Alcanna Inc.
Q1 2021 Earnings Call Transcript

Published: 18 May 2021

[Operator:]

Good morning. We would like to welcome everyone to Alcanna Inc and Nova Cannabis Inc.'s First Quarter 2021 Earnings Results Call. At this time, all participants are in listen-only mode. Following the prepared portion of the call, we'll conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. A copy of the Company's earnings press release and management's discussion and analysis is available on their website and includes cautionary language about forward-looking statements, risks and uncertainties, which also apply to the discussion during today's conference call. All amounts discussed on today's call are quoted in Canadian dollars. I will now turn this call over to Mr. James Burns, Alcanna's Chief Executive Officer. Please go ahead, sir.

[James Burns:]

Thanks. Good morning, everybody. Thanks for your interest in both of our companies, somewhat unusual call today with two businesses. And the departure from our norm here, but I think the statements, Alcanna statements certainly were so noisy that it probably takes a little bit of explanation. I think we'd like to give some overview and perspective on things before we go to questions. And Darren Karasiuk, our CEO of Nova, will also give an introduction and an update on some of the mostly subsequent events that's happening at Nova since the statements really reflect a company that barely exists anymore from last quarter. So for Alcanna's point of view, we were very pleased with the first quarter. The top line was great, and the gross margin equally so, despite having to lap over the last three weeks of March of 2020 when the pandemic first hit and there was significant hoarding and stockpiling and sales like we've never seen before, and probably never see it yet. The bottom line is a little noisy, but most of that is transaction cost or some of the many transactions that we've done this over the last 12 months. And most of those expenses are nonrecurring in our opinion. Operating cost at the store level are as tight as they've ever been and equally at our head office administration level, were equally tight and continue to make adjustments where we can find them. If we take all the nonrecurring costs out, our bottom line for Q1 actually is about 50% better than it would have been last year. Going forward, the business continues to go well. No one knows what the impact of COVID is. Lockdowns continue in Alberta, our main market, obviously, for Alcanna and as they were last year at this time. Last year, outdoor events and barbecues in backyard, so on was permitted this year, not at the moment. But on the other hand, the playoffs are here soon and the oilers are in with the good chance of a decent run. So that always helps us out with our sales, especially in our Northern Alberta centric portfolio of stores. Regardless of the short-term and things that are out of control, weather and so on, which just is what it is. We're very confident and our business is strong, and our market share continues to grow in the trade areas that we want to be in. Well that's key. We're not just go for the sake of it. We don't just have stores for the sake of having stores or putting out press releases. We have stores, and we allocate our capital in a manner that is most efficient for the shareholders. And I guess that's the thing I wanted to stress the most today. Alcanna's is about capital allocation. And that's what it's been for the last three years, and that's what it will continue to be.

[Darren Karasiuk:]

Thank you, James, very much appreciate it and good morning. I'm happy I'll be on this call today and to provide you an update on our recent developments. It's been a busy and an incredibly exciting time for Nova since our go-public transaction just two months ago. As a reminder, Nova's growth strategy is anchored in the value bud banner and servicing the unmet needs to the high of the value-conscious cannabis consumer, a high-volume segment that makes up about 70% of the consumption volume in the market today. Borrowing from Alcanna's success and lessons learned in the discount liquor retailing business, we're developing stores and offering products that resonate specifically with this value-focused consumer and offering a truly better alternative to the unregulated market. Our value bud stores are located where our customers live, work and shop and are designed for both ease of in-store navigation and to accommodate increased customer counts and sales volume.

[Operator:]

Thank you. We will now take questions from the telephone line. And the first question is from Kyle McPhee from Cormark Securities. Please go ahead. Your line is now open.

[Kyle McPhee:]

Starting on the liquor side of the business, I'm just hoping for some color on what you're seeing with the year-over-year sales trend in Q2 so far? You clearly had a big tailwind in Q1 from COVID and all the other market share moves that are still paying off. But in Q2, which is now comped against a full co good quarter. Are you still seeing any lift? Or are you kind of back to neutral for the divestment adjusted business? Any color there would be helpful.

