Alcanna Inc.

Thanks, Paul. Welcome to those calling in.

Appreciate your interest in our company. As it has been recent practice for us, I won't give an opening statement and we'll just turn it over to questions relatively quickly.

Clearly, we've been -- we're pleased with the results of Q2 in the context of the pandemic that our business has been able to stay open and to meet the needs of our customers quite well throughout the piece, and the results speak for themselves, I think so. With that, I will turn it over to questions.

Please Paul.

Congrats on the quarter. Could you just talk a bit about what factors contributed to the fairly strong liquor margins this quarter 22.7%?

Would you say this was impacted by the closure of on-premise locations? And then a follow-up to that would be any changes to where you expect liquor margins to end, let's say, a year to 18 months out?

Sure. As we have been quite clear for some time now, our intent was to raise margins carefully and slowly throughout 2020 and to -- because of the situation, we've been able to, into it, early on in Q2, we were the margin level that we had really targeted to be at the end of this year as opposed to that early on into it.

Couple of reasons for that, a little bit pricing not very much, a lot of it was mostly we have changed the way we buy, we've changed the way we promote. We are taken advantage of limited time offers, much more carefully now and utilizing our warehouse to maximize our buying power and to contribute to margin, and well this is in gross margin, we're also very -- we've got labor in a good shape and in our stores at just the right amount to balance between cost and maintaining good customer service in during very, very busy times.

So, a lot of factors contributed to it. Clearly, volume and sales and demand for and interesting fact I think most people don't seem to really understand is that, at overall liquor consumption is down in the population since the middle of March, not up.

What's changed is on-premise was literally closed for two to three months, and then when it reopened, first to a limited and then to a much more sort of normal degree in a lot of jurisdictions, especially here in Alberta, the customer traffic just wasn't there. So, the fact that the government allowed the restaurants to be open is all very well and good but if people don't want to go, it doesn't really help them.

So, restaurants have been opened in Alberta since May 14th, so over three months. Yes, there have limited capacity because of social distancing, but our results since May and right through till sitting here today, have not changed.

So the reopening of restaurants has not affected the consumer demand for off-premise alcohol by drinking at home essentially, maybe a lot more people are worrying skip the dishes and an ordering their food at home but so far and we don't see this changing, just because pricing to buy it at a retail store is so far superior to buying a restaurant. Anecdotally, we've heard that even people who do go to restaurants are not staying.

They're eating fast and staying in and out, stay for an hour, and the restaurants are encouraging to try to get some business in their limited capacities footprints now. Not are in the second bottle of wine or having the after pre-dinner drinks or the cocktails or the after dinner.

And all of which, I think is playing into our belief, our strong belief that this is not just a one-time blip, it's a trend and societal and consumer behavior trends that will be in place for the foreseeable future.

And while restaurants are seeing a small comeback, our bars and lounges are not. And so, again, that's just a great tailwind for us Jamie said for the foreseeable future.

The other thing that impacted margins, Jenny is, we weren't as promotional in the beginning part of Q2 with the pandemic going on. We just didn't need.

There was real no reason to have a lot of promotions out there. Not to say that we had no sales, we had some sales, but we just weren't as promotional.

So, you'll see us turn on some promotions in Q3 and Q4, which will blend the rate out again. But that'll be offset by better buying other initiatives that we have underway.

So, the rate will still increase as we go through the rest of the year, just not as much as what we had expected because we've made more progress than what we expected to this point.

Go it. And just to recap on the last earnings call, you mentioned kind of your one year to 18 months target of 23.5% to 24.5% liquor margins.

Is that still intact or should we kind of expect a little higher or any change there?

I think that's a reasonable range. It's kind of wide.

But, I think we'll be in that range.

Yes. It depends on how things evolve, how the competitive environment involves, how the economy evolve.

Yes, as economy evolve, I understand we are to hear today, what the Federal Government is planning to do with the AI program to replace the CERV in terms of cash in the system for people, and you know how that impacts discretionary spending, money people have to spend and so on. So, we have to watch all of that and be careful.

You can't just go raising prices for the sake of a tip. We're in a very extremely competitive industry, as we've pointed out many times over the past couple of years, and you have to price within the context of the competition.

Our company has shifted quite dramatically its focus and we're essentially for the most part at discount liquor company now with our Ace banner has 102 stores, whether this is in liquor depot was 79 now. So, Wine and Beyond which is our large format storage, which does have luxury products, but it's not a luxury store, its margins are more or less the same as Ace.

