Alcanna Inc.

David Gordey - SVP & CFO Stephen Bebis - President & CEO

George Doumet - Scotiabank Sabahat Khan - RBC Capital Markets Marc Robinson - Cormark Securities Trevor Johnson - National Bank Financial John Zamparo - CIBC World Markets

Thank you, operator, and good morning to all our listeners. I'm here this morning with Stephen Bebis, Liquor Stores' President and Chief Executive Officer.

I am going to lead off the call by recapping our results for the quarter. Stephen, will then provide some further context on these results as well as some operational commentary and discussion regarding our outlook for the future.

Before we begin, let me remind everyone that during this call, we may make statements containing forward-looking information. This information is based on a number of assumptions and subject to multiple risks and uncertainties that could cause actual results to differ materially from those disclosed or implied.

For more detail regarding these items, please consult either our earnings press release or the associated Management's Discussion & Analysis. Overall, we are satisfied with our third quarter results, which demonstrated our Seven Point Plan is successfully mitigating the challenges in our markets that are most reliant on oil and gas activity.

Consolidated sales for the third quarter were $194.2 million; a 6.7% increase from the third quarter of last year. This improvement was the result of increased same-store sales in U.S., increased sales from Canadian wholesale operations, the year-over-year net addition of two new locations, and $9.6 million positive impact from foreign exchange.

Quarterly same-store sales within Canada decreased by 0.9%. This decline was driven by those locations that are most sensitive to the weakness of the oil and gas industries.

Year-to-date we have written same-store declines in Fort McMurray, where we have seven locations, Grande Prairie, where we have nine locations, and several other smaller markets where our local economy is heavily dependent upon oil and gas activity. Same-store sales continue to grow in Edmonton where we have 81 locations, in Calgary where we have 44 locations.

Same-store sales also grew in British Columbia despite regulatory changes earlier in 2015 that increased the competitive pressure from the provinces government-owned locations. This growth was supported by incurred increases in both our average basket sizes and transaction counts.

In United States, quarterly same-store sales increased by 1%, excluding the impact of foreign exchange. This improvement was the result of continued growth at our 15 Kentucky locations where we also generated increases in both average basket sizes and transaction counts.

The positive performance in Kentucky was offset by declines in Alaska where we have 22 locations. Thus the markets in Alberta or locations in Alaska isn't impacted by slowdowns in their local economies which are dependent on oil and gas activity.

Canadian wholesales for the third quarter were $7.2 million, a 6.9% increase from the third quarter of 2014, primarily due to the addition of new customer accounts over the past year. Our gross margin for the third quarter was $49.8 million; a 6% increase from third quarter of 2014.

This improvement was primarily due to $1 million increase from margin in net new stores as well as $2.2 million positive impact from foreign exchange. These factors were partially offset by a net decline of $0.4 million in gross margin from same-store sales decline.

Our adjusted operating margin for the third quarter was $11.5 million, a $1 million increase from the third quarter of last year. This decline was due to an increase in store operating expenses which share the result of $2.1 million foreign exchange impact, minor rents increases, and the net increase on our number of locations.

These increased expenses were only partially offset by an improvement in gross margin dollars. Adjusted operating margin as a percentage of sales for the third quarter was 5.9% compared to 6.9% for the third quarter of 2014.

A significant portion of our operating costs are fixed and the results our operating margins reflect same-store sales declines. Net earnings for the third quarter were $4.2 million, a decrease of $1.1 million compared to the third quarter of last year.

This decline was the result of the $4.4 million increase in operating and administrative expenses which was partially offset by the increase in overall gross margin dollars. Quarterly earnings per share declined by $0.08 year-over-year.

Net working capital at the end of the third quarter was $114.4 million excluding cash and $18.9 million increase relative to its position at the end of '14. This was primarily due to the impact of foreign exchange which was particularly pronounced as a result of our two new large format stores that we open in Kentucky.

This quarter we also made additional inventory purchases to prepare for the fourth quarter selling season, to take advantage of supplier discounts, and to support the growth of our control and exclusive brands, our prepared label program which have performed very well over the past year. Long-term debt was $127 million at the end of the third quarter, a $35 million increase relative to the end of 2014.

This increase can be attributed to the increase in working capital from year-end as well as the need for cash to support both operating activities and capital expenditures. As a result of the successful implementation of our Seven Point Plan to-date our stable cash flow as well as our available credits and our availability to access new capital, we currently sit in a healthy financial position.

