Nova Cannabis Inc

TSX:NOVC

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, and welcome to the Nova Cannabis' Second Quarter 2022 Financial Results Conference Call. Yesterday, Nova issued a press release announcing their financial results for first (sic) [ second ] quarter ended on June 30, 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 Nova website. Presenting on this morning's call, we have Marcie Kiziak, Chief Executive Officer; and Cam Sebastian, Chief Financial Officer. Before we start, I'd like to remind investors 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. We will now make prepared remarks, and then we'll move on to analyst questions.

I would now like to turn the conference call to Marcie Kiziak. Please go ahead.

[Marcie Kiziak, executive]

Good morning, and thank you for joining Nova Cannabis' second quarter 2022 earnings call. Since becoming a public company 1.5 years ago, Nova Cannabis has focused on the gap we identified in the market to better serve value-conscious cannabis consumers while providing a viable alternative to the illicit market. It's been tremendously rewarding to see our Value Buds footprint grow and thrive, but there's so much more that we can do as the long-term thesis we had on the market opportunity continues to play out just as we had envisioned.

Before we discuss our operations and our second quarter results, I want to take a moment to thank our staff, some of the team that we have worked with us for several years and their outstanding dedication has never wavered. They are the backbone of our operations and I'm grateful for them.

In the second quarter of 2022 we delivered strong growth in revenue and more importantly, this translated to equally strong growth in gross profits that flowed through to the bottom line. With the benefits of increasing scale, Nova has been able to leverage this growth into $2.1 million in positive operating profit before depreciation, impairment and other costs for the second quarter. We achieved record sales of $56.3 million, representing a growth of 90% year-over-year and 13% sequential improvement from the first quarter of 2022.

Our revenue growth continues to outpace the growth of the broader market, reflecting the quality of our store footprint and locations, the sales efficiency of our stores and the appeal of the Value Buds brand. Across our entire network, Value Buds stores generated an average of $2.9 million in annualized sales per store in the second quarter, representing a 26.9% increase compared to the second quarter of 2021. We believe that this is the best-in-class among Canadian cannabis retailers. The positive momentum has continued into the third quarter as we recently hit a revenue record day in July.

Another testament to our sales efficiency is exemplified by our market share in Alberta, where Value Buds has captured approximately 22% of the Alberta market with a 58-store footprint that equates to less than 10% of the total stores in the province. The expansion of Value Buds remains focused on Ontario. And since March 31, we added 4 stores, 3 in Ontario and 1 in Alberta, to bring our current total store count to 82.

Based on the year-to-date industry sales data, growth in cannabis retail sales in Canada is on track to exceed 20% in 2022, and analysts are forecasting a long runway of double-digit growth into 2030. The retail landscape remains highly fragmented and ripe for consolidation as we have begun to see more retail closures and greater focus on profitability.

As the overall economy slows and the inflation cost persists, it is natural to expect more consumers to gravitate towards our value-based discount stores. In this environment, Nova is very well positioned to capitalize on the growth that is in the market while continuing to take share. We will remain disciplined in how we operate to drive margin expansion and deliver greater operating leverage. As part of the next phase of our strategy, we've been able to start edging prices higher at some of our stores where the competition response has waned. This has had a positive impact on our gross margin.

Our partnership with SNDL is a source of competitive advantage for our business. We are moving ahead with them on our private label strategy for Value Buds, which we expect to launch before the end of 2022. Private label is a tried and true strategy in discount retail, but we must get the product right from the start. We have been very particular about the product we will offer in our stores, listening carefully to our customers and studying the data coming from our stores to inform our choices.

SNDL has also increased its capital commitment to Nova by raising the maximum amount available under its revolving credit facility from $10 million to $15 million. Along with our recently announced at the market facility of up to $20 million, we are well positioned to capitalize and invest in our growth initiatives.

We know we must remain disciplined in how we continue to grow Value Buds: Staying the course; being customer-focused; and choosing the best real estate for our strategy, whether it be acquired stores or building our own. As we think about our expansion plans for the remainder of the year, we remain on track with our target to add 10 more stores. Our growth strategy remains focused on Alberta and Ontario.

