Nova Cannabis Inc

TSX:NOVC

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, and welcome to Nova Cannabis Second Quarter 2023 Financial Results Conference Call. Yesterday, Nova issued a press release announcing their financial results for the second quarter ended on June 30, 2023. 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 Novo website. Presenting on this morning's call, we have Marcie Kiziak, Chief Executive Officer; and Cam Sebastian, Chief Financial Officer.

Before we start, I would 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 to analyst questions.

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

[Marcie Kiziak, executive]

Good morning, everybody, and thank you for joining us for Nova's second quarter 2023 conference call. I'm excited to share Nova's results as we continue to drive meaningful year-over-year and quarterly sequential growth across our key financial metrics. I am incredibly proud to report that Nova has achieved record revenue with 7 consecutive quarters of gross margin improvement. These results led to an adjusted EBITDA of $5.5 million, representing an increase of 161% compared to Q2 2022.

Before we dive deeper into our results, I'd also like to take this opportunity to talk about the current state of the cannabis environment, and the proactive steps that our team has taken to solidify Nova's leadership in the retail sector. It is no secret that the current cannabis market is fraught with challenges due to regulatory impediments and an oversaturated market. However, I believe we are reaching a critical juncture where there are still significant opportunities for those who are well prepared to navigate today's economic and regulatory landscape.

Nova's achievements hinge on its ability to continually adapt to current conditions and take decisive actions to secure our future success in the industry. This includes our strategic partnership with SNDL, effective real estate procurement, enhanced data licensing programs to support strong LP partnerships and customer loyalty and margin-enhancing strategies, aimed at boosting revenue and expediting our past free cash flow. We continue to explore all paths to sustainable profitability while remaining true to our customer promise.

Before I move on to our second quarter results, I'd like to update you on our strategic partnership with SNDL. As publicly announced on July 25, while all other provincial approvals have been received, the continued review by one provincial regulator has necessitated a further extension for the closing of the strategic partnership. We anticipate the transaction will close on or before August 25, 2023.

Once the transaction is approved, Nova's multi-banner retail footprint will grow by approximately 33%. There is potential to add more locations through further retail consolidation and strategic M&A, enabling growth in key provinces, including Ontario and British Columbia.

As we look at future store growth opportunities, we'll prioritize real estate quality and attractive economic returns while avoiding unsustainable locations and valuations. Proximity to our customers remains a key driver for store success, so we will actively pursue opportunities in underserved areas, ensure new locations align with the appropriate demographics.

As an additional benefit of the partnership, Nova will receive corporate services through SNDL's shared services model, providing the necessary tools to scale several key programs. This includes an integrated loyalty plan to further grow market share and enable additional margin-accretive strategies. We look forward to reporting on this program in upcoming quarters and believe that this will be a key differentiator to unlock continued revenue growth and customer retention.

Now looking over our second quarter results. Year-over-year revenue increased 14% compared to the second quarter of 2022 to $64 million. Sequentially, Nova's revenue grew 6% from $60.2 million in the prior quarter.

Gross margin for the period was $14.6 million, representing a 38% rise from $10.6 million in the same period of the previous year. Sequentially, the margin grew by 14%, up from $12.9 million in Q1 2023. This marks 7 sequential quarters of gross margin improvement from the first quarter of 2022 to the second quarter of 2023. We've seen a significant increase in gross margins growing from approximately 19% to 23% compared to the second quarter of 2022. This growth is attributed to several factors, including price stabilization in the Alberta market, strategic inventory and pricing review, private label initiatives and the expansion of the proprietary data licensing arrangements.

Private label offerings continue to exceed our performance expectations with Value Bud's private label product representing approximately 7% of the total 28-gram sales and 18% of the 14-gram sales nationwide. Nova's goal is to disrupt and strengthen the cannabis retail market by promoting a wide range of cannabis products at everyday best value prices and encourage greater migration of customers from the illicit cannabis market. We continually explore new concepts to bring this vision to life, including our latest venture Firesale cannabis.

