Nova Cannabis Inc

TSX:NOVC

Earnings Call Transcript 2022-Q4

[Operator]

Good morning, and welcome to Nova Cannabis Full Year and Fourth Quarter 2022 Financial Results Conference Call. Yesterday, Nova issued a press release announcing their financial results for fourth quarter ended on December 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; and Cam Sebastian, Chief Finance 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, everybody, and thank you for joining us for Nova's Full Year and Fourth Quarter 2022 Earnings Call. Before I get into our results, I want to start today's call with a thank you to the store and head office teams. Their contributions have solidified our leadership position and the passion and dedication of our teams has helped the Value Buds model stand out in a competitive marketplace. We take great pride in the fact that our leadership team is made up of 46% female, 35% male and 19% identifying as gender diverse people. Our team brings us together unique backgrounds, experiences and perspectives driving greater innovation and customer understanding. Maintaining a diverse workforce is crucial for Nova to serve the needs and preferences of a wide range of customers.

As I embark on my second year as the CEO of Nova, I strongly believe the Value Buds model is positioned for long-term success, which our full year and fourth quarter results highlights. The market is beginning to show signs of rationalization and through further consolidation and price stabilization in 2023, Nova is well positioned to emerge as a leader in the cannabis retail space. Building on the consistent momentum we've demonstrated throughout the year, Nova posted record revenue of $61.4 million, a 29% increase from the fourth quarter of 2021 and a 4% increase from the third quarter of 2022.

Our annual revenue totaled $226.4 million, a 68% increase from the $134.4 million in 2021. Our revenue increase is accompanied by a greater gross margin growth as we started to adjust pricing in areas where the competitive pressures have waned. This, along with the successful launch of our private label products gives us levers to drive future gross margin growth as we capture greater market share. The Value Buds brand enables Nova to develop higher gross margin offerings, build customer loyalty and long-term brand awareness. The private label strategy focuses on Keystone segments, specifically large format, uniquely curated for the Value Buds consumer and drives meaningful differentiation through the retail network.

Private label sales represented approximately 3% of our Alberta retail sales in the fourth quarter of 2022. Private label margins are approximately 5% higher than comparable competitor products. Since launch, Value Bud's private label sales made up 12% of the total 28 grams sales as 36% of the 14-gram sales for the period ended December 31, 2022. One of the 2 flavor blends, Cookies and Kush, was the best-selling SKU in the 28-gram and 14-gram format through the period ending December 31, 2022. [Tropic and Hays] was the second best-selling SKU in the same categories. We are thrilled that our private label launch has not only generated accretive margin growth but also a positive response from our consumers.

Nova currently operates 91 stores, an increase of 7 stores since September 30, 2022, to 14 stores since the beginning of 2022. While our total store growth for the year is less than we initially projected. Our same-store sales and new store openings are performing as expected and in many cases, exceeding our expectations. Same-store sales have increased 2.7% in Ontario and 1.8% in Alberta in the fourth quarter of 2022 compared to the third quarter of 2022. Nova's market share has increased to 26.4% in Alberta and 7% in Ontario in the fourth quarter of 2022 from 18.9% and 2.1% during the same period in 2021, respectively, based on management's estimates using industry data available.

Nova has added 3 stores to date in 2023, 1 in Alberta and 2 in Ontario. Our approach to new store openings will continue to be calculated and hyper focused on the current market conditions and real estate, which is complementary to the Value Buds strategic pillars. As I've noted in previous quarters, as retailers come up for renewal on their leases, we expect it to be a significant turnover this year, which presents strategic opportunities for Nova to grow through acquisition or it aligns with our business objectives. 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.

We expect to realize additional savings through the 2023 year on our annual rent run rate through lease turnovers or cancellations on unopened or nonoperational leases. In certain instances, you may recognize opportunities to generate revenue and address market challenges by utilizing unopened or nonoperational leases to explore new venture opportunities. These opportunities, along with our proposed strategic partnership with SNDL will contribute to our retail growth pipeline in 2023.

