Freshworks Inc

NASDAQ:FRSH

Earnings Call Transcript 2018-Q3

[Operator]

Good afternoon. And welcome to today's Papa Murphy's Holdings, Inc. Third 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 introduce Nik Rupp, Chief Financial Officer. You may begin your conference.

[Nik Rupp, Chief Financial Officer]

Thank you, Hector. Good afternoon, everyone, and welcome to our third 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 relating 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 SEC rules and the release and reconciliations can be found on the Company's corporate Web site at investors.papamurphys.com.

Here with me this afternoon is Weldon Spangler, our Chief Executive Officer. Weldon will provide high level remarks on the quarter and an update of progress we are making into our turnaround plan. I will then review our third quarter financial results in detail, as well as our updated outlook for the full year, before Weldon provides some brief closing remarks and we open the call for your questions.

And with that, I'd like to turn it over to Weldon.

[Weldon Spangler, Chief Executive Officer]

Thank you, Nik. Good afternoon, everyone, and thank you all for joining us today. I'm going to begin today's call with a high level review of the quarter, followed by a progress update on our key strategies that are returning the system to profitable and sustainable growth. I will also briefly touch on our recent refinancing and discuss the steps we are taking to maximize long-term value for all of our stockholders.

Results in the third quarter included a system-wide comparable store sales decline of 2.1% compared to the prior year's third quarter, and adjusted EBITDA of $4.7 million. While the third quarter same-store sales percentage was still negative, the results represented our best percentage change in same-store sales in 12 quarters. We are also pleased to note that sales trend have continued to improve and are currently tracking slightly positive through the first five weeks of the fourth quarter. Though, we are maintaining a conservative outlook for the balance of the quarter.

The comp sales improvement continues to be driven by the adoption of key marketing messages, as well as by progress on our strategic initiatives. During the quarter, we saw an increasing number of markets comp positively, 39 domestic DMAs in total up from 31, which demonstrated comp growth in the second quarter. These DMAs have fully adopted marketing initiatives with a low, broad and consistent value message, have gone all in on these initiatives and have synchronized all marketing channels to drive traffic to the stores.

Markets that have activated everything from digital communications to in-store signage and scripted crewmember messaging are seeing the greatest transaction sales lift while protecting profitability. We believe that as these markets continue to demonstrate significant success, with some DMAs comp being as much as 12%, we expect more rapid adoption, resulting in further momentum and transaction growth across the system.

The other main driver of improving comp performance has been progress on our key strategic initiatives. As we have outlined previously, our core strategy rests on two pillars, consumer facing initiatives, which are focused on driving profitable sales through relevance and convenience and non-consumer facing initiatives, focused on improving execution through people and process. On the consumer facing front our customers have told us time and time again, the convenience plays an integral role in their decision-making process when figuring out what to have for dinner. Consequently, we have taken great strides to make Papa Murphy's an even more convenient option for consumers, adding to our stable digital tools to ensure that we can engage with our consumers when and where they want to be engaged.

Our new online platform created in partnership with olo.com and fully rolled out in March of 2018 serves as the strong and stable foundation for all of our convenience initiatives. We continue to see an increase in the mix of online orders with an improvement of approximately 26% compared to the second quarter of 2018. Importantly, check averages remain elevated at approximately 25% higher than our in store check average.

In addition, while delivery orders are still a very small part of the business, these have grown by approximately 67% since Q2, and continue to be incremental with attractive and profitable check averages. We now have delivery available in over 400 stores through partnerships with third-party providers. We believe it is critical to form the right partnerships for our stores, and we will be adding relationships with both Postmates and EatStreet later this month. We will continue driving expansion of our delivery footprint and are on our way to offering delivery in 450 stores by the end of the year.

In early September, we launched our new mobile app, which makes it fast and easy for customers to find nearby stores and to place orders. The app has the same great features as the desktop version, allowing customers to add credit cards to their profiles save recurring orders and utilize coupons and promotions. In addition, it is seamlessly integrated into our POS to minimize operational impact. While there's been little marketing support to-date around this launch, we already have over 84,000 downloads. We believe the app, along with a loyalty program that we are in the process of developing, is a great facilitator of driving convenience, while giving us targeted marketing capabilities that we have yet to fully activate.