Pricing stabilization marks the significant opportunity to unlock additional revenue growth. And in April of 2023, Nova introduced its new concept, Firesale Cannabis, which offers deep discounts to support increased product turnover. While we're able to stabilize pricing through the industry, this gives all retailers and licensed producers the opportunity to grow margin share. We must collectively consider the overall health of the industry and explore niches that can be leveraged towards benefit. Currently, we have 2 Firesale locations opened with additional store scheduled to open in Alberta and Ontario.

To further address market conditions and challenges, we're committed to fostering a collaborative relationship with regulators and business leaders to enhance the economic vitality of our sector. As we near the 5-year milestone of recreational legalization in Canada, we have the necessary data and proof points to substantiate the need for regulatory reform, which better supports economic security and future growth of the sector. We look forward to being an active participant in the regulatory process to better align the economic interests with public health and safety.

Novo will continue to explore all paths which solidify our future success. We will look forward to expanding our operational and financial scale to the close of the Nova reorganization. Our results today add weight to our strategy, and I look forward to scaling these tactics through the second half of the year.

I will now turn the call to Cam Sebastian to review our full financial results for the quarter.

[Cameron Sebastian, executive]

Thank you, Marcie, and good morning, everyone. Before we discuss Nova's second quarter 2023 financial results, I want to remind you that all amounts discussed today are in Canadian dollars unless otherwise stated. Certain of the quarterly and yearly comparisons I will be referencing are comparisons to the prior quarters were measured against the previous year. Sequential quarterly and yearly comparisons may provide an additional context considering Nova's rapid growth and expansion over the past 2 years.

In the second quarter of 2023, as Marcie highlighted, sales increased 14% compared to the second quarter of 2022 to $64 million. Compared to the first quarter of 2023, sales increased 6%. Total revenue growth highlights the expansion and growth in our business from 74 stores at January 1, 2022, to 92 stores currently.

Same-store sales continued to improve with average annualized sales of $2.9 million from stores that have been opened for at least 1 year. Gross margin for the quarter was $14.6 million, up $4 million or 38% from $10.6 million in the second quarter of the prior year. This represents 2 consecutive quarters of gross margin increases of more than 35%.

Second quarter sales revenues include $2.7 million from proprietary data licensing sales which have no direct associated costs, a 73% increase from Q1 2023. These revenues represent the initial results of enhancing our data licensing offerings to partners and we anticipate further expansion in the scope and scale of this program.

Gross margin as a percentage of sales before the data licensing revenue was 19.5% for Q2 2023 compared to 19.3% in Q1 2023 and 16.8% in Q2 of 2022. These margin increases highlight Nova's ongoing capitalization on select opportunities for accretive margin expansion in key trade areas. Overall margin strategy and performance continues to reflect the brand strategy to sell good cannabis more affordably to its customers.

Adjusted EBITDA, defined as operating profit before depreciation, impairment, transaction, restructuring and other costs in Q2 2023, was $5.5 million, a record for the company and an increase of $2.3 million from $3.2 million in Q1 2023. This reflects the results of higher revenues at higher margins.

In Q2 2023, the company recorded net earnings of $1.0 million compared to a $1.4 million net loss for Q2 2022.

Now turning to liquidity and capital resources. In Q2 2023, cash provided by operating activities was $2.6 million compared to $1.4 million used in operating activities in Q1 2023. The change in cash from operating activities reflects the continued success of our strategic path to sustainable profitability.

During the quarter, cash flows related to investing and financing activities were not significant other than the completion of investments in 3 additional stores. The next phase of capital expansion will be approximately 32 stores expected to be acquired through the Nova-SNDL strategic partnership.

Nova has an uncommitted revolving credit facility with our partner, SNDL with a commitment of up to $15 million. As of today, Nova is fully drawn at $15 million on the revolving credit facility. Pending the close of its strategic partnership with SNDL, the new revolving credit facility will provide up to $25 million of additional liquidity.