[James Burns:]

Sure, Kyle. I guess we can't talk about the exact numbers and so on, but I think you've -- in your notes, pretty well got it, there's tailwinds still. And nothing's really changed COVID-wise versus -- last year was a weird year. The first three weeks of March was huge panic buying where people thought liquor stores will be closed down, people are trying to store-up and stockpile and so on. And then when liquor retail was declared pretty well worldwide as an essential service. Through the month of April, sales were relatively low last year because people were essentially drinking up their stockpiles that they bought. And then it kind of got up into May, later in May. Finally, when that was done, it sort of started to just settle into a new normal of a pandemic, which we saw for the balance of last year. Given that there's really nothing much changed in the external world from back then, I think it will be a fair assumption to say that things are pretty much just the way they were. How the actual quarter turns out because of the weird bumps in April, I don't know. But net-net day after day, week after week, we're very, very pleased with how things are going in Q2 still.

[Darren Karasiuk:]

So far, Kyle, we haven't skipped a beat from where we were trending in Q1 in terms of just in the current year when you look at week-over-week, forget over last year, and our business is doing very well. And so if we keep on this trend, we're going to have a good quarter. How it will shape up against last year? I don't know yet. And that's really going to come down to how to do the long weekends perform and that comes down to weather for the most part. How do these restrictions on social gatherings shake out over the next couple of months, I don't know. But we're very happy with how the business is moving today.

[Kyle McPhee:]

Got it. And also on liquor, the Alberta liquor retail landscape. You guys were pretty disruptive in recent years. You're now back to your normalized type margins. But wondering if the landscape of the other peer retailers are staying pretty status quo with things like pricing and promotion? Or are there changes starting to emerge? Essentially, just wondering if it's still a pretty rational competitive environment out in Alberta?

[James Burns:]

I think it's pretty rational. Given that the liquor retail industry is all winning as a whole, unfortunately, on the back of the closures of the restaurants and the bars and the lounges and things going on out there. I think everybody in the industry is pretty rational, given that the rising tide floats all boats. And we don't -- I mean, you can never -- competition is going to do what they're going to do. I don't spend a huge amount of time worrying about it in advance as you react is -- but we don't see at the moment any one that looks like there may be kind of some kind of disruptive market share gains. I mean, our main competitions are the grocery stores and Costco. And they build stores near their grocery stores for the most part and use them as part of an integrated business for their grocery business. They're not just willy-nilly growing the liquor business, which is relatively insignificant in the grand scheme of their world. They have very big liquor businesses, but not compared to the size of loblaws or empire, sobeys. So we're -- the industry, I think, is in good shape, as Darren said. And everyone's interest to keep it that way and the consumers are winning. Are we got the prices are down and a really good margins for Alberta can customers. We pay as cheap as retail alcohol prices anywhere in Canada. So, it's a win-win for everybody.

[Darren Karasiuk:]

The one thing to think about for everybody looking at the comps for Q2 versus last year, we really cut back on promotions and marketing last year for the first three or four months of pandemic. Customers were not paying attention to those kind of materials. And so, we'll have a little bit of incremental marketing spend this Q2 just normal promotional spend. So that should be factored in. And normal promotions will lead to some promotional type pricing, which will play with the margins a bit. So again, we're happy with where the business is. It's normal. But look for that comp as you go through for Q2.

[Kyle McPhee:]

Got it. And last one for me before I pass it off. Just on the -- just high level on the Value Buds disruptive strategy you guys are rolling out. Are you seeing any competitive responses yet from the other peer retailers? And maybe even just give some color on where do you think all this big sales is coming from that 120% gain? Is this from the peer retailers? Or is this largely just from the illegal channel?

