Earnings Call: Q1 2020

Jan 8, 2020

Thank you for standing by. Welcome to the Good Foods First Quarter 2020 Financial Results Conference Call. At this time, all participants are in listen only mode. Following the presentation, we will conduct a question and answer session. As a courtesy to others, we ask that each participant limit themselves to one question and if necessary, one follow-up question. Instructions will be provided at that time for you to queue for questions. Please note that questions will be taken from financial analysts I would like to remind everyone that this conference call is being recorded today, January 8, 2020, at 8 am Eastern Daylight Time. Furthermore, I would like to remind you that today's presentation may contain forward looking statements about Good Food's current and future plans, expectations and intentions, results, level of activity, performance, goals or achievements or other future events or developments. As such, please take a moment to read the disclaimer on forward looking statements on Slide 2 of the presentation. I would now like to turn the meeting over to your host for today's call, Jonathan Ferreira, Good Food's Chief Executive Officer. Mr. Ferreira, you may proceed. Thank you. Good morning, everyone, and welcome to this call for Good Food Market Corp, in which we'll present the financial results for the Q1 fiscal 2020 ended on November 30, 2019. I'm pleased to be joined on the call today by Philippe Adam, Good Food's Chief Financial Officer and by Neil Caghi, President and Chief Operating Officer. Our press release reporting Q1 results was published earlier this morning. It can be found on our website at makegoodfood. Ca and on SEDAR. Please be aware that we will refer to certain metrics and non IFRS measures. Where possible, these measures are identified and reconciled to the most comparable IFRS measures in our MD and A. Finally, let me remind you that all figures expressed on today's call are in Canadian dollars unless otherwise stated. Slide 3 outlines our key financial highlights for the quarter. Overall, 1st quarter results surpassed expectations in growth and margin, and we're very pleased with the business performance over the 1st 3 months of fiscal 2020. We achieved record levels on key metrics, including subscribers, gross merchandise sales, revenue, gross margin and EBITDA margin. We also continued to generate positive cash flow from operations and ended the quarter in a very healthy financial position with $47,000,000 in cash, cash equivalents and restricted cash. There are a few items I want to highlight on this slide. The growth in revenue outpaced our growth in gross merchandise sales as a result of lower credits and incentives as a percentage of GMS. Most of this decrease was driven by lower incentives, highlighting our ability to execute highly targeted marketing campaigns with strong results as demonstrated by the addition of 30,000 net new subscribers this quarter. Moreover, the growth in revenue and gross merchandise sales was in part driven by an increase in average order value, underscoring Good Food's ability to provide a more complete offering and to deliver a fuller grocery basket to our Canadians. Finally, our margin improvement continues to build momentum with adjusted EBITDA margin improving 6.7 percentage points. This improvement is the result of strong execution at multiple levels of the operation. I will now turn to Slide 4 to present a few operational highlights. During the Q1, we continued to ramp up our product offering to enhance member experience and expand our market reach. Let me provide you with an update on some of our initiatives. First, we expanded our breakfast meal solutions. Since launching our ready to blend smoothies in the spring of 2019, we built our offering to now have 32 delicious breakfast products available to our members, including numerous internally developed proprietary items like our seasonal oat bowls, savory omelettes and high protein muffins. Our breakfast meal solutions are growing and average run rate gross merchandise sales in the mid teens in recent weeks. 2nd, we continue to make progress in building our private label grocery product offering. We launched several new products in the quarter and optimized our offering of existing products. We are nearing 100 items of everyday grocery essentials offered to our members, all of which are sold under the Good Food brand name and at a discount to the branded equivalent products available at major national chains like Loblaw's, Metro and Sobeys. Going forward, we will exponentially grow the variety of grocery products available in order to work towards fulfilling our members' complete grocery basket. As we significantly ramp up private label grocery essentials, we will continue to optimize our product count by gathering member feedback and monitoring sales. 