Becoming more convenient has become table stakes in the restaurant industry. In order to be successful, we also need to increase our relevance. As a result, we have reevaluated our brand positioning, digital marketing and social media strategies to ensure we are making ourselves relevant to a younger consumer base without alienating our current customers. We're incredibly excited about our new Creative, formulated in collaboration with our new agency, Mekanism. We believe these new materials go a long way to reinforce our relevance with both existing and new customers by focusing on our product, highlighting our do-it-yourself, or DIY, positioning and clearly demonstrating our differentiation.

We previewed this, Creative, at our franchise owner convention in August to strong review and rolled it out through the various traditional and digital marketing channel towards the end of the quarter. I am pleased to say that the campaign has received great feedback from both existing and new customers, to-date. In conjunction with this rollout, we are shifting our advertising mix towards more digital marketing, which allows us to get in front of additional consumers in a more cost-effective manner. We believe the combination of new Creative and shifting mix will introduce our brand to a new group of customers, giving them a chance to try our great pizza and us the opportunity to earn their loyalty.

I would like to turn now to our non-consumer phasing initiatives, which are focused on improving executions through people and process. As I've said before, the most critical component of our non-consumer phasing initiative is strengthening our relationship with our franchise owners. Our success is wholly dependent on their success, and it is our job to give them all of the tools and support that they need in order to thrive. We don’t think of this as a onetime initiative to be rolled out but rather, as an ongoing process to build and maintain trust. We have made significant progress along these lines and believe most of our franchise owners would agree.

In August, we held our franchise convention in Las Vegas. There was great turnout with over 400 franchise owners team members and guests attending. During the meeting, we presented tactical strategies for execution of our successful low, broad and consistent marketing initiative, as well as additional ways franchisees can improve profitability. We received very positive feedback from franchisees following the convention, and they are excited about the future.

In order to best support our franchise owners, we must continue the systematic improvement of processes in our support center, in the field and in our stores. Through this mentality of continuous improvement, not only are we better able to serve our franchisees to intern or better able to serve our customers, but we further our relationship with trust. And with improved relationship, franchisees are more likely to quickly adapt initiatives that benefit the entire system, such as our LVC marketing initiatives.

Before I turn the call over to Nik, I want to discuss steps we are taking to maximize long-term value for all stockholders. First, while we are beginning to see traction in our turnaround strategy, our board remains fully committed to pursuing all path to maximize stockholder value and position the business for long-term success. As a result, the board is conducting a formal review of all strategic alternatives, including but not limited to, the potential sale of the business. As part of that effort, the board has hired North Point as a financial advisor to assist in the process. Please note that we are still in the early stages of this review and do not intend to make any further public comment regarding the review until it has been completed.

Finally, as you may have seen in our release, we just completed 12 month extension of our existing credit facility, taking us through until August of 2020. Nik will go over the details in a moment. But this extension enhances our flexibility to execute against our strategic goals and further ensures that we are well-positioned to achieve long-term profitable growth.

With that, I would like to turn the call over the Nik to review our third quarter results in detail.

[Nik Rupp, Chief Financial Officer]

Thanks Weldon. Before I get into the quarterly results, I first want to touch on the progress we are making on optimizing our store portfolio. We ended the third quarter with 113 company-owned stores, which represent a net decrease of nine stores from the second quarter and a net decrease of 35 stores compared to the third quarter of 2017.

The year-over-year decrease reflects a total of six stores that we closed over the last year and 29 stores that were refranchised. During the third quarter, we completed the refranchising of seven company-owned stores in Dallas and closed one store in the same market. Our portfolio focus remains on ensuring we find the right franchise partners to take over our company operated stores as we work towards returning to at least 95% franchise system with no more than 50 company-owned stores by 2020. We will provide further updates on our progress as we have greater certainty around specific transactions and timing.

During the quarter, franchise owners opened one new domestic store, one new international store and closed a total of 17 domestic stores. At the end of the third quarter, the franchise store count was 1,347 units compared with 1,394 units in the prior year quarter. The net decrease of 47 franchise stores reflects a total of 90 store closures, offset by 14 store openings and a net refranchising of 29 company-owned stores over the last 12 months. As our focus remains on refranchising, we expect franchise owners to open only about 11 new stores in 2018, and domestic and one international. We continue to believe that over the long-term, the system has significant opportunity for franchise developments, both in U.S. and abroad.

Now onto third quarter results. Total revenue in the quarter was $28.8 million, a 14.4% decrease compared to the third quarter of last year. The decrease in total revenue was driven primarily by a net decrease of 90 stores over the previous five quarters, reflecting the net closure of seven company-owned stores and 83 franchise stores; as well as add 2.1% decrease in system wide comparable store sales, comprised of 1.8% decrease of franchise stores and a 6.9% decline at the company-owned stores.

