Freshworks Inc

NASDAQ:FRSH

Earnings Call Transcript 2018-Q1

[Operator]

Good afternoon and welcome to today's Papa Murphy's Holdings, Incorporated First Quarter 2018 Earnings Conference Call. All participants are now in a listen-only mode. After the presenters' remarks, there will be a question and answer session. As a reminder, this call is being recorded.

I would now like to turn the conference over to Mr. Mark Hutchens, Executive Vice President and Chief Operating Officer. Please go ahead, sir.

[Mark Hutchens]

Thanks, Gary. Good afternoon, everyone, and welcome to our first quarter earnings call. Let me start by noting that our formal remarks and responses to your questions may contain forward-looking statements regarding future events or the future financial performance of the Company.

Any such items, including guidance with respect to expected results for 2018 and statements related to our future performance should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements are not a guarantee of performance and actual events or results could differ materially from those anticipated in forward-looking statements due to a number of risks and uncertainties.

I'd refer you to the Company's Form 10-K for the year ended January 1, 2018, filed with the Securities and Exchange Commission, which identifies important risk factors that could cause actual results to differ materially from those anticipated in our projections or forward-looking statements.

The forward-looking statements made on this call speak only as of the date of this call and the Company undertakes no obligation to publicly update any forward-looking statements. Today's discussion also includes non-GAAP financial measures that we believe may be important to investors as metrics to assess the operating performance of our business.

Our earnings release contains reconciliations of non-GAAP measures to the most directly comparable GAAP financial measures in accordance with the SEC rules and the release and reconciliations can be found on the Company's corporate website at investors.papamurphys.com.

Here with me this afternoon are Weldon Spangler, our Chief Executive Officer; Nik Rupp, our new Chief Financial Officer, who joined the team since our last earnings call. Weldon will provide introductory remarks and take you through an update of the progress we're making against our turnaround plan, after which, Nik will take you through our first quarter financial results in detail as well as our updated outlook for the year. Weldon will then provide some brief closing remarks before we open the call for your questions.

With that, I'll turn the call over to Weldon.

[Weldon Spangler, Chief Executive Officer]

Thank you, Mark. Good afternoon, everyone, and thank you all for joining the call today. Before I get started, I'd like to take the opportunity to tell you a little bit of more about our new CFO. Nik joined us in April, and brings more than 20 years of senior level finance and planning experience to the team, most recently serving as CFO of Specialized Bicycle Components. We're thrilled to have him onboard and know he is eager to get to know all of you in the weeks and months ahead.

With Nik now onboard, Mark will be in a better position to drive the business forward as Chief Operating Officer. I'd like to thank Mark for his tireless efforts pulling double duty as both COO and CFO for the last eight months. For the first time since I've been here, with Nik in as CFO and Laura Szeliga in as our Chief Marketing Officer, we now have a full leadership team in place to execute the turnaround of this unique and incredible brand.

During the quarter, we continue to make progress on our focus strategy, designed to stabilize near-term results and build the capabilities to return Papa Murphy's to profitable growth. While comparable store sales continued to decline in the quarter, we are encouraged by sales performance in certain markets that have adopted marketing initiatives designed to improve brand relevance and customer value perceptions. For the quarter, there were a total of 18 domestic markets, representing about 22% of total domestic system sales that had same-store sales growth.

Overall, these positive results were more than offset by markets where comp store sales declined, including 63 markets representing about 20% of the system sales that were fully lapping the effects of the national media test in the first quarter of 2017 and this year had no television media in the quarter. International, which with the adoption of our new segment reporting is now included in franchise comp performance, with a net drag of 20 basis points to the reported system comp performance.

As outlined on our last call, our core strategy can be viewed within the framework of two pillars. One, consumer-facing; the other, non-consumer-facing. While our consumer-facing initiatives are focused on growing profitable comparable store sales, our non-consumer-facing initiatives are focused on improving execution through people and process, which we believe will ultimately make profitable comparable store sales growth more sustainable and at some point, provide the impetus for renewed system unit growth.

More specifically on the consumer side, we continue to believe that the keys to driving comparable store sales growth are improving convenience and relevance to consumers. Combined with an enhanced focus on consumer value perception, convenience and relevance will allow us to compete more fully in today's competitive and fast-paced digital world.

During the quarter, we completed our system migration to olo.com digital ordering platform, a foundational step to improving consumer convenience and providing an online ordering system that our franchise owners can get behind as a key tool to drive their business.

