capital in 2022 to extend our market leadership position in Alberta and expand the Value Buds banner in Ontario, which plans to add another 12 stores this year.

In sum, we believe the first quarter shows the strength and durability of our retail footprint as well as the path to greater profitability. Now with Sundial as our majority shareholder, we have all the same benefits of our previous relationship with Alcanna, but we gain an industry partner with assets across the cannabis value chain that can help to accelerate our strategy and expand our horizons. We look forward to sharing more about our plans and progress in the upcoming quarters.

With that, I'll now turn it over to Cam to discuss the financials.

[Cameron Sebastian, executive]

Thank you, Marcie, and good morning, everyone. I'm thrilled to join the Nova team and look forward to our exciting times ahead. With that, I would like to turn to a review of Nova's first quarter 2022 financial results. I would like to remind everyone that all amounts discussed today are in Canadian dollars unless otherwise stated. Certain of the quarterly comparisons I will be referencing are to the fourth quarter of 2021 as sequential quarterly comparisons may provide additional context considering Nova's rapid growth and expansion over the past 4 quarters.

In the first quarter of 2022, as Marcie highlighted, sales increased 171% compared to the first quarter of 2021 to $49.8 million compared to $18.4 million in the prior year. This increase is primarily due to the 27 retail cannabis stores that were opened since December 30, 2020. The 19 storage acquired late in the first quarter of 2021 as part of the business combination with YSS Corp. and Alcanna, and increased sales from stores that were rebranded to the Value Buds discount banner from Nova Cannabis YSS and Sweet Tree at various times throughout 2021.

First quarter sales represented a 4.6% increase over the previous quarter. Value Buds stores are among the most productive in the country, and we believe this far exceeds the average revenue per store for competing stores in the provinces in which we operate. Gross margin for the period was $9.4 million, up $4.6 million or 95% from $4.8 million for the same period in the prior year. The gross margin as a percent of sales was 18.8% for the period compared to 26% in the first quarter of 2021.

During the comparative period for 2021, the stores were operated under the Nova Cannabis YSS and Sweet Tree banners with a different operating pricing and margin strategy than in the first quarter of 2022 when sales came primarily from the stores converted to the Value Buds discount banner. The first quarter gross margin represented an 11.3% increase from the previous quarter. The higher gross margin is due to Value Buds strategy to sell good cannabis more affordably to its consumers.

Operating loss before depreciation, impairment and other costs for the 3 months ended March 31, 2022, was $200,000 compared to $100,000 in the first quarter of 2021. Included in this quarter's loss were $1.6 million of costs that were incurred as a result of the closing of the Sundial Alcanna transaction that impacted Nova relating to directors insurance, severance, accelerated share-based payment expense and legal fees.

Excluding these expenses, Nova would have recorded an operating profit before depreciation, impairment and other costs of $1.4 million. The increased profit before depreciation, impairment and other costs is primarily a result of the increase in sales and gross margin for the 3 months ended March 31, 2022. For the 3 months ended March 31, 2022, the company recorded a net loss of $3.5 million compared to $2.2 million net loss for the first quarter in 2021, including the previously mentioned costs that were incurred because of the closing of the Sundial Alcanna transaction. Excluding these expenses, Nova would have recorded a net loss of $1.9 million.

Now turning to liquidity and capital resources. For the 3 months ended March 31, 2022, cash used in operating activities was $5.9 million, a $3.4 million increase from the $2.5 million cash used in operating activities for the same period in the prior year. The increase in cash used is primarily related to an increased net change in noncash working capital in the current period primarily due to prepayments for inventory near quarter end and an increase in transaction costs relating to the completion of the Sundial Alcanna transaction.

During the first quarter, cash used in investing activities was $2.9 million, a $2.4 million increase from the $0.5 million cash used in investing activities for the same period in the prior year. The increase in cash used is primarily related to purchases of property and equipment in the current period associated with the construction and opening of new stores in the first quarter of 2022 and the construction of additional stores to be opened in the second quarter.