The proposed agreement with SNDL as announced in December 2022 and additions Nova for strategic growth and expansion through our retail operations. Pending completion of the Nova reorganization agreement, SNDL will vend 32 stores to Nova, primarily operating under the Spiritleaf, Superette and Dutch Love Banners located in British Columbia, Alberta, Saskatchewan, Manitoba and Ontario. The Nova reorganization will increase the company store footprint by more than 35%. The agreement creates a well-capitalized cannabis retail platform through a vertical integration model, leveraging SNDL's upstream and midstream capabilities. The restructuring of Nova, if approved by Nova's minority shareholders will provide Nova a low-cost operating platform, enhanced SG&A savings, strong balance sheet and enhances our multi-banner strategy. The Nova team will manage operations of the cannabis retail platform, positioning us to thrive and focus on growth and profitability in the coming years through this world-class cannabis retail platform.

Before Cam discusses our fourth quarter and year-end results, I'd like to close by sharing some information on our partnership with Re Waste This partnership helps address the excessive plastic waste generated by the strict packaging requirements for cannabis products in Canada. Value Buds retail locations have diverted over 10,200 pounds of waste from landfills to date as measured and reported by the Re Waste team equivalent to nearly 180,000 containers, 700,000 Doob tubes or 850,000 mylar bags. Value Buds has also procured over 550 pounds of Doob tubes made from recycled materials, helping to promote a circular economy. We plan to release our second upcycled accessory in the second or third quarter of 2023. I am proud to share that Value Buds is often used as an industry benchmark for cannabis waste diversion in the retail sector and we have the opportunity to lead sustainable practices in Canadian cannabis by promoting widespread adoption of waste diversion and up-cycling in the industry.

We are proud of our team's efforts and impact through this initiative and hope to encourage our peers to help drive a more sustainable cannabis industry. Our fourth quarter and year-end results prove the value of our strategy. I am proud to progress this year and determined to build on our success in 2023. I will now pass to Cam to cover our full earnings financials.

[Cameron Sebastian, executive]

Thank you, Marcie, and good morning, everyone. Let's discuss Nova's fourth quarter and year-end 2022 financial results. I want to remind you that all amounts discussed today are in Canadian dollars unless otherwise stated. Certain of the quarterly and the early comparisons I will be referencing are for the prior quarters are measured against the previous year, the sequential quarterly and yearly comparisons may provide additional context considering Nova's rapid growth and expansion over the past 2 years.

In the fourth quarter of 2022, as Marcie highlighted, sales increased 29% compared to the fourth quarter of 2021 to $61.4 million an increase of 4.2% over the third quarter of 2022. Year-over-year revenues have increased $92.1 million or 68%, resulting in total revenue of $226.4 million for the year ended 2022. The increase is primarily due to the 14 retail cannabis stores that were opened in 2022 and the increased sales from stores that were rebranded to the Value Buds discount banner at various times throughout 2021 and 2022.

Nova now has a total of 91 retail locations operating including 3 opened in 2023.

Value Buds are [indiscernible] in the most productive in the country, resulting in 2022 annual revenues of approximately $2.8 million per average number of doors opened in the year. We believe this exceeds the average revenue per store for competing stores in the provinces in which we operate, validating our business model and strategy.

Gross margin for the year was $43.9 million, up $19 million or 76% from $24.9 million in the prior year. 2022 sales revenues include $5.5 million from data licensing sales, which have no direct associated costs and represent a 400% increase from 2021. The gross margin as a percentage of sales was 19.4% for the year ended 2022 compared to 18.5% in 2021. Gross margins in the fourth quarter of 2022 were 20.8%, up from the fourth quarter of 2021, where gross margins were 17.7%.

While we continue to observe price compression in markets we serve, we also see select opportunities for accretive margin expansion in key trade areas. And as Marcie noted, we have begun to adjust pricing in areas where competitive pressures have waned to unlock greater gross margin growth. Overall margin strategy and performance continues to reflect the brand strategy to sell good cannabis more affordably to its consumers.