In addition in the third quarter of 2017, we had an additional contribution by all stores for the brand marketing fund of 0.85% or approximately $1.6 million to help fund the National TV advertising test that took place in the first quarter of 2017. Total franchise-related revenues decreased by 1.8% in the third quarter to $15.9 million compared to $16.2 million for the same period last year. The decrease was driven by the 1.8% decline in franchise comparable store sales, a net reduction of 47 franchise stores period-over-period and a decrease in brand funds related growth.

The decrease in comparable store sales for the quarter was primarily driven by continued competitive headwinds and both convenience and relevance guests. As we continue to rollout and gain adoption and traction of our key marketing strategies, as well as critical technology components, we believe we will see this gap close and return the systems to positive comp sales growth. We are still working to improve store level operational excellence and execution in both company stores and franchise stores, and this takes time to affect across the network of approximately 1,400 stores.

Sales of company-owned stores totaled $13 million, a decrease of 26% from $17.5 million in the prior year quarter. The decrease was driven by the net decrease of 36 company-owned stores over the last five quarters, 29 of which were refranchised and seven of which were closed; as well as by the 6.9% decline in company-owned comparable store sales. Note that the refranchised stores had comparable store sales that were above the CSD average in the third quarter, so their transfer added to the period-over-period comparable store sales decline.

Switching now to expenses. Company-owned store operating expenses as a percentage of company-owned store sales increased 480 basis points compared to the prior year quarter to 95.9%. The increase was driven by 380 basis point increase in occupancy and other store operating costs and 220 basis point increase in compensation benefits due primary to states' minimum wage increases. These increases were partially offset by 90 basis point decrease in food and packaging expenses and a 30 basis point decrease in advertising expenses.

As in prior quarters, I'll now discuss results for 53 stores in eight markets unaffected by the portfolio changes we have made of company store division over the last six months. Comparable store sales performance of these stores was 70 basis points better than the overall store base, while margin declined around 40 basis points in these stores as compared with the prior year quarter. Total operating costs as a percent of sales totaled 87.6% for the quarter. Overall, stores opened by the Company over the previous 15 quarters negatively affected third quarter EBITDA by about $400,000 and reduced earnings per share by approximately $0.02.

Reported selling, general and administrative expense in the quarter was $11.7 million, excluding CEO transition and restructuring costs in both periods; as well as approximately $460,000 related to litigation settlements in the prior year period, SG&A expenses decreased 1.5% versus third quarter 2017. As a percentage of total revenue, SG&A expense increased 530 basis points year-over-year adjusted for non-recurring items. The increase was driven by deleverage on lower company-owned store revenues due to store closures and refranchises.

EBITDA in the quarter was $2.1 million. Excluding the effect of store divestitures, closures and transition costs and other non-recurring expenses, adjusted EBITDA in the quarter was $4.7 million or 16.2% of total revenue. This compares to adjusted EBITDA of $5.5 million or 16.5% of total revenue in the prior year third quarter. The decrease period-over-period was primarily driven by CSD sales declines without commensurate declines in operating expenses. For the first nine months of 2018, EBITDA was $12.8 million compared to loss of $9.5 million for the same period last year. Adjusted EBITDA for the first nine months of 2018 was $16.4 million as compared to $11.2 million in the first nine months of 2017. 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 $1.7 million, approximately $675,000 less than in the prior year quarter. Net interest expense in the second quarter was $1.3 million, approximately flat versus last year. Net loss in the quarter was $639,000 or $0.04 loss per diluted share compared to a net loss of $2.7 million in the third quarter of 2017 or $0.16 loss per diluted share. Note the reported net income in the quarter was reduced by store divestitures, closures and impairment expenses of $2.5 million.

Excluding these unusual items pro forma net income in the quarter would have been $1.3 million or $0.07 per diluted share. A reconciliation of pro forma net income to GAAP net income is included in our earnings release. Our effective tax rate for the quarter was 19.9%. We ended the quarter with approximately $3.4 million of cash on the balance sheet and a gross debt of $84.8 million, flat to the prior quarter. The $20 million revolver was undrawn at the end of the quarter. We also ended the quarter in full compliance with all covenants under our amended credit facility, reporting a net leverage ratio of 3.56 times compared to the maximum permitted leverage ratio of 4.75 times; and reported an interest coverage ratio of 4.98 times compared to a minimum permitted coverage ratio of 3.5 times.