In the current quarter, cash provided by financing activities was $3.2 million compared to $39.4 million provided by financing activities for the same period in the prior year. The $36.2 million increase in cash provided is primarily related to the $37.1 million provided by issuing common shares in the prior period, offset by proceeds from our revolving credit facility in the current period.

As Marcie mentioned, Nova has an uncommitted revolving credit facility with Alcanna Inc., now a subsidiary of Sundial Growers. And on May 2, 2022, Nova and Sundial agreed to increase the aggregate principal amount of the credit facility to $10 million. And as at May 9, 2022, $4.5 million is outstanding on the credit facility. Balancing growth with greater profitability and cash flow generation is a key priority for Nova in 2022.

Now I'd like to turn the call back to the operator for analyst questions. Thank you.

[Operator]

[Operator Instructions] The first question is from Ty Collin with Eight Capital.

[Ty Collin, analyst]

Congrats, Marcie and Cam on the new roles within Nova. It looks like another pretty impressive quarter here from a profitability perspective. I'm just wondering if you could provide a little more color on what drove the sequential gross margin improvement in the quarter. Was that primarily from higher data sales or did 4-wall margins actually improve?

[Marcie Kiziak, executive]

Thanks for the question, Ty. I'd say it's a couple of things, but primarily, it's just being really focused on watching how our consumers are shopping and making sure we're making the right decisions. So keeping a pretty close eye on consumer behavior, getting a good eye on what customers are looking for and figuring out how to best manage the margins for those products. So that's for sure. And then secondly, absolutely the data progress.

[Ty Collin, analyst]

Got it. And then as a follow-up, I appreciate the comments in terms of what you're seeing out there in the retail landscape. Just wondering if you could tell us, I guess, what you're seeing now in terms of available M&A opportunities and valuation expectations, and whether we should expect to see M&A ratchet up later this year. And whether M&A would be incremental to those 12 new stores that you mentioned earlier in the call.

[Marcie Kiziak, executive]

Yes. I think -- I mean, absolutely, we're seeing a lot of M&A activity, and I think we will continue to. I think we've been pretty open about that in terms of what we expect to see with consolidation and rationalization in the market. So keeping a close eye on that, but was anything else that has to make sense. So keeping a good eye on where we've been focused in the past, which really is real estate, making sure we're making good decisions and in the right markets. So that's really where we'd be focused on M&A work. And then -- sorry, what was the second part of your question?

[Ty Collin, analyst]

I'm just wondering if M&A would be incremental to the 12 new stores that you mentioned earlier in the call that you're planning on opening. Are those 12 stores just organic?

[Marcie Kiziak, executive]

Yes. So those 12 stores are organic. And then otherwise, it would be what makes sense in terms of the M&A.

[Ty Collin, analyst]

Got it. Okay. And then just if I could sneak in one more. Marcie, do you see the inflationary environment today as a tailwind for Nova, the way it has been for other value-oriented retailers so far? I mean, does anything in your data kind of tell you that customers are trading down or starting to price up a little more than previously?

[Marcie Kiziak, executive]

It's a good question. The big bag strategy that we've leaned into and the value strategy that we need to certainly been successful. So I think that, that speaks to part of your question absolutely. And I think that we've done a really good job of understanding how our target consumers are shopping. And so like the answer is yes. I think that -- but I think that we've done a really good job of addressing that, and we're quite proactive on addressing that.

[Ty Collin, analyst]

Congrats on the great quarter.

[Operator]

Next question is from Frederico Gomes with ATB Capital Markets.

[Frederico Yokota Gomes, analyst]

My first question is about Ontario. So you divested your stores in the province. In your MD&A, you mentioned there was no change in accounting control of the stores. So just curious, could you provide more color on how we should look at revenue coming from those stores going forward as well as the expansion of Value Buds in Ontario?

[Marcie Kiziak, executive]

Yes. Thanks for the question. I'll let Cam take the question. But I don't think there's no difference, I mean, really in terms of how the account is being handled, but I'll let Cam take that.