So, it's a place to get great prices and customers are not comfortable with that. We attracted a huge number of new customers to Wine and Beyond, especially during lockdown, but then they've stayed ever since, who had never necessarily been into Wine and Beyond maybe where they're confused as to what it was, maybe thought it was a high end place or something, then they come in.

And I think they came in be still coming in, in incredible numbers because of the large footprint, and there's what space people feel safe in there. You can move around.

Average customer was staying there for over an hour during the lockdown. I think it was somewhere to go to be honest, but and filling their baskets and realizing that, the pricing in their lower for most items was exceptionally good, compared to anywhere else.

So, we feel we got the Company positioned relatively well to fit the climate of the times.

Okay. And maybe on the cannabis side, in terms of cannabis margins over 34% this quarter.

Is that where we should expect margin to sit going forward? Or are there any exceptional items that happened in the quarter?

That's pretty much standard for the industry, as I understand, reading some other people. And we obviously go comparison shop our other retailers, and most people are getting starting getting around 34%, 35% margin right now.

I don't see that continuing Jenny. In Alberta, there's 511 stores or some insane number right now.

Our stores have been extremely stable on a sales per week basis because we're in good locations. But the ones who are in terrible locations, which is the vast majority of them are just having more and more stores sharing tinier and tinier pieces of their part of the pie.

And the only competitive response people in that situation can do overtime if you look at any retail one-on-one has dropped prices. You can't do more marketing because you can't mark it.

So, we don't anticipate margins staying in the competitive environment that this level for too much longer in Alberta. Ontario, yes, because it's the rollout of new licenses is taking excruciatingly slow, so there's still vastly underserved by retail outlets Ontario and until it gets to sort of the Alberta level of saturation or oversaturation, Ontario will margins will stay good.

One opportunity that still exists from margins in the cannabis space is 2.0 products. We really haven't seen a lot at this point.

What there is, there's a lot of stuff that people just don't really want that's what they're producing and the stuff that people do want there's not a lot of supply. So there's still opportunity for positive margin growth from those items as the margins come down on the products that have been out for a while?

Yes. On flower, it'll come down.

Yes. That good countering that is the wholesale price of flower is coming down extremely fast.

Because there's so much oversupply from the LP, so that will help us as retailers be able to have lower prices, but still maintain some margins for very strong. But is 35% just not sustainable for a long time in any retail, it's just this, it's there's too much, you do very well 35% in a retail environment.

So as long as you're controlling your labor and your rents fine and so on. There's too much room for people to undercut you overtime.

But as David says, the 2.0 products are in the Health Canada numbers are just essentially meaningless. What's really matters is what actually people want, not what they produce.

There's mountains of chocolate that customers aren't that interested in chocolate, gummies and some of the beverages things that people want. There's very, very limited supply.

So we get tiny amounts and we sell it out really quickly, every week and because of that limited supply, obviously you can keep your margins healthy.

And maybe just one last one on SG&A, it's flat this quarter. That's the level that we should expect going forward?

Yes, with the exception that we have some one-off cost this quarter related to the secondary offering that we did is COVID expenses, which I think we gave some guidance on in the MD&A. So, between those two items, I think we had about $2.5 million of extra costs going forward.

Right that we're all over with in Q2, our hero pay ended middle of June at the end of Q2. So and obviously the one time transaction costs are one time transaction cost.

There's always room to improve SG&A and we had continued to look at it that's business, but…

Our operations team has done a great job of getting labor in the stores to where we wanted to be at the end of the year. Again, they've done a great job of accelerating their programs there.

So we're in a range going forward.

Just on your working capital, your inventory, it looks like you put a lot of cash into inventory in Q2. I suspect some of that's just the new stores opening up, but is there anything else in there and Q2 that maybe an abnormal use of cash for inventory?

Maybe something like stocking up on a limited time offered from suppliers?

So, two there Kyle, one, at the end of March, when we didn't really know which way the pandemic was going to impact, we really lowered inventory levels just to turn it into cash. Because again, we just didn't know how this business would do or how the governments might react and close us or keep moving.

So, we've had a stock up from that point. The other place that we increased inventories is just we have some stores that are just doing gangbuster numbers, and we needed to put more inventory in there to support those increased sales.

And then the third place, as you point out, is there's been some great deal on some LTO's from the vendors. And so we've stocked up to keep our margins healthy and remain competitive in the marketplace.