Currently, the company has approximately $5 million of cash on hand, adequate liquidity and is generating positive cash flow. The revolving credit facility's maturity date was extended to August 25, 2023, to align with the anticipated closing of the strategic partnership.

We are very pleased with Nova's second quarter results, particularly the growth in revenue, adjusted EBITDA and positive earnings, as well as our trajectory towards sustainable profitability.

Now I would like to turn the call back to Marcie for closing remarks. Thank you.

[Marcie Kiziak, executive]

In closing, I would like to thank the entire Nova team for their significant contributions. Our people are the catalyst to our success. Despite the challenges posed by a constantly evolving and unpredictable market, their innovative thinking, perseverance, commitment and enthusiasm are the driving forces behind our achievements.

I am proud of our growth across key financial metrics. However, it's equally as important to recognize the indispensable role played by our teams in ensuring our overall success. Employee turnover is strikingly high in the cannabis space, and our ability to nurture and develop our employees is also a key driver in our strong operational fundamentals. Looking ahead, I look forward to reporting on our third and fourth quarters following the close of the SNDL-Nova transaction and as we continue to expand our margin growth strategies.

I will now pass the call back to the operator and open the floor for analyst questions.

[Operator]

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

[Ty Collin, analyst]

Congrats on the really outstanding result here. My first question, Marcie, I'm just wondering if you could elaborate a little more on what you're seeing out there in terms of the competitive landscapes in Alberta and Ontario. Are you starting to see more capacity exit those markets? And maybe you could just speak to what made you comfortable taking a little more price this quarter?

[Marcie Kiziak, executive]

Yes, absolutely. Thanks for the question, Ty. We've talked about this in the previous quarters as well. We're starting to see some real contraction in Alberta. Certainly, no secret that we've seen some very public contractions in the country fairly recently. So we're seeing what we had always said that we thought was going to happen at the point where people had to really start to run new leases when we came very close to the 5-year anniversary of legalization, seeing the market contracting that is, in fact, happening. We're still seeing as much M&A and imbalances as much as we have been in the past.

In terms of feeling comfortable with moving forward with the margin strategy, and it's been in the works for quite some time. We've just been very strategic about how we've moved margins. We've always thoughtful about making sure that we're not -- that we're moving the right products at the right time, listing the right products at the right time. And I think that we've also really had enough time to really figure out what it is that the value-based customer is looking for. And so all those things in combined is what -- in combination is really what's made us comfortable moving forward. Now Ontario is still some room for growth there, but Alberta, we're certainly seeing the contraction.

[Ty Collin, analyst]

Okay. Great. And you touched on the margin strategy. So maybe I'll follow up on that. Obviously, a really impressive gross margin result this quarter. I mean, you pretty much hit the target levels you were talking about around the RTO sitting around where Alcanna used to be at. How much upside is there to gross margins from where they are today, I guess, from data sales, private label pricing, et cetera? And what do you think margins could ultimately settle to in the medium term?

[Marcie Kiziak, executive]

Yes. I mean I'll draw it back and say, we just -- we did exactly what we said we were going to do. We've performed exactly as we said we were going to. So certainly, we're proud of that. Again, it goes to figuring out exactly what that customer is looking for what that -- we're in a situation today that is different than the situation we were in a year ago where we were still just trying to figure out how to delight the customer, how to make sure that we are providing the best possible experience, best possible products. And I think that we've done that.

And by doing that, that's really also given us some room to start to look at how we play with margins, how we play with the categories and the segments within the category. I don't think we're done. I think we're still -- we're focusing a little bit on Ontario right now and bringing that closer to Alberta. So we know you'll see -- that's what I would expect that you'll see when we talk again in a couple of months. But I do think there's still some more room -- there's certainly more room on the private label side. We'll be launching some new products here in the next little while, which was also some upside from a private label perspective. So certainly still some runway in our perspective.

[Ty Collin, analyst]

Okay. Great. And then just for my last one, I'm wondering if you could provide a little bit more color on the delay with the SNDL transaction. It sounds like the hang-up is probably with Ontario, if I'm reading between the lines. Is it just a timing thing? Or has the province expressed any reservations about the structure itself?