We are capable of executing our existing business strategies which Stephen will speak to further in a moment as well as exploring opportunities for acquisition. Our dividend for this quarter was $0.27 per share and we believe our cash flow in the context of the current economic environment is sufficient to maintain this level moving forward.

However, we are aware that many of our markets are facing uncertainty in the near future. And that the factors that challenged our world resource markets this quarter does have the potential to create further challenges.

We will continue to carefully monitor the performance of our stores and company's cash flow requirements as economic conditions evolve. I will now turn the call over to Stephen, who will provide further operational context and discuss our strategic outlook moving forward.

Thank you, David, and good morning everyone. As David mentioned, we are satisfied with our Liquor Stores results for the third quarter of 2015.

On one hand, we are combating challenges within several of our markets in both Alberta and Alaska; weakness in the energy industry has created a considerable economic slowdown. The impact of this slowdown has been particularly pronounced within those markets, most have been on oil and gas activity.

As long as these sectors continue to struggle, it will be difficult to generate consistent same-store sales growth within those markets. While Alaska, Fort McMurray, and Grande Prairie, and a number of small oil and gas relying markets all weighed in on same-store sales in the third quarter, we believe these declines have been mitigated by a number of initiatives on Liquor Stores Seven Point Plan.

As a reminder, the stated goals of this plan are to build our competitive position, invest in opportunities to support long-term profitability, and drive growth across our business. In particular, we believe that plan emphasis on both staff education and the continued introduction of preferred label products has combated well otherwise would likely have been more significant sales decreases.

The plan has also been responsible for encouraging growth in average basket size over the course of 2015, as well as same-store sales improvements, we have seen in our other operating geographies. The continued implementation of our Seven Point Plan will become even more critical as we move forward.

Yes, Alberta is fundamentally economy struggling. We recognize that the challenges facing our most exposed markets could be to greater the pressure upon Calgary and Edmonton two areas where we're operating a total of 125 locations.

This pressure could be aggravated by Alberta's recently announced increases to both personal and corporate provincial income taxes. While we haven't seen this yet, but if it occurs, we believe this strategy is outlined within the Seven Point Plan, will ease any negative impact such as continued store growth outside the province and growing out private label programs.

While same-store sales slowed, our consolidated sales continued to increase reflecting our focus on new growth opportunities. As David mentioned, our Canadian wholesale business for the third quarter was $7.2 million, a 6.9% increase when compared to the prior year.

We have also continued to expand our store base and attribute $2.9 million of our sales growth in the third quarter to our new Canadian and U.S. locations.

To-date in 2015, we have opened nine new stores, seven in Canada, and two in the United States. Some of those seven stores in Canada have cannibalized our existing base which are also can have an effect on same-store sales.

But overall, we've increased market share. Over the next 24 months, we have commenced to open up a further 10 locations, seven in Canada, and three in the United States.

Finally, and very importantly, our stable financial position should allow us to execute one or more strategic acquisition opportunities. We are supplementing these growth efforts with a continued focus on the improvement of existing operations.

Our seven-point plan provides an outline for these internal improvement initiatives which included investments in both our existing locations and their supporting information systems. To-date in 2015, we have spent a total of $2.5 million towards refurbishing our common store base and expect this investment will total $5 million to $6 million by the conclusion of the year.

We have also deployed a total of $1.6 million towards the implementation of our new enterprise resource planning system which is intended to drive new efficiencies into our organization, reduce costs via great visibility to our operations, and provide a scalable growth platform that will drive both organic improvements and accelerate the integration of new businesses. We anticipate investing a total of between $21 million and $24 million in this system over the next 24 months.

In combination, all of these efforts will result will in a greater level of efficiency across our business and make us best-in-class in the adult beverage business. As David mentioned, our adjusted operating margin for the third quarter decreased by $1 million relative to the prior year and our adjusted operating margin as a percentage of sales was 5.9%, down from 6.9% in the prior year.

These declines were possibly due to the same-store sales decreases we saw and possibly due to the fixed nature of so many of our costs. Investing within our existing locations and opening new stores further increases these costs and new locations take time before they're able to provide effective contributions to our operating margins.

However, we believe it is vital that we focus upon maximizing value over the long-term and the seven-point plan was designed for this with that goal in mind. Within the near-term the plan has allowed us to manage the external challenges we are facing within some of our markets.

But over time, if these challenges subside, the plan should lead to both continued revenue growth and thorough efficiency improvements with greater profitability. With that, I would like to open up the call to question-and-answer session.

Operator, please provide the instructions to our listeners.