3rd, we have made important strategic decisions for our ready to eat meal solutions. Recall that these meals were introduced in Quebec and Alberta, respectively, late during fiscal 2019 early fiscal 2020. And we are currently working to expand this offering across Canada. We now have over 20 options available to our members, including full meals, soups, chili bowls and salads. We're still in the early days, but we have seen solid traction for these meal solutions, and we see a great opportunity to capitalize on the significant market opportunity. As such, we've decided to in source a portion of our offering at our Hickmore facility. We are starting construction by the end of January, and we should be operational in the coming quarters. This will allow us to offer better custom products to our members from coast to coast while improving our margins. Overall, in addition to address our members' needs and enhancing the total value of customer orders, These products will be a key driver in taking a larger share of Canadians' food grocery basket. Finally, in the coming weeks, we will be opening a new 84,000 square feet production facility located in the Greater Vancouver area. As indicated in the past, being closer to our British Columbia members will translate into operational and logistics savings, while ultimately increasing the quality of our service. On that note, I will turn the call over to Philippe to go over our financial performance. Thank you, Jonathan. Good morning, everyone. We can now turn to Slide 5, which provides details and detail on subscribers and revenue. We continue to demonstrate solid growth this quarter, driven both by the important back to school period and better than expected Black Friday results. At the end of the Q1, with food subscriber base reached 230,000 with the addition of 30,000 net new active subscribers during the quarter. Obtaining continued net growth on a much larger member base confirms our momentum in the market and among Canadian consumers. The subscriber growth was driven by a combination of factors, including continued growth in British Columbia and Alberta and also in Ontario, where we now have as many subscribers as we do in Quebec, the seasonal ramp up of our targeted marketing campaigns and our new and extended product offering. Revenue has also grown sharply, increasing to a record $56,300,000 almost double the revenue for the corresponding period in 2019 and 44% higher than the 4th quarter. Remember that we increased prices on November 7 in Quebec and Ontario. While the pricing adjustment only impacted our revenue for 3 weeks of the quarter, This was very well received by our subscribers as it has resulted in few cancellations while many opted to lock pricing in advance. Turning to Slide 6. Gross merchandise sales also increased significantly to $68,000,000 up 21% over the 4th quarter and 82% year over year. The strong growth momentum of the Q1 allowed us to approach the $300,000,000 mark in gross per Shanghai sales run rate, finishing the quarter at $276,000,000 When looking at the relationship between GMS and revenue, it is important to highlight that revenues grew more than GMS as we achieved a level of incentives and credits of 17.3 percent of gross merchandise sales, well below the 20% average for fiscal 2019. Incentives and credits are still an effective customer acquisition strategy, but as we continue to increase our revenue base, they represent a lower figure on a percentage basis. Please now turn to Slide 7, which compares our gross profit and adjusted gross profit. Our strong execution and operational improvements have translated in continued net margin improvement. Despite the fact of new products being launched, we have shown a significant increase in profitability in the Q1. Our gross profit increased to $16,200,000 and our gross margin reached a record 28.8%, an increase of 6.9 percentage points year over year. Our adjusted gross profit reached $28,000,000 and our adjusted gross margin reached 41.1 percent, increasing 3.4 percentage points year over year, on track to reach our 45% objective in the medium term. While we remain driven and focused on rapidly growing the top line expanding the business, our strategic initiatives to extend margin are yielding expected results in line with our long term profitability plan. The increase in the adjusted gross margin resulted primarily from lower production costs as a percentage of GMS, lower food, packaging and shipping unit costs due to additional automation investments, operational efficiencies, increased density among the delivery zones and purchasing powers with key suppliers, slightly offset by the launch of new product offering. The next slide shows our adjusted EBITDA and net loss. Our adjusted EBITDA loss in the Q1 decreased from the previous quarter to $3,700,000 or a margin 6.5%, which represents an improvement of 6.7 percentage points year over year, mainly due to higher gross profit margin and stable SG and A expenses, but also despite an EBITDA drag from the launch of new products of over 2.5 percentage points. As a reminder, we continue to successfully execute our strategy, which still focuses on growth and capturing market share in the nascent online grocery industry in Canada. We firmly believe being the leader in fulfilling Canadian's digital grocery basket is the best driver of returns to shareholders. With that said, we nonetheless improved EBITDA margin 14.1 percentage points over the past 8 quarters and continue our strong and consistent execution in achieving long term growth and profitability goals for Bethune. Turning to Slide 9 for cash flow and capital expenditures. For several quarters now, we've been able to finance our growth through cash