[Darren Karasiuk:]

Well, I think we're -- thanks for the question, Kyle. We're seeing it from both, really. We've got some anecdotal evidence where we've had stores where we've got Nova stores and value buds stores and kind of close proximity to each other, where -- and we've launched Nova -- or sorry, launched value buds and seeing this incredible lift, but hasn't necessarily negatively impacted our -- some of our Nova locations too much. And then in other context, we've seen, which just sort of speaks to the fact that we're seeing people coming in from the unregulated market to join us, they're not necessarily moving from one to the other across the board. In other contexts are very much hearing that we are taking from our competition that's out there. And we're seeing some plays by others to try to respond to us. What's happening on Ontario a little bit and you're seeing some price matching efforts attempted underway in Alberta as well. But again, the key takeaway on that one is that we're making this move first. We're making it aggressively, and we're expanding aggressively. And we've got a lot of confidence that we're going to continue to see the growth that we've seen in a few short weeks since we've actually converted these stores over.

[James Burns:]

And that's a good point to highlight, Kyle. When Alcanna did our pilot back in the fall with the first four stores, the ramp-up period was really, really long. Like we had some really good results right off the bat, but it has just continued to grow and grow and grow in most of those stores. Jamie and I were looking at one of those four stores. We hadn't really paid attention to it in the last couple of weeks, and we were just almost fell off our shares. And because we can't market in this industry, it takes consumers a while, word of mouth, coming in, trying it once in a while to see what kind of value offering that we're offering in these stores. And so to be up 120% at this point in a short period of time in these 18 stores is quite exciting. The trajectory that we're on, I think, is quite significant and hope to see some really good gains here in Q2, Q3 and then into Q4 still.

[Kyle McPhee:]

Got it. Maybe just a quick follow-up. When you talk about sales continuing to accelerate beyond the 120%, is that still at that 19% margin? Or have you started lowering that even more, your filings indicated maybe 12% to 15% is where you're taking it down to?

[Darren Karasiuk:]

Yes. We've become more aggressive, Kyle, with that, and we are moving those margins down, which is going to translate to pricing on the shelf that customers are really responding to very well. And we started that process with a view again to only increasing the volume and the share capture strategy and to increase that trajectory in terms of growth on the top line across the board.

[Kyle McPhee:]

Got it. And just to confirm here, my math, like if you're getting a sales list of 120% plus, even down at gross margins of 12% to 15%, you're still neutral to or still adding gross margin dollars while you take this share, correct, so you're not having a negative contribution margin from the stores?

[James Burns:]

Yes. There might be in the early weeks. Kyle. But no, we're quite confident, and that's why we're moving them down even further. There's more market share to be captured and generate at least the same amount of gross margin dollars. But we think, as we saw in the liquor trial or the liquor phase of our discount entrants into the market that we can then move it back up and make substantial dollars on the bottom line in time. Yes, but move it out doesn't mean to move the prices back up and mess with the consumer, it means increased margin in cannabis, unlike liquor. That we have a decent private label business in liquor, but it's very different. You're competing against massive national iconic world brands. Cannabis, there's nothing like that. So I mean, Darren is much better to comment on this, but in -- and he will. But the private label opportunity in cannabis is immense to build our own brand and capture some of manufacturers' margin as well as our own, so normal retail merchant. So that will be a huge source of margin enhancement for a major player with a lot of volume that can participate in a white label program. I don't know, Darren, do you want to add some more in terms of where you're at?

[Darren Karasiuk:]

Well, as we said at the -- when we launched this, there was going to be a significant part of it. And Jamie is quite right, Kyle, the fact that brand loyalty, I mean, even brand awareness still doesn't largely exists in the cannabis space in this country. And given the regulations and the restrictions in place, the place to build brand awareness and build brand loyalty is within the four walls of retail. We recognize that. We know we mitigate with the customers that are there and do so effectively. So with our private label plan, which, again, we've communicated that we intend to get out in the second half of this year, we believe that, that's going to actually only augment what we're doing in terms of, call them, the national brands or the LP brands that are there, which only further entrench our position in the minds of the consumer as the destination to come for the product, the quality that the consumer wants at a price point that's going to be unbeatable in the marketplace.