Adjusted EBITDA, defined as operating profit before depreciation, impairment, transaction, restructuring and other costs for the 3 months ended December 31, 2022, was $3.2 million compared to $2.5 million for the third quarter of 2022, resulting in an increased quarter-over-quarter adjusted EBITDA and positive adjusted EBITDA of $9.2 million in 2022 compared to an adjusted EBITDA loss of $2.6 million for the year ended 2021. These increases are primarily a result of the increases in sales and gross margin for the year and quarter ended December 31, 2022. For the year ended 2022, the company recorded a net loss of $11.2 million compared to a $20.6 million net loss from the prior year.

Now turning to liquidity and capital resources. For the year ended December 31, 2022, cash used in operating activities was $0.1 million compared to $10 million in the prior year. Cash provided in the fourth quarter of 2022 was $2.8 million compared to the fourth quarter of the prior year, where there was a $0.6 million cash used in operating activities. The change in year-over-year cash used in quarter over cash provided from operating activities reflects the success of our strategic plan to sustainable profitability.

During the year, cash used in investing activities was $8.4 million, a $4 million decrease from the $12.4 million cash used in investing activities in the prior year. This decrease resulted from a reduced level of construction related to new store openings year-over-year. In the year, cash provided by financing activities was $3.0 million, reflecting cash provided from the revolving credit facility, offset by the principal portion of lease payments.

Nova has an uncommitted revolving credit facility with our partner, SNDL Inc. During the second quarter of 2022, Nova and SNDL agreed to increase the aggregate principal amount of the credit facility to $15 million. At December 31, $8.7 million was outstanding on the facility. On March 28, 2023, $11.1 million in principal and accrued interest was outstanding on the revolving credit facility, and the company has approximately $4 million of cash on hand. The revolving credit facility has a maturity date of April 30, 2023. This maturity date has not been extended by SNDL at this time.

However, we believe that Nova has adequate liquidity to satisfy its cash requirements until the expected amendment of the Nova-SNDL all strategic partnership at which time Nova will receive an additional $10 million in liquidity from a new credit facility. In addition to the credit facility on July 22, 2022, the company announced the establishment of an at-the-market equity offering program or the ATM program. It 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. To date, the company has not accessed the ATM in a material way due to market conditions. However, it remains available as a source of capital if required.

Balancing growth with greater profitability and cash flow generation remains a key priority for Nova in 2023, and we are extremely pleased to have achieved another year and quarter of accretive growth in retail doors and positive cash flow from operations compared to the prior year and quarters.

Now I would like to turn the call back to Marcie for closing remarks, and then we will open the floor for analyst questions. Thank you.

[Marcie Kiziak, executive]

In closing, I want to express my gratitude for our team's exceptional performance in the fourth quarter and throughout 2022. Our unwavering focus on operational efficiency and commitment to long-term profitability have propelled us forward even in the face of challenging retail conditions. I'm extremely proud of the results we continue to achieve, and I firmly believe that we are on the cusp of even greater opportunities in the industry. By focusing on our core strengths and investing in our people and processes, we expect to unlock continued value for our shareholders. With the proposed agreement with SNDL, I am confident that Nova is on the right course for 2023. I will now turn the call back to the operator for analyst questions.

[Operator]

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

[Ty Collin, analyst]

So maybe I wanted to start off on the same-store sales growth. Obviously, some pretty impressive numbers in both Ontario and Alberta in Q4. Can you just help me understand what's driving that? Maybe what proportion of that was due to the pricing you took? What came from store traffic? And do you see room for continued same-store sales growth throughout 2023, despite the price pressure that Cam was speaking to?

[Marcie Kiziak, executive]

Sure. Thanks for the question, Ty. A couple of things that are happening right now. So firstly, in Ontario, we're not seeing the same length of time in terms of ramp-up that we historically have. And so really have got a good amount of customer loyalty and brand recognition in Ontario, which is really helpful. If you go back to a couple of calls ago, we said that we were still struggling to get a bit of a foothold to get some brand recognition and now where we get inbound requests from customers adopting when we're going to open in their area.