generated by the company. In the Q1, we are pleased to have generated positive cash flow from operating activities of $1,500,000 We've also invested $1,700,000 in capital expenditures to finance equipment for the New Vancouver facility to invest in automation and in some upgrades to our current facilities. As we continue to grow and optimize our operations, we still expect to spend between $10,000,000 $12,000,000 in capital expenditures in fiscal 2020. Before we conclude, I would just like to make a few comments on our next quarter. As a reminder, the 2nd quarter is typically strong with January February being traditionally high demand months. However, December is usually slower as the holiday season is the lowest demand period of the year. Also note that margins in the 2nd quarter are impacted by higher shipping and logistics related costs due to weather conditions. This concludes our financial highlights for the Q1 and our prepared remarks for today. Jonathan, Neil and I will now be pleased to answer any questions you may have. Our first question today comes from Frederic Cambly from Desjardins. Please go ahead. Thank you. Good morning. Good morning. I wanted to ask about the increase in average order value. Can you provide some the magnitude of that increase and then the main drivers behind it? Was it pricing, product expansion, a bit of both? If you could provide a bit of color around that. Fred, it's Phil. Thanks for your question. So average order value increased significantly year over year because of the added products that we've included in our basket. I'm referring to breakfast, ready to eat meals and private label items. So year over year, it's in the range of 5%. So directionally, we're very happy with that. And it's just the beginning because we've provided only, let's say, 150 new items since we started this new division and product offering. So the average order value should continue to go in that direction. Okay. And on the private label grocery items, there was a mention that the number of products would grow exponentially. Provide some detail on the pace of that. You're at close to 100 Diamonds now. Where do you expect to be a year or 2 from now? Yes, happy to provide a bit more visibility around that. So we when you look at grocery SKUs, there's about 80% of sales in the grocery industry that will come from 20% of the SKUs in a typical supermarket. So we'll be targeting those 20% of SKUs that end up being the highest movers. That will translate into, call it, 3000 to 4000 SKUs to hit that 20% of SKUs. And we'll be working on building that out over the next 2 to 3 years. Okay. That's great. Thank you and congrats on a great quarter. Thank you. Our next question comes from Jenny Huang from 8 Capital. Please go ahead. Good morning. Thank you for taking my questions. My first one, in terms of the new product offerings, can you give us an idea of what portion of the customers purchasing these new products are new subscribers versus existing? Sure. Thanks for your question. Primarily, we are selling our new products to our existing customers. So we do have a small amount of breakfast only subscribers. But I would say across the board, we're targeting most of our new products to our existing customers to either increase average order size or increase the frequency of the engagement, so the average order rate that we would see on a customer. And over the next few months or during this fiscal year, we'll be creating the ability to more easily mix and match products to make sure that that experience is seamless and that we can capture an order that contains ready to cook products, ready to eat products, private label products in a combination in a way that is easy and flexible for our customer base. Thank you. And are you planning on further price increases going forward and with capping throughout all the geographies that you're currently operating in? Sure. I think our approach is just like any other business. It's an annual general price increase strategy that we'll be looking at. So making sure that we take inflation costs into consideration and increasing pricing across the board based on inflation. So that's kind of the general price increase strategy on an annual basis. And then on a more targeted basis, we do have the ability to vary pricing of every single product in every single geography. And so based on the demand that we're seeing, based on competition, analytics, customer shopping patterns, we will have an approach that prices differently in every single market. And so that'll be on a more constant basis rather than annual where we can flex that pricing to maximize demand and profitability. Thank you. I'll jump back in queue. Thank you. Our next question comes from Ryan Lee from National Bank Financial. Please go ahead. Thanks for taking my questions and congrats on a good quarter. Just had a follow-up in terms of the incentives as a percentage of GMS. You able to give further details on that? Was that planned? Or was it just a result of the general market in taking up the incentives? And what should we look for in terms of the rest of the year is a good base to work off of? Ryan, thank you for the question. It's Neil here. I'll take the first half, and then I'll let Phil talk about the going forward numbers. What