Can you provide some commentary on the Canadian same-store sales trends? How was it -- has it been deteriorating throughout the quarter and I guess, moving forward, do you expect the urban centers to have further pressures from current levels?

So we really felt that in August and September, George, one of the spots (phonetic) that we pay attention to are layoffs in Alberta marketplace and the layoffs in September were the highest that we had seen since January. And so that really had an impact on our third quarter results.

Where we go from here it’s tough to say; it’s a cyclical business. Our best guess is that we’re kind of a flat line from here to the end of the year as to where we are right now because there would be another leg down possibly, but your crystal ball is as good as mine.

I guess Canadian gross margins, can you may be quantify the impacts of the higher promotions and I guess, moving forward, do we expect those promotions to intensify or to remain at current levels?

Well, we gave away a little bit of margin during the summer times, particularly in September, where we had an impact on sales due to the weather. Our business has a weather -- it’s weather-related, and September this year in Alberta we froze.

I think it was close to freezing four degrees, three degrees versus last year where it was 30 degrees here in Alberta. And so certainly warm weather really helps our beer business.

So we have to give away some margin and I think that had an impact. But overall we are very happy with our margin.

We're very happy that we haven't given it way, we have our hands on the steering wheel. We are not going to race to the bottom.

Listen, we could have a positive same-store sales increase tomorrow if we gave away bulk of cost and we're not going to do that. And so I think the balance of margin and relatively flat sales with some sales growth, I think was a pretty good quarter, we're pretty satisfied with it.

It shows you that we have our hands on the steering wheel.

Okay. And one more, if I may, please.

In the SG&A a bit of a step up this quarter and you guys cited the rate escalations and increased store costs. Just trying to get a sense of the run rate, looking forward, should we assume this quarter’s level?

I think, I wouldn’t assume that, I think that there is some cost in there. We’ve been looking at acquisitions and we’ve been spending some legal fees and costs in terms of their due diligence and looking at things like that.

So I don’t know, David what you think of it?

The other thing not to lose focus on with the impact on the foreign exchange rate there, George, and so that really increases the SG&A cost. And also we launched the two new large format stores in Kentucky which look great, but they take a little bit of time.

So we launched them with full operating cost and not full slate of sales that we would expect on the go-forward basis but it will take some time to mature some so. That’s also impacting the ratios of SG&A to sales.

Thanks. Just on the CapEx, given that you talked about half of the stores refurbishment project roughly, do you expect it to be accelerating that spend in the back end of this year or Q4 to catch up?

Yes, so we, as Stephen mentioned on the call we spent about $2.5 million to the end of September and we expect another $2.5 million to $3 million in October, November before the selling season starts. November is a fairly slow month for us.

So we have a few renovations scheduled for then and we’ll open them with a bang going into Christmas. We will hit that $5 million to $6 million range by the end of the year.

Okay, great. And on the Alberta tax impact you called out it's been slightly positive year-to-date.

Just want to understand how we should think about the overall impact going forward in terms of a potential volume impact or anything else there?

Yes, that 5% if they said that is 5% increase but the 5% increase on the tax, so that relates to like $0.03 on a bottle of beer and like $0.08 on bottle of vodka or $0.10, it’s going to have impact; we're passing it along to our customers but it’s not going to be material.

Okay. And just one last one, I'm just trying to understand the impact that you called out in the smaller market and the potentially due to the large cities.

Is there just a share on people just leaving the smaller towns because there are no jobs or is it a trade down, what are you guys seeing there?

Yes, what we’re seeing in those markets, hotel vacancies and in when our team goes up to Fort McMurray and Grande Prairie, we couldn’t get hotel rooms in the past and now they are empty. So the transient population have seemed to leave that market.

The restaurants and bars are down 40%, 50% in that market -- in those markets, and so I think we’ve lost that business. We haven’t seen a major population shift yet, back to Edmonton and Calgary, but it could happen, I mean I don’t know what's going on.

You heard anything else, David?

No. I'd say, Sabahat, a encouraging thing in those markets are the customers that are shopping with us, those ones that live in those markets but that’s the thing that really hasn’t changed or it’s grown a little bit in some of them.

So that’s important to note; it is the transient market. And plus about two years ago we signed leases to open new stores in those markets and we opened them this year.

So our timing wasn’t futuristic. So those stores are suffering, brand new stores with brand new capital costs and we're down right from the opening based on our plan but we couldn’t predict that two-and-a-half years ago, I would have been the genius.