As both markets are quite different and have different levels of maturity in terms of where the retail cannabis industry stands, we are employing 2 different strategies. In Alberta, we have one more store opening, and then we will pause for new builds. Alberta's landscape will start contracting rapidly with several leases coming to an end. To that end, we will look for growth opportunities through possible acquisitions and where and when it will be most advantageous for Nova.

As for Ontario, our build-and-buy approach will be our strategy, along with keeping an eye out for expansion opportunities. In sum, the first and second quarters of this year have shown a strong trend towards balanced growth and profitability that we expect to build on.

We believe that we have been one of the few retailers in our industry to be producing both positive top and bottom line momentum together in the current market environment. It validates the uniqueness of our model and is a testament to the dedication and execution of the team.

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 would like to turn for a review of Nova's second quarter 2022 financial results. I want to remind you that all amounts discussed today are Canadian dollars unless otherwise stated. Certain of the quarterly comparisons I will be referencing are for the first quarter of 2022 as sequential quarterly comparisons may provide additional context considering Nova's rapid growth and expansion over the past 6 quarters.

In the second quarter of 2022, as Marcie highlighted, sales increased 90% compared to the second quarter of 2021 to $56.3 million. The increase is primarily due to the 28 retail cannabis stores that were opened since December 30, 2020. The 19 stores acquired late in the first quarter of 2021 as part of the business combination between YSS Corp. and Alcanna and increased sales from stores that were rebranded to Value Buds discount banner at various times throughout 2021 and 2022. Second quarter sales represented a 13% increase over the previous quarter.

Value Buds are among the most productive in the country with average annualized revenue averaging approximately $2.9 million per door, 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 $10.6 million, up $5.4 million or 105% from $5.2 million for the same period in the prior year. Second quarter sales revenues include $1.3 million from data licensing sales, which have no direct associated costs. The gross margin as a percentage of sales was 18.8% for the second quarter of 2022, unchanged from the previous quarter of 2021.

The sale in Alberta stores converted to Value Buds throughout 2021 have exceeded expectations. This was offset by lower-than-expected performance over the first few months for newly opened stores in Ontario, reflecting the different stages of maturity in the company's 2 primary markets. The Ontario stores are performing well relative to the competition but are not yet achieving the sales levels that are being seen in Alberta. Overall margin performance continues to reflect Value Buds' strategy to sell good cannabis more affordably to its consumers.

Operating profit before depreciation, impairment and other costs for the 3 months ended June 30, 2022 was $2.1 million compared to a loss of $200,000 in the previous quarter. The first quarter loss included $1.6 million of costs that were incurred as a result of the closing of the SNDL/Alcanna transaction that impacted Nova relating to directors and officers' insurance, severance, accelerated share-based payment expense and legal fees. 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 June 30, 2022.

For the second quarter of 2022, the company recorded a net loss of $1.4 million compared to a $3.5 million net loss for the previous quarter and a $7 million net loss in the same period in 2021.

Turning to liquidity and capital resources. For the 3 months ended June 30, 2022, cash provided by operating activities was $21,000 compared to cash used in operating activities of $5.9 million in the previous quarter and $6 million of cash used in operating activities for the same period in 2021. The decrease in cash used is primarily related to a decreased net change in noncash working capital in the current period, mainly due to prepayments for inventory near the end of the first quarter and a reduction in transaction costs, as I described previously.

During the second quarter, cash used in investing activities was $2.1 million, a $0.8 million increase from the $2.9 million of 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 second quarter of 2022, and the commencement of construction of additional stores to be opened in the third and fourth quarters. Nova's store count currently stands at 82.

In the current quarter, cash provided by financing activities was $3.4 million compared to $3.2 million provided by financing activities in the prior quarter. Cash provided by financing activities in the second quarter represented an initial $5 million in proceeds from Nova's revolving credit facility, partially offset by lease rental payments.

Nova has an uncommitted revolving credit facility with Alcanna Inc. now a subsidiary of SNDL Inc. during the second quarter. Nova and SNDL agreed to increase the aggregate principal amount of the credit facility to $15 million and on June 30 -- and as at August 11, 2022, $8.7 million was outstanding on the credit facility.