we've always said to investors and to the public is that credit and incentive line is really a function of the speed of growth. So with very, very high growth comes a bigger gap between our GMS and our IFRS sales number. And still with the pretty aggressive growth that we've had, it's smaller in percentage terms than in the past, which means that some of that will mathematically just produce the credits and incentives. So that's just a purely mathematic explanation. And then the other aspect is we were always evaluating which markets are discounting heavier than others for that first time incentive. And where we feel we have very, very strong market position, we're able to take that first time credit down a little bit and that's kind of what you're seeing in terms of translation to the overall business? And I'll let Phil take the second half. Yes. Hi, Ryan. So yes, we're very happy with the sequential declines from Q4. Like Neil was seeing, most of it was coming from the incentive piece of the accredited incentive for Q1, and it's a mathematical formula, bigger base, lower incentive on a percentage basis. However, like we said in the past, we're trying to reduce that number over time. So it will vary from 1 quarter to another with the targeted marketing campaign and the strategy that we'll use. However, over time, it should continue to decrease and we're also focusing on balancing or credits that we're giving to our current member as well. We're increasing quality on a weekly basis. Therefore, balancing the credit piece of the credit and incentive is also a focus of ours for 2020 and the year to come. Okay. And then my last question is kind of related to the general market, particularly some of the, I guess, traditional investors have been talking about increased competition in the online space. Have you guys noticed anything over the recent weeks months? Has that stepped up? And how does that impact you guys? Sure. In our in the ready to cook meal space, I would say competition is stable. We definitely have a few competitors that continue to develop the market with us. We saw the consolidation of Crooked and Miss Fresh in Quebec this quarter. So I think overall consolidation is a healthy thing for the unit economics of the industry, reduces competition and gives a little bit more scale to the companies. I think online groceries and meal kit businesses are industries that need scale in order to become profitable and in order to be able to compete in the long term. I don't think that move to combine Miss Fresh and Cook It signals a lack of interest from grocers to get into the meal solution space or into online groceries. I think it really signals that companies need to get scale, right, in order to have leading market share and get dominant market positions that can be sustainable over time. And then in the broader online grocery landscape, we see that the large grocers continue to tinker and to work on their longer term strategy. But we have not seen any direct impact from that on our business today. We feel very comfortable with our competitive position over the next few years. And we think we've carved out a really unique strategy that's going to allow us to compete very well even in a market where investments increase in grocery delivery and meal solutions. Okay. Thanks for taking my questions. Our next question comes from Raveel Afzal from Canaccord. Please go ahead. Good morning, guys. Congrats on a very strong quarter. A couple of questions. First on SG and A, you had very strong customer adds in this quarter probably like if I understand correctly, this will be the highest add for fiscal 2020. Correct me if I'm wrong, but if that's the case, then should we see SG and A remaining relatively flat compared to Q1 fiscal 2020 levels in the subsequent quarters? Or do you see any significant step up in the SG and A because of employee hires or new product offerings? Hey, Ravi, it's Philip. As you know, SG and A includes multiple components, including marketing, but also salaries of office employees and other items that we invest to build the new businesses and the new and launching products. As we grow the business and aim to become the Canadian leader in Align grocery, we've had world class people to help us bring the business to the next level. And I don't know if you saw our new IR deck that was on our website this morning, but we're seeing that the G and A portion of the SG and A represented between 35% 45% of SG and A total. Therefore, I think investing in the SG and A piece will continue to be something important for us. And the F, which is the marketing, should still continue to be a big investment of ours. Q1 was a very good quarter. We've invested in marketing at a very good payback and the next Q2 so far has been great in that sense as well. So I mean, G and A will continue to increase on a dollar basis and same thing for marketing and on a percentage basis. This should continue to be in the same range. Yes, and that's exactly right. And the thing that I would add as well is our ready to cook business continues to drive towards profitability, but it's important to note that we have a few points of EBITDA margin that's invested into our new product offerings. So ready to eat, breakfast products, private label products, There's a few