So we are -- we can do that people are starting to travel a little bit to shop in our stores, which is great. So that's really helpful. Again, brand recognition making pretty considerable difference in Ontario. In Alberta and Ontario both, part of it has to do with the amount of focus we've put on our core selection in the last couple of months. And so really looking at what the consumer is looking for, what's moving, where the trends are going. And so I think that, that has made a pretty considerable difference.

We've always been very, very focused on our inventory and making sure that we're not sitting on obsolete inventory. And so we've been pretty careful with respect to inventory up until now. But now looking at it even deeper with the lens of how many days sales do we think we have, what's moving, where our customer is moving to and making sure that we're not making purchasing decisions that don't reflect what they're looking for.

So I think that's driving a good amount of repeat sales. And then as always, we talk about making sure that we're meeting the customer where they are and continue to focus on staff training and employee training to make sure that we're providing the best possible experience to customers. And so all of those things combined are driving the continued energy around the store and same-store sales. Cam, anything you'd like to add?

[Cameron Sebastian, executive]

I would just add that we've added 11 new stores since the end of Q2, and those are now entering the same-store category. And so there's a shift between new stores and established stores, and so we're seeing that come into the metric for same-store sales, and it's certainly helping because the new ones are very additive to the equation.

[Ty Collin, analyst]

Okay. Great. That's helpful color there. And then, Marcie, you spoke to some of the success you're really starting to see in Ontario, can you speak to what you're seeing the competition do in Ontario? I'm thinking particularly those on the value end of the spectrum. There's obviously been a lot of retailers that tried to follow your pricing model. Have they been able to sustain that? Or are they starting to throw in the towel or starting to claw back some pricing like you are. I'm just wondering what the other value players in Ontario are doing now?

[Marcie Kiziak, executive]

Sure. we're seeing -- certainly seeing the industry is paying a lot of attention to when we look at our pricing any time that we make an increase or a reduction in pricing and are falling, and we're still continuing to do that to some degree. We are starting to see a little bit of price matching drop off which was a bit interesting for us. So we're not necessarily seeing as much of that. I mean we're seeing it being done somewhat geographically. So that's also making a difference.

But no, we are actually starting to see the -- our competition we're starting to see some increases. We're starting to see a little less like I said, price matching. And we're also starting to see stores drop off, right? And so as we said, we would expect to see both in Alberta and Ontario. So all of that is helpful.

[Ty Collin, analyst]

Okay. Great. That's really helpful. And then maybe last one for me before I jump back in the queue. Could you talk about what you're seeing in terms of commercial lease rates in Ontario and Alberta? Are those significantly higher than your existing lease rates? And what proportion of your leases are coming up for renewal in the next year or two?

[Marcie Kiziak, executive]

Yes, it's a great question. So we are seeing -- I mean, certainly, what we saw what would have been a cannabis premium 5, 6 years ago, even maybe 4 years ago. And so we're certainly not seeing that cannabis premium necessarily anymore, which is helpful. In Alberta, in particular, certainly lots of conversation around lease rates as well as around vacancy rates, particularly in the large municipalities that are still not having a great time bringing people back into business and back into the large municipalities. So I'd say a pretty stable.

We're not seeing significant increases across the board, which is helpful. And we're looking at new real estate at a much more reasonable and much more reasonable rates in both Alberta and Ontario. In terms of leases that are coming up for renewal, it's not a considerable. It's not a significant amount. We've always made really good decisions around real estate. Again, we go back to having the legacy of having the liquor business to rely on for trends. And so we don't have a swathe of leases that we signed that we should not have 5 or 6 years ago, and so we are aren't experiencing what a lot of the industry is right now. And the majority of what we're seeing come up for the Nova leases are leases that we would renew and that we would continue to want to operate in those locations.

[Operator]

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

[Frederico Yokota Gomes, analyst]

Congrats on the quarter. My first question is on your gross margins. So you saw a material expansion this quarter. So just two points there. First, how much of that expansion is due to an easing of the competitive landscape? And how much of that do you think is due to changes in mix and your private label program? Do you think that maybe seasonality, the holidays had any impact on margins this quarter? And then the second point there is just do you think that, that margins will continue to improve at that same rapid pace throughout this year?

