Thank you for standing by. Welcome to the Goodfood 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 one question, and if necessary, one follow-up question. Instruction will be provided at that time for you to queue up for questions. Please note that questions will be taken from financial analysts only. If anyone has any difficulties hearing the conference, please press star followed by zero for operator assistance at any time. I would like to remind everyone that this conference call is being recorded today, July 11th, 2019, at 8:00 A.M. Eastern Daylight Time.
I would like to remind you that today's presentation may contain forward-looking statements about Goodfood'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 two of the presentation. I would now like to turn the meeting over to your host for today's conference call, Jonathan Ferrari, Goodfood Chief Executive Officer. Mr. Ferrari, you may proceed.
Thank you. Good morning, everyone, and welcome to this call for Goodfood Market Corp., in which we'll present the financial results for the third quarter of fiscal 2019, ended on May 31st, 2019. I'm pleased to be joined on the call today by Philippe Adam, Goodfood's Chief Financial Officer, and by Neil Cuggy, President and Chief Operating Officer. Our press release reporting third 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&A. Finally, let me remind you that all figures expressed on the call today are in CAD 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 the critical back-to-school period. The second quarter is typically strong, with January and 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 third 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 fourth quarter is slow given vacation time and nicer weather, which changes and influences the behavior of our members and of potential customers.
The fourth quarter 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 third quarter 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 from operations on a year-to-date basis and our strongest cash position ever of CAD 50 million at the end 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 third quarter is typically the start of a slower period, we are very pleased to have sustained the strong momentum achieved in the first half of the year. At the end of the third quarter, Goodfood'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 nine months. Quarterly revenue has also grown sharply. Revenue increased to a record CAD 49.9 million for the quarter, more than doubling the revenue for the corresponding period in 2018 and 36% higher than the second quarter. This increase resulted in revenue exceeding CAD 137 million on a last 12 months basis. This progress 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 CAD 61.2 million, up 32% over the second quarter and 134% year-over-year. On a last 12 months basis, gross merchandise sales reached CAD 171 million, quickly approaching the CAD 200 million mark. The strong growth momentum of the third quarter driven by net subscriber additions, new meal plans, and meal solutions allowed us to surpass the CAD 250 million mark in gross merchandise sales run rate, finishing the third quarter at CAD 257 million.
It is also important to highlight that incentives and credits as a percentage of gross merchandise sales drops 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 second 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 first 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 CAD 10 million despite limited marketing investments. In order to continue the development of our breakfast product line, we recently leased a new 20,000 sq ft production facility in Montreal exclusively for our breakfast meal solutions and will add approximately CAD 100 million of production capacity by the end of FY 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 third quarter, we also launched Yumm.ca, a value meal kit targeting cost-conscious Canadians.
Yumm is the lowest price ready-to-cook meal option in Canada, starting at CAD 6.99 per serving, and offers a choice of six meal options per week. This new initiative effectively expands our total addressable market as it unlocks untapped demographics, including students and busy families. Our Yumm business model will provide a similar gross margin profile, enhance 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 and order rate.
We are also continuing the pilot testing of our ready-to-eat meal solutions in the province of Quebec, and will 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 CAD 2 billion in FY 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 CAD 200 million-CAD 400 million, 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 fourth quarter. As indicated in the past, the sales capacity will double to approximately CAD 200 million annually. Furthermore, we recently signed a lease for a new 84,000 sq ft production facility located in the Greater Vancouver area.
Being closer to our Vancouver members will allow us to unlock operational and logistic savings while increasing the quality of our services. At first, this new facility will add approximately CAD 50 million annually in sales capacity, and we expect it to be 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's a great deal on the way at Goodfood to continue to build Canada's largest perishable direct-to-consumer grocery network, and we're confident that these initiatives will bring the desired results to drive shareholder value.
Please turn to slide nine, which compares our gross profit and adjusted gross profit. We were able to show a significant increase in profitability for the third quarter, with our gross profit increasing to CAD 14.1 million, almost double the previous quarter. Annual gross margin reaching a record 28.3%, an increase of 740 basis points compared to the second quarter of 2019. Our adjusted gross profit reached CAD 25.4 million, up 44% over the second quarter, and our adjusted gross margin reached an all-time high of 41.6%, an increase of 375 basis points over the previous quarter. This marked improvement reflects our recent investment 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 second quarter were only installed and operational during the third quarter, 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 fourth 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 third quarter decreased significantly from the previous quarter to CAD 2.4 million or 4.8%, which represents an improvement of more than 1,000 basis points, mainly due to a higher gross profit margin, but also to lower SG&A as a percentage of revenue.
Net loss for the third quarter was CAD 3.6 million, which is an improvement of CAD 3 million 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 third quarter, we generated a record CAD 2.4 million in cash flow from operations due to a favorable change in working capital and lower net income losses, which brings a total for the first nine months of the year to CAD 3.9 million.
It is important to note that we expect cash flow from operations to turn negative in the fourth 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 CAD 1.5 million in capital expenditures in the third quarter or CAD 4.9 million for the first nine 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 CAD 50 million. As at May 31st, 2019, our total debt was CAD 10 million with a CAD 2.5 million revolver undrawn.
After adjusting for our cash position, we have a negative net debt position of CAD 39.7 million, 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 third quarter and our prepared remarks for today. Jonathan, Neil, and I will now be pleased to answer any questions you may have.
At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Aman Handa 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. Is that only going to serve Western Canada? Will you guys do breakfast there or breakfast are still expected to be done on the East Coast?
Hey, Aman, this is Neil here. I'll take that one. The idea for launching a Vancouver facility is a couplefold. 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. We were lucky to find a production facility that fit our criteria and the timelines that we were looking at. The purpose of the facility will be a couplefold. It'll 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, we ship our products across the country and then distribute them from the relevant facility. No breakfast manufacturing in Vancouver in the short term.