The platform provides a seamless user experience for both customers and franchise owners, and we've already had a chance to pressure test the system with two separate event days subsequent to the full migration, Pi Day, and our own Love at 425 Day, which of course happened on April 25. On these two days, we drove online mix of total transactions at participating stores to 51% and 37%, respectively, and the system performed great. Overall, online results continued to be consistent with our previous experience, with check average 20% to 25% higher for orders placed online.

We are also seeing higher conversion rates on the new site, which means we are turning more site visitors into pizza buyers. Overall, we now have a stable online ordering platform that we are confident and can support our business needs. As such, we will aggressively push more of our business online, and we'll be looking at store layout and design to ensure our stores are supporting the needs of the operation.

We expect to follow on with the relaunch of a mobile app in the second half of the year and are exploring key attributes of a loyalty program. The transition to the olo.com platform also allows us to accelerate our delivery initiatives, a key component of improved convenience and relevance. As we have said before, our product is uniquely positioned for success in the rapidly growing home delivery space. It's pretty simple. Pizza just tastes better when it's fresh out of the oven. And because our customer gets to bake our award-winning pie at home, the quality of our product doesn't degrade as it sweats in a warming bag. Our consumers get the same high-quality, great-tasting pizza, whether they pick it up themselves in store or have it delivered.

Nearly a quarter of our stores now have delivery capabilities through Amazon Restaurants, Grubhub, DoorDash, Uber Eats, City-Spree, Bite Squad and GrubSouth, an increase of nearly 120 stores since the beginning of the year. Delivery orders remained highly incremental, with attractive and profitable check averages. We will aggressively expand our delivery footprint and expect to offer delivery in about half of our stores by year-end.

Further, on relevance, we recently completed a comprehensive creative review and are happy to announce Mekanism as our new creative agency. We're confident that Mekanism is the right agency to tell our unique story and believe the resulting new creative end messaging will go a long way towards reinforcing how we are different from the competition and improve our relevance to consumers.

Additionally, Mekanism is particularly strong in the areas of social media and digital marketing, both of which are increasingly important in today's competitive environment and areas to which we and our franchise owners continue to allocate a greater percentage of our marketing budgets, especially in markets where we lack scale to afford a full complement of traditional media.

We look forward to the launch of our new messaging and creative later this year, highlighting our unique, empowering, do-it-yourself or DIY positioning. We believe this positioning will improve our relevance to our existing customer base, as well as a new set of younger consumers.

Also, on the consumer-facing side, we are aggressively promoting several marketing initiatives, which layer on top of our convenience and relevant efforts, and focus on driving sales through stronger value promotions, more efficient media mix and aggressive lapsed customer reengagement. We were encouraged to see that the markets participating in these initiatives not only outperform the other markets, but in fact reverse their trends and grew sales in the quarter. We're encouraged that more franchise owners are starting to see the benefits of these efforts. Getting more franchise owners to embrace what is working will be the key to moving the system forward with profitable comp store sales growth.

Switching now to our non-consumer-facing initiatives, which are the key enablers of the business that focus on people and process. These initiatives support not only near-term comp store sales growth, but also make profitable growth sustainable over the longer-term. For us, the most critical aspect of the people part of the business is the relationship we have with our franchise owners, which has been a key area of focus from me since I joined Papa Murphy's.

We continue to pursue an engaged and open communication with our franchise owners, and I remain impressed by the passion and the insight that these partners bring to the business. Our universal role at the Company is that of service to our franchise owners, and we know the company will be successful only through their success.

We believe that the growing momentum behind adoption of the marketing initiatives outlined above is evidence that we are making progress rebuilding a trusting relationship with our owners. In a highly-franchised system, momentum is key, and though we aren't yet putting points on the board, I do believe we are building a groundswell of momentum that will move the business forward.

To ensure we maintain the trust and support of our owners, we are putting significant efforts behind better process that will enable us to execute better. As I said on our last call, execution is everything in the retail food business, and we are dedicated to systemic process improvements in the support center, in the field, and in the stores. We believe these process enhancements will enable us to better serve our franchise owners and allow our franchise owners to better serve their customers.

Before I turn the call over to Nik, I want to touch on the progress we are making in our store portfolio. We ended the quarter with 145 Company-owned stores, which is in line with last quarter and represents a net decrease of 23 stores compared to the end of the first quarter of 2017.

The decrease reflects a total of 16 stores that we closed over the last year, and seven stores that were refranchised. Subsequent to the end of the quarter, we entered into a definitive agreement with Fresh Take, LLC, an existing franchise owner, to refranchise the Company-owned stores in Colorado for a total of $7.7 million.

