Earnings Call: Q3 2019

Jul 11, 2019

Thank you for standing by. Welcome to the Good Food Third Quarter 2019 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 1 question and if necessary, one follow-up question. Please note that questions will be taken from financial analysts only. I would like to remind everyone that this conference call is being recorded today, July 11, 2019 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 potential 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 conference call, Jonathan Ferreri, Good Food's Chief Executive Officer. Mr. Ferreri, 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 Q3 of fiscal 2019 ended on May 31, 2019. I'm pleased to be joined on the call today by Philip Adam, Good Food's Chief Financial Officer and by Neil Caghi, President and Chief Operating Officer. Our press release reporting 3rd quarter results was published earlier this morning. It can be found on our website at www.makegoodfood. Ca and on SEDAR. Please be aware that we will refer to certain metrics and non IFRS measures. Where possible, these measures are defined and reconciled to the most comparable IFRS measures in our MD and A. Finally, let me remind you that all figures expressed on the call today are in Canadian dollars unless stated otherwise. I'd like to start off with a few comments on the typical seasonality of our business, which should help provide a better understanding of both the market we are serving and our performance within it. Our first quarter is the strongest on several key metrics with a critical back to school period. The 2nd quarter is typically strong with January February being traditionally high demand months. However, December is slower due to the holiday season. Margins are also usually impacted by higher shipping and logistics related costs due to weather conditions. Our 3rd quarter is usually the start of a slower period impacted by spring breaks in March across Canada and by the start of the nicer weather in May. Finally, our Q4 is slow given vacation time and nicer weather, which changes and influences the behavior of our members and of potential customers. As such, the Q4 is characterized by lower order rates, lower marketing expenses and fewer new active subscriber additions. Margins are also significantly affected by higher packaging costs due to the warmer weather. I'll now turn to a review for our most recent results. I'm pleased to report that the Q3 was excellent. We achieved record results on a number of key metrics, including the number of subscribers, gross merchandise sales, revenue, gross margin and adjusted gross margin. We also generated an all time high positive cash flow provided by operations on a year to date basis and our strongest cash position ever of $50,000,000 at the of the quarter. We continued to build strong and accelerating growth this quarter, generating triple digit growth in active subscribers and revenue on a year over year basis. Considering that the 3rd quarter is typically the start of a slower period, we are very pleased to have sustained the strong momentum achieved in first half of the year. At the end of the third quarter, Good Food's subscriber base reached 189,000 with the addition of 30,000 net new active subscribers during the quarter. This represents an increase of 100,000 subscribers since the beginning of fiscal year 2019, more than doubling our subscriber base in only 9 months. Quarterly revenue has also grown sharply. Revenue increased to a record $49,900,000 for the quarter, more than doubling the revenue for the corresponding period in 2018 and 36% higher than the 2nd quarter. This increase resulted in revenue exceeding $137,000,000 on a last 12 months basis. This progression was propelled by continuous growth across Canada, the success of new meal plans and our market leading brand recognition. Western Canada results continue to be above expectations as we are maintaining our position as the number one home meal solutions player in Alberta and British Columbia. Subscriber growth remains robust, while churn is slowly decreasing, we are seeing strong order rates from our members. Gross merchandise sales also increased significantly to $61,200,000 up 32% over the 2nd quarter and 134% year over year. On a last 12 months basis, gross merchandise sales reached $171,000,000 quickly approaching the $200,000,000 mark. The strong growth momentum of the 3rd quarter driven by net subscriber additions, new meal plans and meal solutions allowed us to surpass the CAD250 1,000,000 mark in gross merchandise sales run rate finishing the 3rd quarter at CAD250 $7,000,000 It is also important to highlight that incentives and credits as a percentage of gross merchandise sales dropped from over 20% in the first half of the year to 18.6% in the third quarter, reflecting our seasonal marketing strategy with lower incentives starting in Q3 and in addition incremental costs associated with harsh winter conditions in the 2nd quarter. In a moment, Philippe will discuss the financial performance of the company in greater detail. We are continuing to focus on growth and on improving member experience. Our objective is to expand our product categories to capture further opportunities. Since the beginning of the year, we have been expanding our offerings and actively working towards adding additional meal options with different levels of engagement from ready to cook to ready to eat meals. A few months ago, we launched our 1st