points of EBITDA margin that are purposefully being invested into that. Great. That's all. Thank you. And then when you look at your overall incentives and you take out just the quality incentive piece out of that, do you see any opportunities to optimize that and reduce the money being spent on quality incentives? Yes. Hey, Rajil. You're saying on the operational quality or on the non quality? Sorry, I'm talking about on the revenue side, I'm talking about the credit incentives. And within the credit incentives, you have within the credit incentives, you also have quality incentives? Yes. So that's what I'm talking about, product being returned back to you? Yes, yes, perfect. So we don't actually have returns because it's perishable. So whenever there actually is an issue, we'll just credit the member and let them keep it. So but yes, absolutely, like we've made actually some amazing progress over the last two quarters on just executional quality across the board. As Phil mentioned in the prepared remarks, the winter snowstorms are never easy on a logistical business like ours. So we've gotten a lot better on that as well and have a pretty solid plan for this winter season versus past winter seasons. Opening the Vancouver facility is going to help massively as well. As you know, the Rockies can get shut down for days at a time in the winter with avalanches and snowstorms. So we're not promising any massive changes in that, and I would go with Phil's guidance, but it's slow and steady progress across the board. As we increase the number of SKUs, add new facilities and continue to invest in the team. We also have some great tech. We hired a new CTO who has a lot of operational experience that's going to help put a lot of tech into the ops, which should lead materially to some changes in the coming quarters. Perfect. That's good. That's all for me. Thank you, guys. Our next question comes from Michael Glen from Raymond James. Please go ahead. Hey, good morning. Are you guys so you're highlighting the positive cash from operations this quarter. Can you provide some indications for how we should think about that for the balance of the year? It swung positive, negative through 2019. I'm just wondering if you can do you think it will be consistent and positive this year? Or should we think of some swings quarter to quarter? Hi, Michael. It's Phil. So as you know, like in 2018 2019, we're able to show positive cash flow for the year. There's definitely swings between quarter. Like for instance, even though we were positive cash flow, almost €1,000,000 in 2019, our cash flow in Q4 was from operation was negative because of the summer. We have a lower demand, lower subscriber adds, which impact our negative working capital structure. So Q1 was pretty good with €1,500,000 We're happy with that. We should definitely see some swings in the quarter. You should expect that and you should definitely expect negative working capital impact in Q4 and then negative cash flow from ops. Our goal is still to have cash flow from ops neutral while growing at a fast pace. So we're going to try to achieve that in 2020. And yes, so you should expect swings, but so far, very happy with the cash flow from us in Q1. Okay. And then on the $10,000,000 to $12,000,000 in CapEx, can you provide is there a bucket sort of breakdown you can provide to that, like where that capital is getting spent? Yes. Michael, I'll take that. So we're not adding much capacity other than the Vancouver facility. That was one of the major CapEx plan for fiscal 2020. And then the rest has been continuing to invest in automation to increase profitability, gross margin, predictability of the business. So it's really those 2 buckets. And then as we said in the prepared remarks, we've, I guess, finalized the location inside of our facility for our ready to eat in house facility, which as you know, we've been outsourcing for a while into a third party production. So that will cost a little bit there. But in terms of scale, automation still remains the largest and then Vancouver and then Ready to Eat. That's probably the 3 biggest buckets. Okay. And the 10% to 12%, because you have another line on your cash flow statement intangible assets, does the 10% to 12% exclude what would be that amount in the acquisition of intangible assets? Because it was $200,000 this quarter. Yes. Hi, Michael. So intangible relates mostly to the ERP system that we've implemented, And that's part of the $10,000,000 to $12,000,000 that Neil mentioned. It's not the biggest CapEx investment we're going to do this year, but it's still significant enough to be mentioned and to be discussed. And yes, the ERP system is changing the way we're looking at or operate the business and it's going to help us definitely launch new products faster and control a bit better the operation. Okay. Now I just wanted to clarify that, that is included in the 10% to 12%. Okay. Thanks for taking the questions. Yes. Thank you. And we have no questions in queue at this time. I'll turn the call back to the presenters for closing remarks. Thanks very much for joining us on this call. We look forward to speaking with you again at our next quarterly call. This does conclude today's conference call. Thank you very much for attending. You may now disconnect.