[Marcie Kiziak, executive]

Yes, great question. Certainly, an expected question. There has been no flags or issues raised, simply appears to be a timing issue in terms of turnaround time. But we've not been made aware of any impediments or challenges.

[Operator]

[Operator Instructions] The next question comes from Frederico Gomes with ATB Capital Markets.

[Frederico Yokota Gomes, analyst]

Congrats on the quarter. Just on the margin side and on your data licensing revenue. I think you mentioned in the outlook section there that you expect to increase gross margins by approximately 2 percentage points in each quarter. So can you talk a little bit about that? It seems like a large increase from data licensing. And then does that sort of guidance already bakes in the new stores from the SNDL transaction, which have sort of a different gross margin profile?

[Marcie Kiziak, executive]

Sorry, Frederico, can you ask the second half of that question again?

[Frederico Yokota Gomes, analyst]

I was on mute, sorry. Yes, just to complement that. No, the gross margin outlook here already considers the new stores coming in from SNDL given that they have a different gross margin profile.

[Marcie Kiziak, executive]

Yes. Okay. Thank you. So a couple of things, and Cam probably also have some insight here. But from the data perspective, before I pass it over, what I'll share is, it took us -- it took us some time to figure out what the best data program possible, the best data licensing revenue program would be for us.

And so it took us some time to get that right, and I think that we've got it right now. And so -- which is why you're seeing the increase that you're seeing attached to that really gives us the opportunity to have a little bit of extra runway and again, make decisions at the store level. Cam, do you want to talk a little bit about the margin on data program?

[Cameron Sebastian, executive]

Yes. So if you look at the run rate implied by the Q2 data revenue that we had it, you would add 2% to the margin. And given the, call it, restructuring of our data program offerings, the uptake has been very high. And so we expect that to, in fact, accelerate as we go through the rest of the year. And so quite conservatively, I would say that Q2 is a lower end on what we'll see for data revenue on a quarterly basis going forward.

[Marcie Kiziak, executive]

And then in terms of the -- question. In terms of the stores, the 33 stores that we'll be adding, I think that we'll see once we closed the transaction and are really operating in -- moving forward with those stores, I think you'll probably see a bit of -- the margin profile evolves to be a little more similar to our current offerings.

[Frederico Yokota Gomes, analyst]

Got it. Okay. On Firesale, just any update on the economics there now that you're planning to increase that concept and open 2 new stores. What are you seeing? And how profitable is that banner?

[Marcie Kiziak, executive]

Yes. So the Firesale banner, we were really focused on testing that banner. We really do believe that, that is a benefit to the entire industry. We also think that there's a number of benefits to Firesale, including sorting out the oversupply, working through what's currently sitting in the warehouses and being able to make some room for, again, building product assortments and offerings that customers are really looking for.

So I'd say we're very much still in the testing phase and trying to figure out exactly what that model looks like, much like when we converted the stores to Value Buds in the beginning, we're first -- we're on a new idea. So moving forward with that, a lot of testing is still happening. So we'll certainly be able to give you a better sense of how it's working and if we're able to prove out our hypothesis. Cam, anything to add?

[Cameron Sebastian, executive]

No, that sums it up, Marcie.

[Frederico Yokota Gomes, analyst]

Just the last one here on your cash flow. So very positive there, obviously. And it seems like you already reached a positive free cash flow at this point. Just thinking about that and thinking about the SNDL transaction happening. Do you expect any sort of bumps in free cash flow as you sort of integrate those new stores and make some changes to operations? Or should we expect the free cash flow to remain on the positive side as you go forward?

[Cameron Sebastian, executive]

I would say we're not expecting any bumps if anything, the SNDL-Nova transaction is accretive to cash flow because of certain of the terms, particularly the relief from management fees. So that is not really of concern to us at this point.

[Operator]

That is all the questions that we have for today. And this concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.