breakfast meal solution, ready to blend smoothies nationwide. To date, we have internally developed 16 original flavors of smoothies and surpassed the gross merchandise sales run rate of CAD10 1,000,000 despite limited marketing investments. In order to continue the development of our breakfast product line, we recently leased a new 20,000 square foot production facility in Montreal exclusively for our breakfast meal solutions and will add approximately CAD100 1,000,000 of production capacity by the end of fiscal year 2019. In addition to our ready to blend smoothies, we are also working on other products in the segment, which we expect to launch in the coming months. Considering the size of the Canadian breakfast segment, we have plenty of runway for future growth. During the Q3, we also launched Yum. Ca, a value meal kit targeting cost conscious Canadians. Yum! Is the lowest price ready to cook meal option in Canada, starting at $6.99 per serving and offers a choice of 6 meal options per week. This new initiative effectively expands our total addressable market as it unlocks untapped demographics, including students and busy families. Our Yum! Business model will provide a similar gross margin profile, enhanced customer retention and lower acquisition costs by leveraging our scale and platform, which will lead to a superior customer experience with high quality ingredients. We believe it will also improve unit economics for the overall business by pairing the right meal solution to the right customer, thereby increasing the engagement and loyalty among our members. Our other meal options continue to do well with the Clean15 and Easy Prep Meal Kit experiencing a rising adoption in order rate. We are also continuing the pilot testing of our ready to eat meal solutions in the province of Quebec and we'll add testing to the other Canadian provinces in the near future. At this stage, the results are very promising with increasing members' ratings and positive feedback. We anticipate to fully enter this new segment and large opportunity estimated at more than $2,000,000,000 in fiscal 2020. On that note, I will now turn the call over to Philippe. Thank you, Jonathan. Good morning, everyone. I will now turn to capacity expansion and production efficiency. I'm happy to report that the Eastern Canada facility expansion is on track to be completed under budget and ahead of schedule. When the expansion will be fully operational, it will double the production and sales capacity of Eastern Canada from $200,000,000 to $400,000,000 which will allow us to better serve the needs of our fast growing member base as we add new meal solutions and expand our product offerings. In Calgary, the enlargement of our refrigerated section is progressing well. We expect it to be completed by the end of our Q4. As we indicated in the past, the sales capacity will double to approximately $200,000,000 annually. Furthermore, we recently signed a lease for a new 84,000 square feet production facility located in the Greater Vancouver area. Being closer to our Vancouver members will allow us to unlock operational and logistics savings while increasing the quality of our services. At first, this new facility will add approximately $50,000,000 annually in sales capacity and we expect it to be EBITDA accretive in the short term. Our planned move in date is scheduled for the beginning of calendar year 2020. Finally, we're making good progress on our plan to automate over 75% of our operations. Currently, our Eastern Canada facility is more than 50% automated, and we're quickly ramping up our Western Canada facility. These additional automation investments will allow us to continue to improve our efficiencies and should drive higher margins over time. There is a great deal on the way at Good Food to continue to build Canada's largest perishable direct to consumer grocery network, and we're confident that these initiatives will bring a desired result to drive shareholder value. Please turn to Slide 9, which compares our gross profit and adjusted gross profit. We were able to show a significant increase in profitability for the Q3 with our gross profit increasing to $14,100,000 almost double the previous quarter And our gross margin reaching a record 28.3 percent, an increase of 7 40 basis points compared to the Q2 of 2019. Our adjusted gross profit reached $25,400,000 up 44% over the 2nd quarter our adjusted gross profit gross margin reached an all time high of 41.6%, an increase of 3.75 basis points over the previous quarter. This marked improvement reflects our recent investments in our automation ecosystem as well as continued efficiencies generated in our Eastern and Western Canada operations, the progress we've made on labor, shipping and packaging from economies of scale and increased buying power. As previously mentioned, most of the automation equipment we purchased during the Q2 were only installed and operational during the Q3, which explains in part the greater margin improvement between Q3 and Q2 than Q2 and Q1. It is also worth noting that we expect our 4th quarter margins to be lower due to the warm weather of summer months, where we need to adjust packaging to keep our ingredients fresh. We expect to see further gross margin improvements in fiscal 2020. The next slide shows our adjusted EBITDA and net loss. Our adjusted EBITDA loss in the 3rd quarter decreased significantly from the previous quarter to $2,400,000 or 4.8 percent, which