The deal is expected to close in two parts, in May and July, and will reduce balance of your adjusted EBITDA by about $0.6 million. Following the close of the deal, Fresh Take, LLC will operate a total of 30 stores across the State of Colorado. We continue to be committed to returning to at least a 95% franchise system and are in active discussions with both new and existing franchise owners to refranchise the Company-owned stores.

We'll remain on track to reach our goal of operating no more than 60 company stores by the end of the year, but reserve the right to revisit that should we not find the right owners to take over these stores.

During the quarter, franchise owners opened four new domestic stores and closed a total of 23 domestic stores. At the end of the first quarter, the franchise store count was 1,359 units, compared with 1,398 units in the prior year quarter, reflecting a total of 78 franchise store closures, offset by 32 franchise store openings and a net refranchising of seven company owned stores over the last 12 months.

As our near-term portfolio focus remains on refranchising, we expect franchise owners to open only about 10 new stores this year, all in the U.S. Over the long-term however, we believe this system continues to have significant opportunity for franchise development, both in the U.S. and internationally.

With that, I'd like to turn the call over to Nik, to review our first quarter results in detail.

[Nik Rupp, Chief Financial Officer]

Thank you, Weldon. As a reminder, during the first quarter, we adopted two new accounting standards, ASC topic 606, revenue from contracts with customers and ASC topic 842 leases. The adoption of the new revenue standard had two effects on our income statement.

The first is a small increase in revenue from franchise fees due to the amortization of these fees over the contract term. For the first quarter of 2018, this increased franchise fee revenue by $0.3 million, and for the first quarter of 2017 by $0.2 million, as compared to previously published results.

Secondly, Brand Fund contributions must now be disclosed as revenue and are no longer netted against the corresponding expenses within selling, general and administrative expenses. This change resulted in an increase to revenues and an offsetting increase in SG&A of $5.9 million for the first quarter of 2018 and $8.5 million for the first quarter of 2017, before elimination of inter-segment revenues of $1.5 million and [$0.5 million] in 2018 and 2017 respectively.

As part of our implementation of the new standards, we have restated our 2017 financial statements. The following results are for our first quarter, which ended April 2, 2018. Total revenue in the quarter was $34.8 million, a decrease of 13.4%, compared to the first quarter of last year. The decrease in total revenue was driven primarily by a net decrease of 62 stores of the prior four quarters as well as a 3.9% decrease in system comparable store sales.

As a result of changes in the Company's executive management responsibilities effective January 2, 2018, the Company changed its reportable segments by combining domestic and international franchise business into a single franchise segment and separating Brand Fund's business into separate reportable segments. We believe this change better reflects the priorities and decision-making analysis around the allocation of the company resources, prior period results for the affected segments have been retrospectively revised to reflect this change.

Franchise-related revenue in the quarter totaled $16.2 million compared to $19.4 million in the first quarter of last year. The decrease was driven by the net decrease of 39 franchise units over the previous four quarters of 4% decrease in comparable store sales at franchise stores and the elimination of an incremental advertising fee of 0.85% of sales charged to all domestic stores during 2017.

Sales and company-owned stores totaled $18.6 million, a decrease of 10.6% from the prior quarter. The decrease was driven by the net decrease of 23 company-owned stores over the last four quarters as well as by a 2.7% decline in company-owned comparable store sales.

Switching over to expenses, with the closure of some of our lower-volume stores in the portfolio over the past four quarters. The reported company store operating expenses in the quarter as a percentage of company-owned store sales decreased by approximately 460 basis points compared to the prior year quarter to 86.7%.

The decrease was driven by a 170 basis point decrease in food and packaging, a 150 basis point decrease in advertising and 120 basis point decrease in occupancy and other store operating costs. In addition, under the new lease accounting standard we recognized lower occupancy costs for stores that had an asset impairment in 2017.

As we've done in the prior quarters, I'll now discuss the results for 73 stores in 10 markets unaffected by the portfolio changes we've made at our Company store division over the last 13 quarters. Comp store sales performed at these stores declined only 1% in the quarter, outperforming the broader company store portfolio by 169 basis points. We did see some margin compression of around 100 basis points in these stores compared with the prior quarter with total operating costs as a percentage of sales totaling 83%.

Overall stores opened by the Company over the previous 13 quarters negatively affected first quarter EBITDA by around $200,000 and reduced earnings per share by approximately $0.01. Reported selling, general and administrative expense in the quarter was $13 million including a litigation reserve of approximately $1 million, $360,000 related to e-commerce transition and $240,000 related to CEO transition and restructuring.