And on those limited time offerings, is this kind of just normal courtside buy for you? Or was it bigger than typical this year?

So giving out the capital your balance sheets and in such good shape and maybe helping gross margins more than others?

We made a deliberate to sit down with the operating team and they asked, and they had a well thorough plan for wanting to do as much as in the high point as much as 10 million to 12 million extra dollars to invest in inventory to the VLT as they start coming and the conversations they've been having with vendors as to what might be possible. So, it was a very deliberate thing we did and you'll see the benefits of that on the income statement over the next four years, because it's purchased now but the pricing is, it'll have an impact on positive impact on margins going forward.

So yes, it was strategic, it was carefully. And as David said, some of the stores especially the Wine and Beyond, so we're just literally couldn't keep the shells are running out every single weekend.

Those stores are doing Christmas like numbers and week after week after week, and we just couldn't literally keep it on the shelf. So, we really had to put in greatly enhanced inventory in store just to keep them running and meet the customer demand.

And then based on all the color you just gave, it sounds like the back half of the year, you're working capital flows should normalize. So it's usually a cash inflow.

Is that still the case this year?

Absolutely. Yes.

No, we don't plan on increasing inventory dramatically. We'll have a little bit of a spike going into the holiday into Q4 and get that pack, through Christmas.

Yes, that's right.

Okay. And then moving on to your leases and in an environment like this I think there's potential for renewal the lower right, is that in the cards for you even have a significant portion of leases up for renewal this or next year?

Well, when you have as many leases as we do, you always have normal flow like 10% give or take whatever leases every year come do. So, yes, no, absolutely, no, I think you can save with almost certainty there's not going to be any rent increases for sure.

And it's situational case by case. If you've got a some of our great liquor depots and which have restrictive covenants and a grocery anchored mall, which do very well and we wouldn't have the same leverage you might think we'd have with a landlord because if we, if you say no, they get somebody else.

So, other situations we do have tremendous leverage, obviously one of the very few retailers right now who is not only able to pay their rents but very comfortably able to pay the rent so wherever desired can and always have been, but even more so now. I think where we see the opportunity on rents Kyle is new builds, like new Wine and Beyond sites, as big box retailers continue to struggle and either go under or try to get out of leases that we see a tremendous opportunity, if we're patient to get some extremely attractive real estate for very, extremely attractive rents to build Wine and Beyond, especially, in places where so far we've had trouble namely Calgary in British Columbia, but the deals are already starting to come.

Right now, we think the landlords are still living in the past and haven't accepted what their futures going to look like but that will come with time.

And all those Wine and Beyond, I don't think I saw CapEx spent Wine and Beyond in your updated guidance is the new locations within the cards early next year and we might see some of that CapEx issue?

We have one for sure in the books that, there might be a little bit of spend this year, but most likely mostly in Q1 and we're trying to open in Colona for Easter next year somewhere in that time range. So, first foray into British Columbia, and we're actively looking for more sites.

We have some things in mind that we want to do. But, again, as Jamie said, we'll play out how the landlords see rents going forward.

Yes, I mean, we could sign five leases today on yesterday's news rents, but we're not going to do that. Why would we do that?

Wait few months until these people see the reality here, get the rose colored vision that their assets are no liabilities so they better come to the table.

And last thing on leases here. I think you have a number of leases in place for cannabis stores.

Not yet opened but coming. I'm wondering, if you were actually paying the rent on those in Q2?

Or does those rent payments start later, so there was no kind of unabsorbed rent and your Q2 OpEx?

Almost none in Q2, but it does starting I can think of, I think two.

Yes. But it's relatively small.

Exactly, MOST of them in Q3, we're paying rents. It all depends on, you usually get a three month extreme period.

And depending when we got the lease and how long that to excel it.

It does start here in Q3.

Yes, I think we're paying rent on all of them.

I want to get back to liquor margins and the completion or I guess substantial completion of your SAP install. What does that allow you to do that can result in further margin expansion in open the next year or so?

It's actually not SAP, its Microsoft Dynamics 365. So, John, but, our ERP, yes, yes, you go ahead, David.

Yes, the improvement in margins that we're going to get likely are kind of next year and beyond. This year has just really been a focus of get all the stores on and make sure it's stabilized that it's performing well for a customer interaction.

But, what we've been doing in the background is really finding the right mix of centralized procurement versus the stores we've talked in the past about how 80% plus of our replenishment is done by our stores versus the office with some sort of a technology behind that, supporting that to make better buying decisions. And so, as we go into 2021 and the system stable, which we're not good, we're in pretty good shape on that already, you'll start to see some margins come as we get a little bit more strategic in how we buy.