As Marcie mentioned, Nova recently implemented an at-the-market equity offering, or ATM program, allowing the company to issue common shares of up to $20 million at prevailing market prices. To date, Nova has not issued shares under the ATM. However, it provides ongoing financial flexibility as market conditions warrant. Balancing growth with greater profitability and cash flow generation remains a key priority for Nova in 2022, and we are extremely pleased to have achieved positive sustainable cash flow from operations in the second quarter.

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

[Operator]

[Operator Instructions] The first question is from Frederico Gomes with ATB Capital Markets.

[Frederico Yokota Gomes, analyst]

Marcie and Cameron, congrats on a great quarter. I guess my first question is you mentioned that you're being able to increase prices in certain locations due to competition waning. So could you provide maybe a little bit more color on which geographies you're seeing this? Is it concentrated in some specific markets in Alberta, big cities or smaller markets? And also, what's the magnitude of that price increase in the locations that you're able to do so?

[Marcie Kiziak, executive]

Thanks for the question, Fred. We -- so the markets are maturing, continue to mature at different rates. Alberta, certainly there was many more licenses granted in Alberta much sooner than any other province. And so we're seeing Alberta sort of hit their fifth year and start to mature a little differently. We're also starting to see a lot of contraction in the market here for a couple of different reasons. I mean, certainly, there is an oversaturation of licenses throughout the province.

Secondly, we're also -- you're about to see leases start expiring, so 5-year terms expire and folks are going to make the decision to not continue or not renew their lease. So we're seeing more contraction in Alberta than anywhere else. And so it's giving us an opportunity to really look at the market here.

Alberta on the whole, I guess we certainly could separate rural from large municipal. There are certainly some rural locations where the oversaturation continues to be an issue, but not quite as much. Municipally the larger municipalities, definitely a little different. In Alberta, there also was -- there was restrictions in terms of how close for -- to be together.

And so we're certainly seeing it happen a little differently here. So Alberta really is the market that we're focused on and just trying to be really strategic about it, looking at products, looking at segmenting within categories, really digging into the good, better, best within categories.

Ontario, as we've said and continue to say over the last couple of months, we'll be leaving it. We're still looking to gain market share there. Alberta is a bit different.

[Frederico Yokota Gomes, analyst]

Okay. And maybe just to that point, so you mentioned yet your stores in Ontario are still performing below your stores in Alberta. So how should we think about your margins and sales per store for the remainder of the year as you increase your number of stores in Ontario and kind of focus your expansion there in Ontario?

[Marcie Kiziak, executive]

Yes. Ontario is really going to be a focus in terms of making sure that, again, we've made a lot of -- so let me answer that differently. Ontario, we think we made some really great real estate choices. And so we're going to be really focused on market share in those areas. We have been really focused on choosing areas that are underserved right now, where there's not that same market saturation, or are close to where there are still restrictions in terms of where cannabis can be.

The ramp-up in Ontario definitely is a little different. What you saw in Ontario was a lot more retailers or store launches retail brands versus the conversion, which we had to benefit from in Alberta. And so it's a different landscape there for sure.

So in Ontario, again, it's going to be about making sure that we're choosing good real estate, as always, making sure that our real estate is highly accessible and highly visible and is in good locations, where -- good traditional retail locations, that will be the focus for us in Ontario.

[Frederico Yokota Gomes, analyst]

Okay. Maybe just a last question for me, about your private label partnership with Sundial. So could you maybe talk about which categories are you looking to launch first, more sort of percentage mix? Are you looking to reach for private label products within your stores?

[Marcie Kiziak, executive]

You bet. So the second part of that question is a little more difficult to answer. The first part, absolutely, we're focused on flower. We over-index on flower, particularly big bag. And so we're really focusing -- Value Buds is really not meant to be all things to all people necessarily, but it is meant to and has always meant to serve the part of the market that has historically been underserved, and that really is your value-conscious regular consumer.