Excluding these items SG&A for 2018 and 2017. SG&A expense would have been $11.5 million or 33% of total revenue compared to $23.5 million or 58.5% of total revenue in the first quarter of last year, which excludes $2.2 million in CEO transition and restructuring costs incurred in the first quarter of last year.

EBITDA in the quarter was $5.6 million excluding the legal accruals e-commerce transition and cost associated with the CEO transition and restructuring, adjusted EBITDA in the quarter was $7.1 million, or 20.5% of total revenue. This compares to negative adjusted EBITDA of $2.3 million in the prior year first quarter.

The increased period over period was driven primarily by no national advertising expense in the first quarter of 2018 and partially offset by the quarterly decline in comparable store sales. A reconciliation of EBITDA and adjusted EBITDA to GAAP net income is included in our earnings release.

Depreciation and amortization expense in the quarter was $2.1 million, approximately $1 million less than the prior year quarter. Net interest expense in the first quarter was $1.3 million, up slightly from $1.2 in the first quarter of last year. Net income in the quarter was $1.6 million or $0.09 per diluted share compared to a net loss of $5.2 million in the first quarter of 2017 or $0.31 loss per diluted share. Note that after tax is the CEO transition and restructuring expenses, e-commerce transition cost and the litigation settlement accruals reduce report net income in the quarter of $1.1 million or $0.07 per share.

Excluding these unusual items pro forma net income in the quarter, would have been $2.7 million or $0.16 per diluted share. Our effective tax rate for the quarter was 26.9%. We ended the quarter with approximately $1.5 million cash on the balance sheet and gross debt of $90.6 million, $4.8 million less than the prior quarter, reflecting net positive cash generated in the quarter. The $20 million revolver was undrawn throughout the quarter.

We also ended the quarter in full compliance with all covenants under our amended credit facility. We reported a leverage ratio of 3.78 times, compared to a maximum permitted leverage ratio of 5 times and reported an interest coverage ratio of 4.81 times, compared to a minimum permitted coverage ratio of 3.5 times. We continue to believe that in the current business environment it's prudent to maintain an even more conservative balance sheet, and continue to expect to use operating cash generated by the business and net proceeds from refranchising to further pay down debt.

Based on our current growth plans and financial forecast, we believe that the expected cash flow from operations and refranchising and available liquidity under the amended credit facility and revolver are sufficient to fund our business and anticipated capital expenditures going forward, within the financial covenants prescribed in our amended credit facility. We are currently in the market to refinance the amended credit facility, which expires in August of 2019, and have begun preliminary discussions with our existing bank group to that end.

Based on those conversations, we expect to complete that refinancing prior to the existing facility going current in August of this year. Based on current information and reflective of the new accounting standards, we are updating our full-year outlook for 2018, which ends on December 31, 2018 as follows. Full-year system comparable store sales are expected to be about flat for fiscal 2018 as compared to previous guidance of flat to low single-digit growth. We now expect comparable store sales growth in the second quarter to be down low single-digits. We continue to expect domestic franchise owners to open around 10 stores over the course of the year.

We expect selling, general and administrative expenses to total approximately $50 million, including approximately $23.8 million of expenditures from the Brand Fund and excluding certain nonrecurring costs totaling around $4 million. We continue to expect adjusted EBITDA of approximately $21 million.

We expect cash flow from operations of around $7.4 million, a net of expected legal settlements totaling $5 million, and cash provided by Investing Activities of around $6.1 million, which includes about $7.1 million net after-tax proceeds from refranchising activities less approximately $1 million in capital expenditures. We now expect our full-year effective book tax rate to be approximately 27.7% and we continue to expect diluted share count to be approximately 16.9 million.

Note that the 2018 financial outlook does not reflect the impact of any additional refranchising in the year. We will update our outlook for refranchising activity as the financial impact and timing or more fully know.

I will now hand the call back to Weldon for closing remarks.

[Weldon Spangler, Chief Executive Officer]

Thanks Nik. We remain excited about the opportunity to return this unique brand of profitable growth. We have a great product and an extremely loyal customer following, a highly-differentiated position, which provides an inherent competitive advantage in delivery and an enthusiastic team of employees dedicated to serving our passionate franchise owners. We believe our strategy focused on improving, consumer convenience and relevance, including improved consumer value perception enabled by people and process enhancements will drive profitable and sustainable comp sales growth. We remain confident that successful execution of this strategy will drive positive and sustained results, creating substantial long-term value for all of our stakeholders.