represents an improvement of more than 1,000 basis points, mainly due to higher gross profit margin, but also to lower SG and A as a percentage of revenue. Net loss for the Q3 was $3,600,000 which is an improvement of $3,000,000 over Q2 2019. Recall that we are successfully executing our strategy, which currently delays short term earnings in order to invest in market share leadership, scale and density. We believe that these investments will maximize longer term shareholder value by allowing us to deliver greater value to our members compared to our competitors while attaining high returns on invested capital. Turning to Slide 11 for cash flow and capital expenditures. In the 3rd quarter, we generated a record 2 point $4,000,000 in cash flow from operating activities due to a favorable change in working capital and lower net income losses, which brings the total for the 1st 9 months of the year to $3,900,000 It is important to note that we expect cash flow from operations to turn negative in the 4th quarter due to the seasonal impact on our negative working capital structure. Business usually picks up quite briskly in early September with back to school and cash flow from operations should then revert to positive territory. We also invested $1,500,000 in capital expenditures in the Q3 or $4,900,000 for the 1st 9 months of the year, primarily to fund the investment in automation and expansion of the production facilities in Montreal and Calgary. The majority of our capital expenditures to date in fiscal 2019 were financed by the bank facility. Turning to Slide 12 for our financial position. We ended the quarter with a solid financial position with cash of $50,000,000 As at May 31, 2019, our total debt was $10,000,000 with a $2,500,000 revolver undrawn. After adjusting for our cash position, we have a negative net debt position of 39 point $7,000,000 which places us in a very solid financial position to continue growing at a very fast pace and execute on our business plan. This concludes our financial highlights for the Q3 and our prepared remarks for today. Jonathan, Neil and I will now be pleased to answer any questions you may Your first question comes from the line of Anay Hazy from GMP Securities. Your line is open. Hey, good morning guys. Thank you for taking my questions and congratulations on the good numbers. Thanks. It's a question on the BC facility. So is that only going to serve Western Canada? And will you guys do breakfast there or breakfast are still expected to be done on the East Coast? Hey, Lynn. This is Anil here. I'll take that one. Yes, so the idea for launching the Vancouver facility is a couple of fold. We recently became the number one meal solutions brand in BC and thought that the scale required to continue that merited having a facility that was closer to our members. So we were lucky to find a production facility that fit our criteria and timelines that we're looking at. The purpose of the facility will be a couple of folds. It will be the manufacturing and fulfillment center for the province of BC for meal kits. Our breakfast manufacturing will be centralized in Eastern Canada for now. And we ship our products across the country and then distribute them from the relevant facility. So no breakfast manufacturing in Vancouver in the short term. But we anticipate rolling out multiple product lines in this facility over the next kind of 12 to 24 months that could include a prepared commissary as well. Okay. Thank you. And you said it will be ready by fiscal year 2020? No. We said it will be ready at the beginning of calendar year 2020. So we can think of the Q1 of the calendar year, something like that. Yes. I think the other thing that I wanted to mention on the rationale was you shipping over the Rockies cost quite a bit of money and can affect the freshness. So there'll be a gross margin accretion from that facility and EBITDA accretion as well. Great. Thank you very much. Your next question comes from the line of Ryan Lee from National Bank Financial. Your line is open. Good morning, guys. Congrats on a good quarter. Just want to follow-up on the Vancouver facility. It's 84,000 square feet, but it's only $50,000,000 in capacity. Is it right to assume that it won't be fully utilized in the beginning and there's additional room for expansion? And also what are the capital investments you guys anticipate for this particular facility? Yes. Hey, Wren. I'll take that one again. So the CapEx maybe I'll start off with the CapEx part of it. CapEx should be between $2,000,000 $3,000,000 dollars to realize that $50,000,000 of sales. And the idea behind that is that amount of CapEx can hit those that revenue capacity or that subscriber capacity that we're talking about. The facility being 84,000 square feet can support much more than that. We just don't want to build out too much CapEx in the facility. And just given the length of the leases, we wanted to make sure we had a facility that we could grow into. So $84,000 can support more, but the CapEx supports that number. Okay. Thanks, guys. Your next question comes from the line of Frederic Brinde from Desjardins. Your line is open. Thanks. Hi, everyone, and congrats on a strong quarter. First question would be on the future gross margin trajectory. Obviously, we saw a nice improvement in Q3. You did mention that Q4 would be lower given seasonality. Just looking at fiscal 2020, do you expect further improvements in gross margin? And