Okay. Understood.

Thanks. And I want to get a sense of how you're thinking about the fourth quarter at this point.

It's of course, seasonally, very strong. Presumably there'll be less socializing in Q4 four, but balance that against the fact that more consumption will be at home.

So, just would like to get your thoughts of how your thinking Q4 would play out this year in the current environment.

Yes. John, as I said a little bit earlier, I think where we see for the foreseeable future and what does that mean?

12 months, 18 months, I don't know, till there's a vaccine that trends that have developed over the four to five months of first total lock down and then partial lockdown, it was never really total on Alberta, but there'll be substantial luck down done are going to continue. And we see absolutely no signs that they're not, and quite kind of the reverse, they're even getting stronger again is entertaining is now something you do at home.

You want to watch the hockey games, you -- room, you don't go to a bar or a restaurant and that's just going to continue for a foreseeable future. Not only your people, certainly generation my own kids in their thirties, they didn't cook much before this, and now they're used to it.

And their visa bill at the end of the month is a lot lower than it used to be, when they stay out of the bars and restaurants and that kind of like it. So, they're still ordering some food, but they're buying their alcohol at home and they're entertaining at home instead of out of home, which was their culture and lifestyle.

And we here in Alberta, we see that trend very strong and getting stronger. So, yes, there won't be office parties and people going out to restaurants and so on, but all of that, they will still be seasonal.

People still are going to have dinners, Thanksgiving, Christmas, we still see as going to be extremely strong. It's hard to see, we can get any stronger than we've already been week-after-week, because it's, but I think it'll happen.

I mean, we're extremely, we're in this down situation for the perceivable future 12 to 18 months until there's a vaccine, and this is actually over with, if in fact that ever is, then nothing is going to change in our opinion.

There's also two other things at play, which might be all they add up to be something that's helpful to us which is, people have a lot more disposable income, even though maybe the economy is a lot softer. They're not maybe putting their kids into hockey and spending big money on that.

They're not doing trips and not making other purchases in their lifestyle. And so, there's a little bit more room in the budget for alcohol right now.

The other one is, Alberta has a lot of snowbirds and I don't think they're going to be going into the U.S. So, we're going to have a little bit larger population base in Q4 and Q1, again small, but every little bit helps.

So, there's a lot of things that are contributing to this tailwind going forward.

Okay. That's helpful.

Thanks. I want to get some clarity on a comment you made in the press release.

You'd said, the second half of Q2 and into Q3 that you've seen transaction count normalized versus last year, but basket remained elevated versus last year. Is basket size kind of the same second half of Q2 and the beginning of Q3 versus the first half or is it just compared to last year that it's still up?

That's compared to last year. So, no, we are not seeing big 20% increases in basket size, but it's still very healthy.

And again, and I think it's more just because people are consuming more alcohol at home.

Right, exactly, and they're no one's stocking up. No one is afraid that we're going close and during especially in the early months of COVID for like late March, so that was stuck up.

But April and May where things were really looked down, people just didn't want to go out. So, once they did go to stores, they would buy a lot and they were not just for themselves, but for either family and friends and then, and also to minimize who in your family grouping had to go to a store to be out in public.

So, that stopped. But as David said, this the overall at home on-prem, off premise, depending who you, on-premise, I should say, depending what numbers you want to believe in, it's all over the map.

But it's probably something around 20% of the market or it used to be. Some people say 25.

Some it depends. But whatever it is, it's a huge, huge number.

And it's just essentially gone. So they added it, but the liquor sales, even though overall consumption is a little bit down.

Not a lot, but a little bit if you read the all the earnings reports and the announcements by the various distilleries and wineries and breweries. There's sort of a, people are heading around that everyone's drinking themselves to get through their panda.

It isn't actually true consumption is about, it's more or less the same. It's just all off premise.

And then lastly, for me on Ontario cannabis, you referenced it earlier. I think we've all seen the delays on the licensing process.

Do you feel confident you can get to the six to seven open before year-end? And just broadly, how are you thinking about this market now versus say three to four months ago now that we are seeing some more stores open, you've obviously got the one store on Queen Street, which now has some competitors in the region.

So just would like to get your sense of your thinking on Ontario cannabis more broadly?

To answer your first question, are we confident we'll have them over the year? No, not at all.