[Operator:]

Thank you. The next question is from Graeme Kreindler. Please go ahead. Your line is now open.

[Graeme Kreindler:]

Thank you for taking my question. I wanted to start out on the liquor side of things. And on the last earnings call, you called out some of the consumer trends you saw with a bit of trade down exhibited by customers in the holiday period, probably driven by the fact that they weren't spending it with any large groups. When we consider the commentary you gave at the top of the call about things trending very well in stores in terms of volumes and in customer behaviors. I was wondering, if there's any specific trends on the purchasing behavior that might affect the comp a bit, whether we're starting to see customers trade back up or if that trade down phenomenon still persist in the Q2? Would appreciate any color there.

[James Burns:]

The trade down that we saw in the fourth quarter really was around the holiday events. People weren't entertaining as much. They weren't having people over. So they weren't buying the top shelf type stuff for those parties. They were just drinking their regular stuff for the most part, that's generalization. In Q1, early Q2, you don't -- other than Easter, which is a less significant holiday, you don't have those same comps to worry about. And so I think people were just in a normal habit of drinking their normal stuff, and we didn't really see any trading around from Q1 2020 to Q1 2021.

[Graeme Kreindler:]

Understood, and then switching over on to the Nova side. With respect to the eight retail authorizations out of the total 19 planned stores in Ontario right now. Is the expectation that those would be able to open immediately after the emergency order is lifted in the province? Or have there any -- have there been any further delays or construction delays on those authorized stores because of COVID? Or is it basically waiting for the green light from the province here?

[Darren Karasiuk:]

In terms of Ontario, it's a little bit of both. We've got a number of stores that were ready to open. In fact, just yesterday, we opened a new store at Lora Landsdown, and we've got Queen West store, which is scheduled to open this week as well. But in terms of the timing on those specific ones, the individual RSA dates are a little bit further out. So we'll be looking at those, again, opening up towards the back half of this quarter and the beginning of the next quarter when we'll be seeing most of those stores actually opening up in Ontario.

[James Burns:]

Yes. Just -- but to further to your point, Graeme, construction has not slowed. It's halted. We have not been able to touch these stores for a very long time other than like it was about a very brief period there for a week or two where it opened up and then got shut down again. So unfortunately, it just -- it's nothing to do with us and it's like in the time of COVID, where many stores, which we would have hoped to have had built out and ready for both an RSA or lifting lockdown are not going to be because we're not allowed to do construction. So as soon as that lifts, we've got our teams. We've got our construction crews or country. Everybody is ready. It's just got to wait for being permitted. So -- and your guess is as good as mine when that will be. At the moment, I think it's early June at the earliest. And I guess, depending on the situation at the time, the Ontario government will decide whether we can get back in back to business of construction or not.

[Graeme Kreindler:]

Okay. Understood. Then my last question here is, with the additional 30 locations, you called out in the press release in Ontario that are under negotiation, can you give us any color on what the mix looks like there? Are these existing operating stores? Are these leases on just retail locations at this point in time? And quite a substantial amount with 30 locations under negotiation. What does that mean relative to the valuation environment? I know it's looking at the time value of scarcity, Ontario with the increase in the ramp of retail authorizations, is the market getting better or more conducive to making some nice deals here as the year goes on?