what would be the main drivers behind that? I've read it's Phil. Yes, so like we said, Q4 gross margin will be affected by the summer months and the warmer weather, but we should continue to see an increase in the gross margin in 2020. I mean, there's still a drag coming in from Western Canada and the new segments like breakfast. The drag is very low, closer to 50 bps. So that drag should disappear over time. On top of that, the main driver will definitely be the additional automation. So like we said, we are above the 50% mark nationwide, and the goal is to be 75% automated across our several facilities and additional automation will increase significantly the margin. And we're still seeing very good economies of scale and the effect of the buying power on our margin as well. So 41.6% gross margin for our Q3, and you should see an improvement in the next quarters of fiscal 2020. Okay. And is the 75% goal for Automation, is that a goal that you intend to achieve during fiscal 2020? I mean, in facility like Montreal, definitely. And the other facility, they are mostly new. So we're going to ramp up the facility like we did at Calgary. Calgary, we're not at the 50% mark, we're getting there closely. So it's going to be over time, but it's it's going to I mean, we're still investing significantly. So we're going to see that mark in the next coming years or quarters. Okay. And last question for me on Yum! I know it's early, but so far, have you so I mean, what the I guess, the source of the subscriber would be in terms of is it mostly people migrating from your regular service instead of canceling, let's say, migrating to Yum! Or is it mainly brand new customers that are coming to that service? As we were launching Yum! Our focus was first on using Yum! As a retention tool to transition Good Food subscribers that might have been canceling from Good Food for price reasons to give them the right meal solution at the right price. As we think about bringing the Yum! Business to the next level in the fall and in the winter, we will be going out to acquire first time subscribers as well. We're quite pleased with the development that we're seeing with Yum! Today. You might have noticed we increased the number of recipes that we're offering each week from 4 to 6 recipes. The ratings are very strong and our customer feedback is excellent. Okay. Thanks very much. Your next question comes from the line of Raveel Afzal from Canaccord. Your line is open. Good morning, guys. Thank you for taking our questions. Just with respect to automation, you said Calgary is not at 50%. Can you guys give us some indication of where the Western Canadian facility is compared to the Eastern Canadian facility, which is already at 50%? Yes, of course. So the Western Canadian facility, for the automation investments to start to make sense, there's a certain amount of scale required. So the Western operations globally has hit that scale and we've started to make those investments over the last 6 months. But as Phil mentioned in the prepared remarks, it takes a little bit of time for these investments to kick in, people to get trained on them and then to kind of really ramp up. So we should see that in the first half of our 2020 fiscal year. Percentage wise, it's tough to put an exact number on it, but much lower than the 50, probably in the 20 to 25 range, something like that. But the real kicker will be on the next phase that's going to come into account, like I said, in the first half of twenty twenty. Got it. And is there some sort of a linear relationship that you can point to that historically you guys increased automation by XX percentage age and that resulted in gross margin improvement of XX. Is there some sort of a linear relationship just with respect to automation that you can point to so we can project how much margin improvement we can see in fiscal 2020? I wish it were that easy for sure. I think there's a couple of different things that factor into it. Like we as we mentioned in our public documents and our investor presentations, we think long term adjusted gross margins are at 45% or above and that kind of includes all of the product lines, breakfast, ready to eat, ready to cook, West, East, all different parts of the country. So we want to we are consistently targeting that and we hope to be able to significantly beat that. But the other thing is with the automation investments, we don't keep all of the gross margin savings. We want to make sure that we're continuously adding value back into the product, back into experience, back into the members. So if we go up by 5%, it doesn't mean that there's a 1% increase in gross margin because we may keep some of that or share some of that with the member base and improve the value proposition even further and kind of keep our scale running through the flywheel. Perfect. And just sticking with the automation theme, is it possible to speak about the Vancouver facility? Now can this facility be automated from the get go? Or is there some are there some practical reasons why the facilities are not initially automated and then automated over time? Yes, good question. So given that there's a good amount of scale that's going to be able to go through that facility virtually day 1, we're going to look to automate it even quicker than we did with Calgary. So we take what we've learned in Montreal, we take what we've learned in the Calgary facility and we're going to apply that to Vancouver. Just