I can't, I don't know what the government's going to do. I'm having a clue, they're extremely slow.

I mean, you compare the Ontario performance to the regulator out here, it's just night and day, these guys know what they're doing. So we have no idea how long it's going to take.

We will build out next seven more stores now and have them ready, if we get them licensed. We'll go do some or if we're just sitting on them and not getting licenses, we're not going to go invest in paying leases on stores that aren't open and have CapEx invested in a store that's just sitting waiting for a license.

So we're, where it's kind of, we're going to wait and see, John. And if the government, the regulator gets the licensing process ramped up, obviously, there's going to be lots of competition eventually, it's just how fast it's going to be there.

So it's, we run our cannabis division, the way we run the rest of our company, like a real business somewhat unique in the industry, and we're dead. So we're going to do it as we can make money and get a profitable return on our investment, as opposed to a hype job trying to sell shares.

So we're going to be careful, and we'll do it when it's financially sensible to do it. And eventually we'll be at the top of the pack, just like we are in Alberta making money.

Just one more follow-up on a comment that you made earlier Jamie, could you talk a bit about kind of in recent months, what you're seeing in regards to liquor consumption habits. I know a lot of restaurants in Alberta did reopen, but it's still kind of operating under fairly restrictive social distancing rules.

Any comment you can provide fair and consistent consumption habits?

No, I think if you just look at our own observations, our sales talking to people in own restaurants here. Restaurants would open for three over three months here.

It's been a long time. They were really only close for six weeks on government decree.

But the people aren't going back there. When they do go there, eating and running, and there we just see, overall alcohol consumption is essentially flat.

They'd be a little down. It has been on premises been almost totally replaced by off premise.

But that's the dining has gone from entertainment. You went out to eat, but it was more for the entertainment of it.

So you'd have a drink at the beginning of the meal, a couple of the end you'd linger. You'd have a lot of fun.

And people, as Jamie said, are just kind of getting in and going out. Maybe it's different from what you see out there.

But that's our observations here in West.

I've done twice since it all reopened and it's weird. The tables are spread out.

There's no noise. There's no vibe in the room.

You kind of just servers have masks on it's just not the same.

Hi, one last one for me. Just on your capital allocation, your balance sheets increasingly in great shape looks like your convertible refi is going to be a non-issue or something the cash you should have by then you hadn't even drawn on your revolver as of now as well.

So, what do you do with your capital? Could a dividend be in the cards at some point?

Or do you want to hold on to the cash for potential growth opportunities? Just any color would be appreciated on how you're thinking about that?

Well, as usual, that's an excellent observation, Kyle. We just had a board meeting yesterday and obviously that was a topic of some discussion.

And at this stage, we have a number of options in front of us which we're considering for growth. There's always the Ontario liquor opportunity still there.

Hopefully that comes in which case we got lots of places to use our cash in Ontario building Wine and Beyond, the Ontario cannabis BC, Wine and Beyond it'll be a little more expensive in BC because you're probably going to have to go by, because there's various restrictions there of a kilometer. So you're going to probably have to buy a current license holder or the current store to be able to get into a trade area.

So, it could be 5 million to 6 million a store, but time you invest in your working capital in your inventory and BC. So, we have many places we can invest capital that we still feel will provide a decent return to on those investments, but as I said, we're going to also be very careful where land rents are going to come down, there's no sense jumping just for the sake of it when we can get a much more cost effective rent structure, if we bide our time and be patient.

Same with Ontario, we're going to bide our time and be patient not so much rents there, but it's more licensing and making sure we can be open in good locations where it doesn't really matter if there's competition or not, which is what's happened in Alberta. We just really haven't dropped when people, the competition has showed up, because they've showed up in places that no one wants to go.

So, it's a work in progress and it's something that's sort of the as you said, it's a very high class problem to have, it's not even a problem, but I like high class issues here. But we foresee our company doing, continuing on the kind of operations and performance that it's had so far throughout 2020.

Including Q1, the pre-COVID, we were just had really turned the corner weren't doing very well even without those last two weeks of March. So, in terms of how we position going forward, it's something that we're, that occupies what David and I do all day.

Okay, thanks, Paul. Thanks very much.

Appreciate the questions and the analysts who follow us. We do appreciate your efforts on our behalf and the time you take to understand our company, we're sort of a unique business and no one really understands this, if you don't do the work.

So we do appreciate it as well as to everyone who was called in. Thanks very much, and we'll talk to everyone again in November.

Thank you.