Okay, and just one last one as a follow-up to that, if you could just comment on how your private label program is progressing and how are you kind of accelerating the growth of that program in light of the macro conditions [indiscernible]?

Absolutely, Sabahat, that’s a very critical part of our seven-point plan and we’re having great success with that program. We currently have well over 100 labels in our wine program and we anticipate growing that over next five years.

We have a team dedicated to that business. Our customers are enjoying the quality and the value of our products, and I want to argue it’s one of the best wine programs in North America today already and so good stuff.

We just introduced a new Bourbon and that’s doing very well in Kentucky, in Alaska and in certainly here Alberta. So doing well.

I’m wondering what you think the ability is to increase margins in a same-store sales growth declining environment, I guess specifically in private label has been a big focus on the margin expansion and then there is some commentary having to lower prices because of the competitive or the economic dynamic, so just what is your ability I think to raise margins in this environment?

It’s good question. I would say we still have bandwidth to right margins, I feel good about what we’re working on.

The question is how bad is the economy going to get, right, and how competitors are going to get, I don’t know, I can’t predict that in Calgary and Edmonton. So far they held up very well, these urban markets, British Columbia is doing well.

And in my view, we need to diverse, diversify out of Alberta and from a strategic standpoint and we’re working very hard of doing that particularly into the United States, and I think that’s the long-term answer in terms of marking our margins up, but we’re getting good margin growth in Kentucky and in Alaska which is mitigating some of the oil and gas markets that we have here. And we’re not going to give away the firm, we are not going to do that, at least don’t feel that is the right thing to do but we are going to offer value to our customers.

And so in a lot of these markets our merchants are working very hard with our suppliers to bring in some great deals where can drive traffic to our stores.

So with this lower pricing on private label a permanent fix or do you think it’s a temporary thing or still unclear?

No we’re not changing private label pricing, private label pricing is strong, our margins are strong and what we will do maybe is run Budweiser on you’re a 24 pack or 48 pack at a great price, a Smirnoff vodka at a great deal, that kind of stuff, but private label program is robust margins and we continue to grow that.

Okay. I’m just wondering the rent escalation was headwind to your SG&A but there is also lot of commentary around vacancies, I’m wondering if given the economic environment you may actually get some relief some of these rents, or lease terms roll off, are you seeing that?

It’s a good point, Marc, I think there is opportunity there and we’re certainly working on that right now, hopefully, we’ll get some release.

Again and then just finally here, I mean there is so much requirement, so many places to put your capital, it's probably a non-exhaustive lift but I’m just sort of looking for you to maybe prioritize your places for capital here if we think that sort of renovations, M&A, greenfield development, the ERP system and the dividend, maybe I am missing something, but can you sort of just maybe prioritize that so I understand where your first dollar goes if things start to deteriorate further?

Well, first of all, the dividend is a board decision, right, and so they will make the decision on that dividend based on a bunch of factors, but the board I know feels very confident of our seven-point plan and for the outlook for the markets which we operate and I know that. And right now we both management and the board see great value in our dividend and we understand how important it is to our shareholders.

So if we need to trim some expenditures or if we need to trim growth CapEx or other issues, we will probably do that first. But that said, yes, we see the opportunity to grow with our strong balance sheet and overall health of our business, we think that we can make acquisitions, do some organic growth in the United States specifically, and to make continued progress with our strategic objectives.

So, I guess my point is from a priority standpoint that’s how we think about things.

And with the intention for in M&A would it be to have that the free cash flow accretive, not just EPS accretive, I guess in asking that would M&A sort of help the payout ratio?

Absolutely, Marc, and we’ve been open with the market around the fact that we are looking at both organic growth and acquisition growth, and the deals that we continue to see there would be accretive to both of those metrics.

Just wondering if you could give a little bit of color on the management changes in the Alaska portfolio and to-date performance how that’s gone versus your expectations?

Sure. We celebrated recently in Alaska, we made plan in one month first time I think in the couple of years made our business plan, and so we’re getting quick momentum in that market.

She's done a great job; we made a lot of management changes there. We’ve also even though there we have good performance in Kentucky, we made a major management change there, and so we had a new leader in Kentucky, our Kentucky stores.

And so we hope to see an improvement in our management team there overall. And we’re focusing on our U.S.

markets more than we’ve ever had before in the history of our company. And so we’re very focused on improving our performance and we’re seeing it in the results.

In terms of your diversification from Alberta obviously you’ve mentioned earlier, is there any way to do something unrelated with Liquor Stores be open to that under Liquor Stores umbrella like i.e., not as a retailer per se? Have you thought about that, and is that something that might unfold down the road?