[Marcie Kiziak, executive]

Great. Thanks, Frederico. A couple of things to talk about. And so I talked earlier about the margin strategy around the core assortment and around making sure that our core assortment, it makes a lot of sense. And so I think a lot of that has to do with the fact that we're just being much more strategic in particular in terms of how we're managing our core assortment. Really stripped it back and then looked at what made sense. And then again, as always, looking at the categories to make sure that we're appropriately managing the margins within the categories, within good, better, best and value categories.

And so I would say it has a lot to do with continuing to be very strategic. The buying patterns are starting to become very clear. They've evolved certainly especially as innovation has evolved, but the buying patterns are becoming very clear. And so it's allowing us to make some good decisions there and determine what people are buying and when and how.

So a lot of it has to do with that. Some of it certainly does have to do with private label. I mean our private label, as I mentioned, was a top seller at the end of 2022 and continues to be a very -- a great seller, and we continue to expand private label to have more offerings that make sense for our core consumer. So all of those things combined really are what's driving the strategy and driving the performance. And then certainly, we are seeing a reduction in stores. Again, particularly -- and we feel it more in Alberta when you see stores closed, just it's not quite as fast, but that is also contributing.

[Frederico Yokota Gomes, analyst]

Okay. And then on your data sales, we know that LPs, they're -- they continue to see headwinds and many of them are cutting costs. So you say that could potentially have a negative impact on your data sales this year and also, obviously, on the margins as well?

[Marcie Kiziak, executive]

Great question. I don't think so. It's hard to argue with the volume that runs through new Value Buds stores. And so I'd say that it's perfectly reasonable that LPs are cutting back on cost, but I think they're just also being more strategic about where they're putting their dollars. And again, the volume that runs through Value Buds is important. And because we're doing a very strategic job of managing what SKUs get listed in the stores that also makes a big difference because we can be very focused and make sure that we're driving the appropriate performance on both sides for LP and for retail. Cam, anything to add?

[Cameron Sebastian, executive]

No, I think that's fair. It's we -- if anything, we see an increase in inbound requests for data sales agreements. And we're broadening our scope on that side of the equation. So I don't see that being an issue.

[Frederico Yokota Gomes, analyst]

Okay. And then last one for me. Just on your [Star footprint], [Star expansion]. You're looking at about maybe potentially 120 stores, if and when the restructuring with SNDL closes. So in addition to that, you expect to continue to expand in the second half of the year. Is there any target in terms of number of stores that you plan to exit 2023 with? And you'll be seeing some of your competitors or pausing growth this year. So I'm just curious on your perspective there.

[Marcie Kiziak, executive]

Sure. We have varied by province, I'd say. You -- what you're seeing with the restructure and the result of that is some expansion into other provinces, which will be helpful for us. Also gives us an opportunity to really take a good look at some of those provinces and how they're performing and what growth might look like there. So there's certainly that. There's -- as we see pretty much every quarter, the number of inbounds continues to grow from retailers who are looking to exit the market. So certainly still seeing lots of inbounds coming in. So it's a bit hard to say because, again, we're going to be very focused on what makes sense.

We're going to be very focused on real estate that continues to drive performance and makes sense and watching the -- our target markets really, really closely to see who's entering, who's leaving the market. Alberta is a tougher one because again, we don't have a lot of levers to pull with inventory, and so we have to be very strategic and very resourceful in terms of how we move things around. And so we're very careful to make sure that we're making the right decisions in Alberta. And like I said, the opportunity for us to expand into some other provinces is now real and will give us an opportunity to decide what makes the most sense there. So in terms of an actual number, difficult to say.

But what I can say is that we're always very cautious and conscientious about making sure that we're doing the right things for our shareholders. And that also includes making the right real estate and the right acquisition decisions.

[Operator]

[Operator Instructions]

And this concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.