in terms of bandwidth of the team and capital allocation, we want to make sure we're doing it in the right phases. So when we open it up in calendar Q1 of calendar 1, Q1 of calendar 2020, we want to make sure that we have some of the low hanging fruit and then over the next kind of 6 months, we'll bring that up to what we see in the Calgary facility. But the good thing is the volume justifies some of the investments already. So we'll start to make them earlier than we have in the past. It won't be up and running day 1. Got it. And I'm wondering if there's a way to quantify what your penetration is now in Eastern Canada versus Western Canada, can be in terms of revenues, can be in terms of just market penetration, whichever way, if possible? I mean, we still think we have a good 40% share of the market and our run rate at $2.50 I mean, we think maybe penetration rate is around the 2%, 3% mark in Canada. But it's always hard to quantify it precisely as we're the only public company reporting in Canada. But yes, I mean, just us alone, we have a penetration rate of more than 1% across Canada. Obviously, Eastern Canada is a market that is more mature for good food and in general. But there's not much difference between the Western and Eastern Canada market in terms of penetration rate. The difference is not that big. Got it. And the type of and just to go a little bit deeper on this point, the type of growth that you're seeing in Eastern Canada right now, is it similar to the growth that you're seeing now in Western Canada in terms of new customer adds? Or is there a significant difference in the space at which are growing in Western Canada, your customer base compared to Eastern Canada at this time? We definitely see that our Eastern Canadian market is a little bit more mature. So the growth continues to be a bit faster in Western Canada. Perfect. And just my final question with respect to your marketing spend. My understanding was historically that your marketing spend is going to be front end loaded to the fiscal year. This year, we're seeing it slightly more even. And I'm wondering if that's a change in strategy or this is how we should expect fiscal 2020 to play out as well. Generally speaking, we do try to spend more in terms of absolute marketing dollars during the back to school season and during the January, February, March period. They continue to be the periods of the year where we see the best conversion rates, the best customer acquisition costs, the best lifetime value. And so we should expect that trend to maintain during fiscal 2020. And I would say we do maintain some flexibility within that framework if we see certain opportunities either in certain geographies where we're seeing that competition is more or less active to kind of shift that marketing spend around. Perfect. I'll get back in the queue. Great quarter. Thank you, guys. Thank you so much. Your next question comes from the line of Ryan Lee from National Bank Financial. Your line is open. Hey, guys. Thanks for taking my follow-up. I want to food store CPI has been elevated over the last couple of months, first half of the year. And typically for grocery stores that represents passing off higher merchandise costs for them. Are you guys noticing any pressure from that? And have you had to make adjustments to your recipes? Two question, Ryan. We see food CPI a couple of different ways for sure and we were obviously we get affected by the same overall trends that the greater market would see. We're able to build the menus according to what we're seeing better pricing on and the fact that we're still growing very, very rapidly and moving through the food supply chain has usually more than offset any of the upward pressure in pricing. So we're still able to reduce our internal CPI or increase our internal buying power for whatever food ingredients that we put in the recipe. So we haven't felt that we're handicapped in any way or building recipes just because we continue to grow and renegotiate terms and bring on new suppliers to have better scale themselves, better automation themselves and that allows us to share some of the pricing. Okay. Thanks. Your next question comes from the line of Raveel Afzal from Canaccord. Your line is open. Hey, guys. Thank you for taking my follow-up. Just I wanted to see some of the Canadian grocery stores are also launching their meal kits still relatively early stage. I'm trying to understand if you're seeing any impact of that in terms of the competitive dynamics of the Canadian wheel kit marketplace at the moment? Or any how you see the competitive environment changing as these guys ramp up further? Any intel you can give us on that will be helpful. Sure. Currently, we have noticed a few of the Canadian grocers are testing out and developing some meal kit offerings. We see this as a really favorable sign for the industry. It helps create more awareness of the category and improves the interest in the space and we view kind of this trend quite favorably. At this stage, we consider the initiatives to be still quite small in the context of the overall market. So we're definitely following it closely, but it has not affected our business currently. Perfect. That's all for me. Thank you. There are no further questions at this time. I will turn the call back over to the presenters. Thanks very much for joining us on the call today. We look forward to speaking with you again in our next quarterly call.