We haven’t thought about it, not really because we're just focused on being the best alcohol retailer in North America and just have really focused on that.

And in terms of the portfolios that might be able to help with the diversification, how is the flow of that? Is it pretty steady?

Are you consistently is there any transaction potential, just wondering how lumpy and/or do you define these types of opportunities?

They’re not easy to find, so that’s why they take a long time, they’re not easy, but when you find them we’re looking for good ones. And ones that are bolt-on and part of our long-term strategic plan, example would be want to buy small chain in Nevada probably not, but if there's one available on the eastern seaboard that fits into our growth plan along eastern seaboard we will jump on it.

And so we’re looking at a bunch of them and we have been, and we’re very selective. We want to buy profitable businesses that are accretive from the day we buy them, and so we want to buy good businesses.

We don’t want to do turnarounds and transformations. And there's a few of those that we’re looking at, that we're involved in.

So hopefully, one of those will land one of these days.

And pricing reasonable, not unreasonable, just wondering how it’s falling in the spectrum?

We like looking at the businesses that we could buy anywhere from four to eight times sales at the top, we think that’s very accretive. I know our stock price yesterday was pretty good, I don’t know about today, but we feel that adds value to our shareholders and that would add synergies, we can buy these businesses and then on top of that we can put in our preferred programs, we can leverage our store support center costs and we can lower that ratio dramatically over the next few years after these acquisitions.

And last one from me, I know you can’t say it on behalf of the board in terms of dividend policy, but can you just walk us through may be one or two of the key metrics that they’re looking at, like I know it’s tough because of the moving pieces to figure where cash flows are going to come in with all the growth and economic uncertainty in a lot of your key markets, but is there any color you can give maybe just in terms of what they’re looking at to try to get a hold on what the appropriate size payout would be for the business right now?

Well, obviously, we want to bring out payout ratio down, we have been doing that. We feel that we cannot grow the yield.

So we've got a lot on the curve (phonetic), and we feel the U.S. is pretty much wide open for a topnotch retailer like ourselves.

And so board feels very confident in our strategic plan, they feel, they know what we are thinking about a year, two years, five years down the road. We have a very strong management team, we’re performing very well in all our new initiatives, and so I think there is a lot of confidence in the management team to grow out of the yield over the next while.

And with, let’s say, a high single, low double-digit cost of equity, do you still think that the U.S. growth ambitions are financeable with that type of cost of capital?

Sure. Absolutely for sure.

Thank you. Good morning.

Stick with the acquisitions topic, Stephen, I was hoping you comment a little bit more on the M&A environment, you’re seeing particularly in the parts of the U.S. you’ve identified targets and any commentary on multiples of transactions that you’ve seen would be helpful?

Sure. Sure.

We like buying -- first of all, a lot of businesses that we’re looking at are private held, typically they’re either family run businesses or owned by owner-operators. And of course they all think their businesses are worth like gazillion dollars.

And I don’t obviously go in there and show them how we can help monetize their businesses for their families and their long-term for their grandchildren and so forth. But it’s a bit of sell-story and so it takes some time that I find it’s easy to buy a publicly traded company than there is a privately held one, if they were in the family for 50 years, probably found them, and we’re talking to them and we’ve been active in the space for two years now.

So we know what we’re doing in the space and how to negotiate these deals. And so, it’s just all about timing, getting the timing right for everybody.

And I can’t bet, I can’t promise you we're going to close in an acquisition but I think part of that we’re working on multiple fronts and hopefully one of these will close very soon.

And would you consider buying less than 100% stake or is 100% control a prerequisite for you?

No, we will consider buying less than 100%. You do want control.

We won’t buy anything that we can’t control them at least, but certainly we're working together on partnerships and so forth, we're open to those types of conversations. It depends on the management team, the partners, we have confidence working with them and so forth, so that all has -- and we have to factor all that in.

Okay. On the sales to licensee customers, you said in the past the company didn’t pay quite enough attention to this, do you see this type of growth as attainable on an annual basis or do you see it more as a one year lift?

Well, I don’t know it will have these types of lift next year, I can’t predict that, but I can tell you that we doubled our staffing in that department recently. And we’re focused on building that business, we like it.

We think that we offer restaurants, hotels and bars preferred programs, our private label programs gives them their job in terms of their margins and our margins, and so we’re working very hard to grow that business profitably.

Well, thank you all for joining the conference call today and I look forward to talking to you next year after the fourth quarter and the year end. Thank you so much.