So the focus will be on flower and will be on large format flower. It would be critical for us to make sure that the product in the bag is a great product, and so that's really where our focus is right now, and making sure that we can stand behind the product and stand behind the flower in the bag. But the initial product offerings will be large format flower.

[Operator]

[Operator Instructions] The next question comes from Ty Collin with Eight Capital.

[Ty Collin, analyst]

Marcie, Cam, congrats on an impressive quarter here. Really, really solid top line growth, especially considering only 2 store adds in the quarter.

I'm hoping to unpack that sequential growth a little bit. How much of that was kind of new store versus same-store growth? Was any of that really driven from alternative revenue streams like the data sales that Cam mentioned? Just want to get at why there was such a big jump in the quarter-on-quarter growth rate compared to Q1.

[Marcie Kiziak, executive]

Good. Sure, no problem. Cam, I'll let you start, and then I'll fill the gap.

[Cameron Sebastian, executive]

I think we're seeing really strong sequential growth within the same-store part of our portfolio, Ty, and so that's a large part of it. And the new stores also ramped up quite quickly, and so they also contributed to that. So the combination of the 2 really led to the quarter-over-quarter growth in top line.

[Marcie Kiziak, executive]

Yes. We had the benefit in Alberta of there being a bit of energy and theater around the Value Buds conversion from Nova to Value Buds. In Ontario, again a bit of it, it's certainly a different market there. But what I can tell you is we are no longer seeing the slow growth that we did when we originally built out the last tranche of stores there. There is -- Value Buds now has a brand recognition, enough brand recognition that the ramp-up is much quicker than it previously was.

[Ty Collin, analyst]

Okay, great. That's some helpful color. And then I just want to pivot to the balance sheet here. So I mean you seemed to be in a pretty comfortable position for the time being with almost $12 million of liquidity, and it looks like the existing store base is pretty much free cash flow positive here.

But obviously, growing the network is going to take some more investments. So I'm just curious kind of where do you expect that next tranche of growth capital to come from? Does it come from expanding that line again? Or do you kind of expect to tap into that ATM program in the near term?

[Cameron Sebastian, executive]

In the near term, we don't see any liquidity requirements in excess of what we currently have in place. That gives us runway through the rest of this year easily. And then with now having positive cash flow from operations, we see ourselves -- funding ourselves organically for the next little while here.

With respect to the ATM, unclear. We'll assess that as market conditions evolve here, but it's certainly a nice source to have available to us.

[Ty Collin, analyst]

Okay, great. And then maybe final one for me. I just wanted to ask, I guess, about the longer-term view for the size of the store network. At the time of the RTO that target, I think, was around 200 by 2023. Marcie and Cam, I know that kind of predates your positions at the company and obviously the Sundial transaction. But I'm curious whether there's any long-term target that you're thinking of now or what the vision is for the ultimate size of the store network at maturity?

[Marcie Kiziak, executive]

Yes, it's a great question. I think one of the things that I think has been really beneficial about Nova and Value Buds is that we've been pretty nimble and able to pivot pretty quickly, and we've done that in 2 ways. A North store operations and execution is dialed in, and so we don't have to spend a lot of energy there right now because it is so dialed in, and that gives us the opportunity to kind of look at the market and look at our business, kind of, the in versus on concept.

So to answer your question, we really -- I really couldn't -- I can't answer your question necessarily, except that we're looking at absolutely everything and making the best decisions for Nova moving forward. And so that means we're looking at every opportunity, both organic and via acquisition. And when we're looking to make really good choices.

What we're not going to do is we're not going to buy things simply for the sake of size. We don't think that, that's the right decision for us. So when we buy things, we make sure that they fit the model, we make sure that they fit the seams, the pillars that we continue to talk about in terms of how -- the things that make our stores so successful. Again, making sure that they're in great locations and visible and accessible and in traditional retail-type locations to really continue to break that stigma.

And so I appreciate -- it's probably not the answer you're looking for. But the answer is that we're just looking at absolutely everything and staying really focused to our strategy.

[Ty Collin, analyst]

Got it. Marcie and Cam, congrats on a great quarter.

[Operator]

[Operator Instructions] That's all the questions we have for today. This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.