[Darren Karasiuk:]

Thanks Graeme. The stores that we're talking about there, those are net new that we're looking at developing, which we've got a nice mix, but it's consistent with our overall strategy, as we've articulated for some time now, Graeme, which is trying to move away and definitely moving away from the areas which are perhaps oversaturated for the downtown cores. And again, looking at locations where our core consumers live, work and shop, the broader 905 strategy with smaller communities throughout Southwestern Ontario. But those 30 stores that we're talking about there are ones that we are looking at in terms of, I'll call them, organic for the most part, which is to say, ones that we've identified that's fitting our model that we levered the Alcanna real estate team to help get us leases that are favorable to us, and we started to work towards those ones. In terms of your other question, which was, if I'm understanding it correctly, trying to understand about sort of what's happening in the Ontario market. Listen, Graeme, it's no surprise that a lot more RSAs are being issued, and we've been in process for some time. And we will continue to monitor that. And as we look forward to our, I'll say, an acquisition strategy, we're only going to do those acquisitions if they make sense to us, right? The market is going to continue to, I'll say, compressed. There's going to be increased competition, and valuations are going to continue to fall, we believe, for those opportunities that are out there in the market. So we're going to look for those that fit within our broader strategy and only do those that makes sense, obviously, economically to us. We're, again, well capitalized. We've got a strong strategy, and we want to be vigilant in that going forward.

[Operator:]

And the last question is from John Zamparo from CIBC. Please go ahead. Your line is now open.

[John Zamparo:]

I wanted to start on the liquor side of the business. And if we look at its history, this segment had achieved gross margins, I think, north of 25%. And obviously, there's a lot of changes since then, and the heavy discount component would suggest a lower ceiling. But how should we think about what level these gross margins can settle at once you've extracted gains from private label and some of the other initiatives you're working on? Is there a long-term target that you do have in mind?

[James Burns:]

Hey, John, yes, again, just given the history, as you say, where it's been in the Alberta marketplace and especially in the last few years, largely as a result of our own doing. We would -- in terms of the ability to raise prices for the consumer that they see, there's probably not too much room left to go. You can always play here and there, but not a lot. Our ability to raise margins will be based on -- we continue to maximize our buying power on using limited time offers to make sure we get a couple of points. And it's a business of really small margins now, and it's detail, detail, detail. Every little bit helps. We have a warehouse in Edmonton. We will soon have a warehouse in Calgary, which is a back part of a new one. And beyond we're opening, we had a large extra space. So we're going to use that as another warehouse to be able to hold LTO, given the cost of capital generally being so low, it's very advantageous for us to make large buys when the vendors put products, especially the hot selling products, which you don't make a lot of margin on anyway, the Smirnoff and Captain Morgan of the world to buy those in bulk when you can to save a few -- even a few basis points is huge to us, given the volumes that we process. So that will be things like that. Again, we continue to hone and enhance our private label program, which continues to do extremely well. Especially just interestingly enough, it's -- wine is always the cornerstone to that, but we've been introducing some private label spirits made right here in Alberta. But you've been extremely successful over the last 18 months, and those are great margin products for us as well as wait for the vendor here in Alberta and for our province. So with those sort of things, you could always going to hope you can get maybe another 100, another 150 or over time, but just raising prices, not so much. You don't want to go down that trap again. I mean, you could do it for a year and then you'd be back to where you were again. It's not logical to, us. That's short-term thinking so.

[John Zamparo:]

Understood. That's very helpful. Moving to the balance sheet. Even after the SIB, it's still a very well capitalized business in terms of access to liquidity so any update on what you plan to do with the free cash flow that the business is likely to generate in '21 and '22? And if it's M&A, what would you potentially be looking for?

