Nova Cannabis Inc

TSX:NOVC

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, and welcome to Nova Cannabis Third Quarter 2022 Financial Results Conference Call. Yesterday, Nova issued a press release announcing their financial results for the third quarter ended on September 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 the 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 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 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' Third Quarter 2022 Earnings Call. I'd like to start by thanking the Nova team who continues to execute and deliver on our growth plans. This includes everybody on our corporate teams, our partners at SNDL and most importantly, those in our Value Buds stores. Our retail employees, operations leadership and store support teams are fundamental to creating a guest experience that resonates in today's market.

To ensure sustainable profitability through effective capital allocation and management, it is crucial that we design our operations in a way that focuses on core operating efficiencies. This includes payroll, labor costs, lease negotiations and our shared services model with SNDL. By exercising this diligence, we can provide competitive pricing, even amidst the current market conditions and while generating positive revenue and accretive margins to enable successful future expansion and long-term profitability.

I will expand on our plans for future growth shortly, but I'd first like to highlight our results for this quarter. Our third quarter results featured record sales of $58.9 million, a 52% increase from the third quarter of 2021 and a 5% increase from the second quarter of 2022. This increase is primarily due to new store openings and the conversion of Nova, YSS and Sweet Tree stores in 2021 as well as the increasing same-store sales. The same-store sales increased from $38 million to $0.8 million to $39.1 million to $2 million in Alberta and Ontario, respectively, from the second quarter of 2022.

The sales in Alberta stores converted to Value Buds throughout 2021 have exceeded expectations and our momentum continues to build in Ontario. While our basket value remains steady despite intense price compression, we've seen sequential quarterly increases in total transactions with over 1.4 million transactions completed in the third quarter an increase of 7% compared to the second quarter of 2022 and 23% increase from the first quarter of 2022.

Nova currently has 85 open locations, an increase of 5 stores since June 30, 2022, and 11 stores since the beginning of 2022. Nova's market share has increased to 21.5% in Alberta and 2.9% in Ontario in Q3 2022 from 18.9% and 2.1% in Q3 2021, respectively, based on management's estimates using available industry data.

Gross margin increased to $11.1 million or 19% of sales, a 71% increase from the third quarter of 2021 and consistent with gross margin for the second quarter of 2022. While the yearly gross margin growth is positive, and we hold steady sequentially in plan to execute several additional strategies to further solidify these gains. We continue to stay aggressive with pricing to capture market share, specifically in Ontario, however, in Alberta, we have begun to increase margins to test elasticity in varying segments, while still offering best-in-class value for our consumers.

An additional avenue for margin growth and an exciting milestone for the Value Buds team is the launch of our private label, which arrived in Alberta last week and will launch in Ontario in the first quarter of 2023. The private label offering created with the SNDL team provides accretive margin growth and enables an approximate 5% additional margin when compared to our existing large format offerings.

The private label strategy focuses on keynote segments, specifically large formats, uniquely curated for the Value Buds consumer and drive meaningful differentiation throughout the retail network. The initial launch will include 4 large-format SKUs in both 14-gram and 28-gram offering. As we target the value conscious, high-volume consumer look to divert sales from the illicit market, the offering is extremely well aligned with Nova's mission of providing quality cannabis by value prices.

Now looking to 2023 and future expansion, our approach will be calculated and hyper-focused on current market conditions. We expect to add 2 Value Buds locations by the end of the year and expect 3 additional store openings in the first half of 2023. We will continue to pursue opportunities based on the quality of the real estate and the potential of attractive economic returns, while avoiding unsustainable valuations. Strategies focused simply on total store growth are not effective in driving long-term value and sustainability in today's cannabis retail market even with the competitive price model. As total cannabis revenue nationwide wanes, we must adjust our revenue strategy to reflect current market conditions and balance sustainable targeted growth with operational efficiency to deliver long-term profitability.

As we see leases expire in 2023, we may have the opportunities to grow through acquisitions, but only if they are well positioned in underserved communities and meet our location quality standards. In summary, our third quarter results highlight our team's continued focus on operational efficiencies and commitment to sustainable long-term profitability. I'm extremely proud of the results we continue to deliver and along with our partnership with SNDL, we are well positioned to extend and strengthen our value chain while maximizing shareholder value. I look forward to closing the year strong through the fourth quarter.

I will now pass the call over to Cam to further expand on the financials from this quarter.

[Cameron Sebastian, executive]

Thank you, Marcie, and good morning, everyone. I would like to turn to a review of Nova's Third Quarter 2022 Financial Results. I want to remind you that all amounts discussed today are in Canadian dollars unless otherwise stated. Certain of the quarterly comparisons I will be referencing to are for the second quarter of 2022 as sequential quarterly comparisons may provide additional context considering Nova's rapid growth and expansion over the past 7 quarters.