We'll now open it up for any questions you might have.

[Operator]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] The first question is from Mr. Will Slabaugh, Stephens Inc. Please go ahead sir.

[William Slabaugh, Stephens Inc.]

Thank you. You mentioned you saw trends improve sequentially as the quarter went along. Can you give any more color around the degree of improvement that you saw? And also, did that improvement continue into the April and May periods?

[Weldon Spangler, Chief Executive Officer]

Yes. Thanks for the question. So I can give a little more color around it. As we talked about, we expect Q2 to be flat to slightly down. January was challenging. We had a couple of what we consider really good events that were positive for us moving into February and March. Valentine's Day was especially good and as we got olo.com up and running, as I mentioned, we were able to see how many transactions we could get, and we actually ended up with moving a lot more business online for Valentine's Day.

And then, as I mentioned, as we went into Pi Day, and our own Love at 425. So we are seeing some improvement. It's slower than we want it to go, and we are seeing some benefit in several of the markets that are adopting a lot of the value promotions.

[William Slabaugh, Stephens Inc.]

Got it. Thank you for that. And can you also talk a little bit more about the marketing initiatives that you mentioned? I think you talked about three of those through value and then media mix and then maybe I think you said lapsed customer engagement. That did, you said, impact the markets and drive positive same-store sales growth. So anymore color around what those involved would be helpful?

[Weldon Spangler, Chief Executive Officer]

Yes, so we have been on the lapsed users, we have been working on this now for several months, and we're able - we keep learning every time we run this program, every week we're learning more about how people are responding to it. How we're able to drive the sales and drive profitable sales for the franchise owners.

As we work with the franchise owners on redemption rates and what they're seeing in-store. We were actually able to make some refinements to that and started doing some more tests in Q2 to look at redemption with different offers, different days of week, and how we can how we can continue to find and reengage in incremental sales in a profitable way for the owners.

So that's one that we're very happy about. We've also seen some success with the XL, New Yorker, Pizza, which is a great - it's a great product at a really attractive price point. In most markets, it's at the $8 price point. It's an extra-large Pizza that - it's one we're very proud of in the customers seems to be responding to it very well. So when we're showcasing that showcasing that product outside at store through different media channels that we're getting good reaction on that.

[William Slabaugh, Stephens Inc.]

Great, thank you.

[Weldon Spangler, Chief Executive Officer]

Thank you.

[Operator]

[Operator Instructions] The next question is from Andy Barish of Jefferies. Please go ahead sir.

[Andrew Barish, Jefferies LLC]

A question actually on kind of the core G&A in the first quarter, it looked a little bit lower kind of taken out the one-timers and obviously taken into account on the advertising expense now. Then we were modeling, where there some timing issues or maybe just some commentary versus where you are kind of on an annualized basis, if you take that number as well that's going to be lower than the 26, you're looking for minus some of those new expenses?

[Mark Hutchens]

Yes. Hey, Andy, it's Mark. So obviously over the last year, we've taken a very hard look at SG&A and we've - the team is being down. Some of the first quarter, I can't really talk about the degree, but some of the first quarter is timing for folks like Nik weren't here for the first - for the full quarter. Laura wasn't here for the first quarter, right? They will be in the run rates going forward. But I'd say some of that is very meaningful permanent actions that we've taken over the last 12 months in particular to take cost out.

[Andrew Barish, Jefferies LLC]

Okay and then thank you for that. And then just trying to gauge, I know it's a moving target, the company-owned restaurant level margins does and I know the first quarter is a seasonally good quarter. But does Colorado have a noticeable impact as those come out in 2Q?

[Mark Hutchens]

I mean Colorado, we includes what Denver and Colorado spring. I think the average mix of those margin are better than the average. So I think they will impact the CSD margins going forward. To the extent we don't sell any other particularly lower performing stores.

Obviously the focus is to get down to around 50 stores, which means that some additional markets with margin above the average are going to go and obviously the focus is to get rid of some of the poor performing markets, where we need a franchise owner to come in and really build those markets out.

[Weldon Spangler, Chief Executive Officer]

Thank you very much. Gary, are there more question?

[Operator]

There are no further questions at this time. So I'd like to turn the floor back over to Weldon Spangler, Chief Executive Officer for closing remarks.

[Weldon Spangler, Chief Executive Officer]

All right, thank you very much. Thanks everybody for calling in today and we look forward to updating you on our progress again next quarter. Have a great day.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.