[James Burns:]

We're going to build one and beyond. That's what we're going to do, John. And also some smaller format convenience discount liquors. Largely those ones in new areas, new neighborhoods of Calgary and Edmonton, particularly that are growing just as cities grow. So it's -- we're pretty well -- our free cash flow is pretty fully spoken for. We -- the four one and beyond this year and the other five we've targeted for next year and four for the year after, right now with hoping to get more. We can -- we have a financial capacity to build as many as Proper, I stress Proper, properly allocated capital sites we can find. We're not going to build them just for the sake of it, but we're going to build them where we think they're successful and where the overall EBITDA of the Company will be enhanced to justify the capital invested. So yes, we'll providing increased cash flow, but as we also have the capacity to consider future return of capital to shareholders and there's the usual mechanisms. We've used one. I mean, I can always use that one again, but there's NCIB dividend. These will -- so specs are always available, and we do have the ability and the capacity to do all of the above if we choose and shareholders who contact us quite a bit and give us their views as to what they think we should do with the Company that they own part of, which we always welcome. It's their company after all ours. We are big shareholders personally. We'll see what the future brings. We're also very cautious generally by nature. So we don't -- COVID is just so uncertain. Things are so uncertain. Alberta economy right now is really picking up again as the L patch starts to reinvigorate itself after a very long dry spell. If oil prices continue to stay at the levels that we're seeing, a lot of people are back at work that have been working for 18 months and so on. So anecdotally, things are looking positive for us. And if our results keep continuing like this, yes. M&A, again, anything that's accretive and its proper allocation of capital, we'll certainly look at, but we're not trying to find one. We'd rather give the capital back to the shareholders then we will do some acquisition just to feel better.

[John Zamparo:]

Understood. Okay. A question for Darren. I want to better understand the sales increases you see when you transition these stores to value buds and I think it was 120% increase you saw from the recent conversions that -- I mean, it's remarkable, but it is a step down from the 240% or so, you saw from the initial conversion. So is it that these stores that you're converting now, are they behaving any differently? Or is it that the earlier test stores started at a lower level, similar to what you're seeing now and then they jumped up? Is there an element of competitive response that's impacting that? Just would like to understand the cadence of increase on the recent conversions versus the initial ones? Is there anything to help reconcile the difference between those two numbers?

[Darren Karasiuk:]

Yes. I appreciate it, John. I appreciate the call -- the question, rather. These stores that we're talking about here, we really kicked this process off middle of this last quarter. And what we've seen has been early days in terms of the lift. When we talk about sort of what we saw with the original experiment last year that was over a longer period of time. It's a different marketplace, to be sure. But this is still early days, and we've got confidence now these stores and the trend lines associated with them will continue, particularly as we get even more aggressive in the margin profiles. And really, what matters is the price that the consumer is going to be seeing on shelf. So when you take it as sort of look at it across the board, this is very much in alignment with what we've seen previously with the experience just at a broader scale. There's absolutely increased price competition from folks out there as they recognize that this is really where the core of the market is, and they really also come to recognize that this is where the core consumer base is. We just happened to have identified it sooner than anyone else.

[James Burns:]

And John, just to put a fine point on that. For the same period as those four stores that we piloted last fall versus these 18, the 18 are on the same trajectory as those four were at this very same point in time. And so -- and maybe even a little better, I might be being conservative in that comment. So we're very happy with where these stores are today. Are they going to get to 240%? I don't know. That would be a home run, but anything north of where we are today, we're in really, really good shape.

[John Zamparo:]

Okay. That's very helpful. And then one last one for me, more of a housekeeping question. I wanted to ask about administrative costs and what you expect here. You called out the -- I think it was $2.1 million of transaction costs in the quarter. If we back that out, you get to a bit over $6.5 million. I think last quarter, we suggested maybe the Q2 or Q3 number from last year was probably what you'd see moving forward, and that was around $5.5 million or $6 million. So was there anything else onetime in nature that you can call out? Or is Q1 the right way to think about administrative expenses moving forward?

[James Burns:]

No. And I guess we weren't maybe as clear as possible, but we said transaction costs and other nonrecurring amounts. And so yes, Q2, Q3 is a much better trajectory for going forward.

[Operator:]

That concludes the question-and-answer session. We'll turn the meeting back over to Mr. Burns.

[James Burns:]

Thanks, Laurie. I appreciate everybody's interest, as usual, and we got to get back to work. Thanks very much till August.

[Operator:]

The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.