We anticipate rolling out multiple product lines in this facility over the next kind of 12-24 months. It could include a prepared commissary as well.
Okay. Thank you. You said it will be ready by fiscal year 2020?
No, we said it will be ready at the beginning of calendar year 2020.
Okay.
You can think of the first quarter of the calendar year, something like that.
Great.
Yeah. The other thing that I wanted to mention on the rationale was, shipping over the Rockies costs quite a bit of money and can affect the freshness. 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 wanted to follow up on the Vancouver facility. It is 84,000 sq ft, but it is only CAD 50 million in capacity. Is it right to assume that it will not be fully utilized in the beginning, and there is additional room for expansion? Also, what are the capital investments you guys anticipate for this particular facility?
Yeah. Hey, Ryan. I will take that one again. Maybe I will start off with the CapEx part of it. CapEx should be between CAD 2 million and CAD 3 million to realize that CAD 50 million of sales. The idea behind that is that amount of CapEx can hit that revenue capacity or that subscriber capacity that we are talking about. The facility being 84,000 sq ft can support much more than that. We just do not want to build out too much CapEx in the facility. Just given the length of the leases, we wanted to make sure we have a facility that we can grow into. 84,000 can support more, but the CapEx supports that number.
Okay, thanks, guys.
Your next question comes from the line of Frederic Tremblay from Desjardins. Your line is open.
Thanks. Hi, everyone, and congrats on a strong quarter. First question will 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?
Hi, Fred. It's Phil. 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. There's still a drag coming in from Western Canada and the new segments like breakfast. The drag is very low, closer to 50 basis points, that drag should disappear over time. On top of that, the main driver will definitely be the additional automation. 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, definitely, the margin. We're still seeing very good economies of scales and the effect of the buying power on our margin as well.
41.6% gross margin for our Q3, and you should see an improvement in the next quarters of fiscal 2020.
Okay. Is the 75% goal for automation, is that a goal that you intend to achieve during fiscal 2020?
In a facility like Montreal, definitely. In the other facilities, they are mostly new, we're going to ramp up the facility, like we did Calgary. Calgary, we're not at the 50% mark, but getting there closely. It's going to be over time, but we're still investing significantly, we're going to see that mark in the next coming years or quarters.
Okay. The last question from me on Yumm. I know it's early, but so far, just wondering what 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 Yumm? Is it mainly brand-new customers that are coming to that service?
As we were launching Yumm, our focus was first on using Yumm as a retention tool to transition Goodfood subscribers that might have been canceling from Goodfood for price reasons, to give them the right meal solution at the right price. As we think about bringing the Yumm 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 Yumm today. You might have noticed we increased the number of recipes that we're offering each week from four to six recipes. The ratings are very strong, our customer feedback is excellent.
Okay. Thanks very much.
Again, if you'd like to ask a question, press star then the number 1 on your telephone keypad. Your next question comes from Asdaq 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 just 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. The Western Canadian facility, for the automation investments to start to make sense, there's a certain amount of scale required. The Western operations globally have hit that scale, and we've started to make those investments over the last 6 months. As Phil mentioned in the prepared remarks, takes a little bit of time for these investments to kick in, people to get trained on them, and then to really ramp up. 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%-25% range, something like that. The real kicker will be on the next phase that's going to come into account, like I said, in the first half of 2020.
Got it. Is there some sort of a linear relationship that you can point to that historically, you guys increased automation by XX% 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 different things that factor into it. As we mentioned in our public documents, in our investor presentations, we think long-term adjusted gross margins are at 45% or above, and that includes all of the product lines, breakfast, ready-to-eat, ready-to-cook, West, East, all different parts of the country. We are consistently targeting that, and we hope to be able to significantly beat that. 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.
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 keep our scale running through the flywheel.
Perfect. Just sticking with the automation team, is it possible to speak about the Vancouver facility? Can this facility be automated from the get-go, or are there some practical reasons why the facilities are not initially automated and then automated over time?
Yes, good question. Given that there's a good amount of scale that's going to be able to go through that facility virtually day one, we're going to look to automate it even quicker than we did with Calgary. We take what we've learned in Montreal, we take what we've learned in the Calgary facility, 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. When we open it up in first quarter of calendar 2020, we want to make sure that we have some of the low-hanging fruit, then over the next six months, we'll bring that up to what we see in the Calgary facility.
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 one.
Got it. 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.
We still think we have a good 40% share of the market and our run rate at CAD 250, we think maybe penetration rates around the 2%-3% mark in Canada. It's always hard to, again, quantify it precisely as we're the only public company reporting in Canada. 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 Goodfood than in general. 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. Just to go a little bit deeper on this point, the type of growth that you are seeing in Eastern Canada right now, is it similar to the growth that you are seeing now in Western Canada in terms of new customer adds? Or is there a significant difference in the pace at which you 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, the growth continues to be a bit faster in Western Canada.
Perfect. 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 are seeing it slightly more even. I am wondering if that is 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. So we should expect that trend to maintain during fiscal 2020. 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. Food store CPI has been elevated over the last couple months, first half of the year. 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?
It's a good question, Ryan. We see food CPI in a couple different ways for sure, and 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. 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. 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. 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 that 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 Asdaq Afzal from Canaccord. Your line is open.
Hey, guys. Thank you for taking my follow-up. 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 meal kit marketplace at the moment. 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 in the category, and improves the interest in the space and we view this trend quite favorably. At this stage, we consider the initiatives to be still quite small in the context of the overall market. 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.
This concludes today's conference call. You may now disconnect.