In the third quarter of 2022, as Marcie highlighted, sales increased 52% compared to the third quarter of 2021 to $58.9 million. The increase is primarily due to the 14 retail cannabis stores that were opened since September 30, 2021, and increased sales from stores that were rebranded to the Value Buds discount banner at various times throughout 2021 and 2022. Third quarter sales represented a 4.6% increase over the previous quarter. Value Buds stores are among the most productive in the country with the average annualized revenue averaging approximately $2.8 million per door, and we believe this exceeds the average revenue per store for competing stores in the provinces we operate in, validating our business model and its strategy.

Gross margin for the period was $11.1 million, up $4.6 million or 71% from $6.5 million for the same period in the prior year. Third quarter sales revenues include $1.4 million from data licensing sales, which have no direct associated costs. The gross margin as a percentage of sales was 18.9% for the third quarter of 2022 compared to 18.8% in the previous quarter. While we continue to observe price compression in markets we serve, we also see select opportunities for margin expansion.

The sales 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 and the current competitive landscape in Ontario. The Ontario stores are performing well relative to the competition but are not yet achieving the sales that are 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 September 30, 2022, was $2.3 million compared to a loss of $1 million in the third quarter of 2021. 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 September 30, 2022. For the third quarter of 2022, the company recorded a net loss of $1.5 million compared to a $1.4 million net loss for the previous quarter and a $6.2 million net loss for the same period in 2021.

Turning to liquidity and capital resources. For the 3 months ended September 30, 2022 cash provided by operating activities was $3.3 million compared to $21,000 cash provided by operating activities in the previous quarter and $845,000 of cash used in operating activities for the same period in 2021. The cash provided from operating activities reflects the success of our strategic plan to sustainable profitability.

During the third quarter, cash used in investing activities was $1.7 million, a $0.4 million decrease from the $2.1 million cash used in investing activities for the same period in the prior year. This decrease resulted from a reduced level of construction related to new store openings during the third quarter and Nova store count currently stands at 85. In the current quarter, cash used in financing activities was $1.4 million, reflecting the principal portion of lease payments.

Nova has an uncommitted revolving facility with Alcanna Inc. now a subsidiary of SNDL Inc. And during the second quarter, Nova and SNDL agreed to increase the aggregate principal amount of the credit facility to $15 million and at September 30 and November 4, 2022, $9.8 million was outstanding on the credit facility.

In addition, the term of the revolving credit facility has been extended from October 31, 2022, to April 30, 2023. On July 22, 2022, the company announced the establishment of an at-the-market equity program or ATM that allows Nova to issue up to $20 million of common shares from treasury to the public at the discretion of the company and subject to regulatory requirements. No common shares have been issued through the ATM program to date due to the current market conditions in the cannabis equity markets. The ATM program provides Nova optionality to access additional capital if needed. 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 another quarter of positive cash flow from operations.

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

[Operator]

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

[Ty Collin, analyst]

Marcie, Cam. Congrats on another solid quarter here. First question for me. We know new store growth has kind of been slowing down in Alberta for a little bit but has also really started to come down in Ontario as well in recent months. I'm wondering if you could talk about whether you're noticing any change in the competitive intensity in Ontario from the sort of fewer new entrants coming into the market? And whether that's maybe starting to put a floor on pricing and margins in Ontario?

[Cameron Sebastian, executive]

I'll take that one. We've actually seen a number of new licenses show up in Ontario. And so the rate of growth has certainly slowed, but there is still a material competitive tension within Ontario.

[Ty Collin, analyst]

Okay. Got it. And then I appreciate the additional disclosures this quarter on the market share in Alberta and Ontario, obviously, a very impressive share you guys have in Alberta. I'm curious what you attribute the year-over-year share gain in Alberta to given that the store count has been relatively flat over the last year? And do you see any structural reason why Nova can get to a similar share in Ontario over time?

[Cameron Sebastian, executive]

I think it's really a factor that we're ahead of the curve in Alberta, Ty. The market is more mature. We're well established across the province, and it's really starting to show itself. And I think as we move into our private label strategy as well that that's going to make a material difference.

[Ty Collin, analyst]

Okay. Got it. And then maybe last 1 for me. Just on the M&A front, our private valuations at a point where you would consider using your stock in an acquisition, and I guess, conversely, if that's still the preferred auction at this point, what's your comfort level in terms of leverage? And how big does that allow you to get?

[Cameron Sebastian, executive]

We're almost in a position where -- to the point that we do selective acquisitions, we can do it out of cash flow without debt or equity. It's still we find it challenging to get our heads around issuing equity at current valuations. And so if that corrects at least slightly, we might consider that. But right now, it just feels so dilutive.