[Cameron Sebastian, executive]

That's right, Marcie. From an accounting point of view, Frederico, nothing has changed. We'll continue to report 100% of the revenue and gross margin from the Ontario stores. Legally, we do not own the stores. However, for accounting purposes, we're deemed to control the stores. And so therefore, we consolidate them 100%. And continue to -- we did not have a disposition and a reacquisition. It's just continuity of accounting.

[Frederico Yokota Gomes, analyst]

Okay. And then on the second part of the question about expansion of Value Buds in Ontario.

[Marcie Kiziak, executive]

Is the question are we going -- are going to be continued stores open in Ontario?

[Frederico Yokota Gomes, analyst]

Yes.

[Marcie Kiziak, executive]

Yes. Yes. Absolutely. We're going to continue to see some more stores open this year. There's -- I think we're going to see 11 more open -- sorry, 9 more open in Ontario, already committed this year.

[Frederico Yokota Gomes, analyst]

Okay. My second question is just on your -- the strategic aspect of your relationship with Sundial. Obviously, you mentioned potential access to capital on your expansion. But I'm just curious, what sort of changes or differentiation of that partnership with Sundial bring to your product mix as well as your private label strategy, maybe you gained access to some better deals than all the retailers. So could you talk about.

[Marcie Kiziak, executive]

So thanks for the question. We're excited to have Sundial in the fold. It's a great Alberta story and a great Alberta product. So excited to have them in the fold. And they've also got some great products in the market and some really good innovation. So excited to see it back in our stores and in our stores and so far is performing well. But I mean, as we've always been, we're a house of brands. And so we're bringing in complementary products to -- that we've always made to having a house of brands. With respect to private label, absolutely something that we're looking at. We had spent a good amount of time on it last year, took a bit of a pause as a result of the transaction and now getting back after it.

[Frederico Yokota Gomes, analyst]

Okay. My last question is on your sales per store. You mentioned that you're probably one of the leaders in the mattress here in Canada. So just curious on whether you see any opportunities for [ suspension ] in sales per store in 2022? Or would you say that most of your growth this year will come from new store openings?

[Marcie Kiziak, executive]

I think as you continue to see the market consolidate in more rationalization at the retail level, I imagine -- we expect it will see an increase of lift come simply by having fewer competitors in the market. So I think we'll see that. And then also with 12 new stores coming into the market over the course of the year.

[Operator]

The next question is from Pablo Zuanic with Cantor Fitzgerald.

[Matthew Baker, analyst]

This is Matthew Baker on for Pablo. With several other retailers talking about pursuing a discount strategy, what would you say makes your pricing strategy more unique and also more or less sustainable?

[Marcie Kiziak, executive]

Thanks for the question. So there's a couple of things. And so, again, as I said earlier, we're really focused on making sure that the pricing makes sense. For us, we've tried and said often that we're looking to try to bring people in from the illicit market. And so our product mix and the way we price our products is really reflective of that. So I think that, that's the strategy that we continue to follow.

And then also our in-store experience is also a differentiator for us, which we try to, again, meet our customers where they are and understand where our customer is. And so to really hard to make sure that we've got an experience that makes sense for them. And in some cases, that's highly transactional, and we make the experience as easy as possible for them, the really great stuff.

[Matthew Baker, analyst]

For our second question, will there be any strategic coordination with Spirit Leaf retail business of Sundial?

[Marcie Kiziak, executive]

That's a great question. So Value Buds, we've always said that we weren't trying to be all things to all people, rather, we were trying to make an impact in the market that hadn't previously been served. With the addition of the 3 new stores, it will becomes the ability to be more things to more people and really coordinate and figure out the right ways to position both of those banners.

[Matthew Baker, analyst]

All right. Great. And just one last follow-up. Maybe this is a question for Sundial. But will Nova remain listed, given the parent company Alcanna will be part of Sundial? And if so, why?

[Marcie Kiziak, executive]

Yes, we'll defer that question to Sundial.

[Operator]

As there are no further questions, this concludes today's conference call. You may disconnect your lines.

Thank you for participating, and have a pleasant day.