[Operator]

The next question is from Frederico Gomes with ATB Capital Markets.

[Frederico Yokota Gomes, analyst]

Congrats on the great quarter. So my first 1 is just on your number of stores. I think that earlier in the year, you had a guidance of 92 stores by the end of 2022. And right now, we're looking at potentially 88 stores by early next year. So could you just comment on what happened there in terms of your store openings? And what are your expectations for 2023 in terms of the brick-and-mortar expansion?

[Marcie Kiziak, executive]

Can you hear me?

[Cameron Sebastian, executive]

Yes.

[Marcie Kiziak, executive]

Okay. So I had a line issue on the last call, so apologies. Thank you, Cam, for that. Fred, I apologize, can you reask the question, my line wasn't working.

[Frederico Yokota Gomes, analyst]

Yes. Sure, Marcie. It's just about your guidance. So earlier in the year, you had a guidance for 92 stores. And right now, we're looking at maybe close to 88 stores by early 2023. So just to comment on that, what happened in terms of your expansion plans? And also, what are your expectations for new stores in 2023?

[Marcie Kiziak, executive]

Sure. I'll start, and then Cam certainly will likely also have some insight. So I mean the reality is Fred is we take a good look and we talk a lot about our real estate strategy, and that continues to be really the guiding principle for us in terms of what makes sense. And so when you combine our real estate, our perspective on real estate and you combine that with what's happening in Alberta and Ontario in terms of market contraction and what's happening with the opening of the current stores, it makes the sense for us to take a step back and really look and see what makes sense.

The reality really is that right now, this is definitely a quality versus quantity conversation for us regularly and so we're looking to see where it makes sense. We're seeing stores -- many stores for sale, many banners for sale valuations that don't make sense, and we're not willing to do that. And we're seeing lots of stores closures and stores for sale in areas that don't make sense.

In Ontario, we still see large municipalities that still don't allow cannabis. And so that's going to be an area for opportunity in 2023. In Alberta, we're seeing continued contraction. But one of the things that doesn't get talked about a whole bunch in Alberta specifically is how difficult it can be to move cannabis throughout the fleet of stores. And so again, it makes good sense for us to make good choices so that we don't end up with an inventory at an issue of obsolete inventory.

So we look at those things. So that's really what has slowed the growth. We're just making really good choices that make good sense for the business that make good sense, so we can continue to operate really efficiently and make good sense for our shareholders.

That's the half your question. Sorry for the back half of your question. Is there some -- we've got 2 more stores that we expect to open before the end of this year, before the end of this month actually, and then at least 3 more fairly early in the new year.

[Frederico Yokota Gomes, analyst]

Okay. I appreciate that. That's great color. Just about your margins. So you mentioned that you are increasing prices in Alberta and that you expect positive impact in Q4. Can you give us a sense of what's the magnitude there in terms of margin expansion you expect to achieve with those pricing adjustments? And do you expect that to have any impact in your sales per store in Alberta?

[Marcie Kiziak, executive]

Sure. I'll take the first half of that question and then pass over to Cam. In terms of sales in the stores, no, we don't. We're making really good choices around the margin increases. So it's not a matter of blanket increases, rather done very strategically. A lot of testing being done in terms of elasticity and really looking at new products and new innovations that are coming into the market. So no, we don't anticipate there to be a significant challenge in terms of sales as we move forward. But we do believe that we're making the right strategic choices, particularly in Alberta. Cam, do you want to comment on margin?

[Cameron Sebastian, executive]

No, margin seems to be very predictable for us now given our scale and history. And so to Marcie's point, we haven't seen any effect of price elasticity. We have really consistent margins throughout the portfolio and encouraged by that. And so I think the selective piece is the most important piece as to where and when we try and push on price.

[Frederico Yokota Gomes, analyst]

Okay. And then I guess my last question is just on your market share in Alberta, you mentioned over 20%, which is very positive. But at the same time, I know it poses a question on how much more market share can you gain in Alberta. So could you provide some color on how you view growth in that market going forward?

[Marcie Kiziak, executive]

Sure. It's a great question. We're going into retail Christmas and so it would be interesting to see what happens throughout the rest of the year. In terms of the rest of the market share, we are seeing contraction in Alberta quite rapidly. And so I think that's also going to lend itself to market share. And then also, we are putting a ton of work and thought into the products that we're carrying into the curated selection in the stores. And also, we continue to work on the efficiency of the transactions in the stores. And so all of those things together, we believe, will continue to help us win this market. So really, I mean we anticipate that we will continue to gain market share for all of those reasons.

[Operator]

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