Based on our current growth plans and financial forecasts, we believe that expected cash flow from operations in 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 within our amended credit facility. We continue to believe 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. As Weldon mentioned, we've recently completed an extension of our existing credit facility, which was set to expire in August of 2019.

On November 6, 2018, PMI Holdings, Inc. signed a second amendment to its senior credit facility. The amendment, among other things, extends the term of the senior credit facility by 12 months, setting the maturity date to August 2020. In addition, the amendment provides for increases in the maximum leverage ratio, requires continuation of quarterly $2.1 million installment payments through the new maturity date and increases the applicable interest rate margins.

Turning now to guidance. Based on current information and reflective of the new accounting standards, we are updating our full-year outlook for fiscal 2018, which ends on December 31, 2018 as follows; full-year system-wide comparable store sales are expected to decline low single-digits; domestic franchise new store openings of approximately 10 units; full-year selling, general and administrative expense of approximately $47 million, excluding nonrecurring items, a reduction of $2 million as compared to previous guidance; these expenses include approximately $24 million of expenditures in the brand funds and excludes certain non-recurring costs totaling around $4 million; adjusted EBITDA of at least $21 million, $1 million higher than prior quarter guidance; cash flow from operations of around $12 million, excluding expected legal settlements, totaling approximately $6 million; cash provided by investing activities of approximately $7 million, which includes $8.7 million net proceeds from refranchising activities less $1.5 million in capital expenditures; full year effective tax growth rate of approximately 26.8% and diluted share count of approximately $17 million.

Note that the 2018 financial outlook does not reflect the impact of any additional refranchising in the year termWe will continue to update our outlook with franchising activity as the financial impact and timing of any additional changes are more fully known.

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

[Weldon Spangler, Chief Executive Officer]

Thank Nik. Papa Murphy's is a highly differentiated brand with inherent competitive advantage and an enthusiastic team of employees, dedicated to serving our passionate and engaged franchise owners. We are pleased with the progress we are making and the accelerating business momentum we are beginning to achieve. We continue to believe that our focused strategy of improving convenience and relevance and enhancing people and process, alongside increased activation of our low, broad and consistent marketing initiative, will drive profitable and sustainable comp sales growth in both the short and the long-term.

In addition, we continue to manage all discretionary costs closely to ensure improved profitability, while ensuring we make the necessary investments to position us for future sales growth. I remain confident that we are on the right track to return this unique brand to profitable growth.

I would now like to open up the line for any questions.

[Operator]

Thank you. We will now be conducting a question-and-answer session [Operator Instructions]. Our first question comes from the line of Andy Barish with Jefferies. Please proceed with your question.

[Andy Barish, Jefferies]

Just wondering where the key product price point on maybe XLNY stands these days? And where is that in the system and category where we are seeing on a $5 stop? Just thinking about how you approach product price points as part of the LBC strategy?

[Weldon Spangler, Chief Executive Officer]

The XLNY continues to be a strong performer with us. We have expanded it across most markets to three different versions of it. And we really run it in the $8 to $9 price range in most cases. And we are finding that the consumers are responding really well that, while it's not a $5 price point, it’s a large pizza, it’s a great pizza, it's one that we're getting a lot of relative reactions from customers. And we are finding when we advertised it, whether it's on TV or on digital channel, the $8 to $9 price point is pretty compelling for people.

Additionally, we have got a number of markets who are using it for an even more aggressive deal during certain days of the week, at for example, $6 price point, which is -- it’s a fantastic value for such a great pizza at $6 dollars. So that's where XLNY plays into it. And then we're continuing to really work against $10 Tuesday, we are making progress with that and we have a number of markets who are doing a deal on Friday, whether it’s $5 price point or $6 price point for specific pizzas. So we have got a lot of value messages out there. And we are, as usual, working hard with the franchise owners to make sure that it remains a profitable deal for the owners and a compelling deal to get customers in the doors.

[Andy Barish, Jefferies]

And then just on the progress in the fourth quarter to-date. I guess is there anything to call out versus last year's October numbers that pushed the comps sequentially couple of 100 basis points better? And then does that same thought process of comparisons or something else factor into your thoughts on just being conservative for November-December?

[Weldon Spangler, Chief Executive Officer]

They're a number of things that are really affecting the comp outlook for November and December. One of the big ones is we've got some price increases that we'll be rolling over from last year. A lot of owners took price increases along with the cost increases of minimum wage and other costs. And so that’s going to put some pressure on our average check in November and December, and that's one of the reasons we want to go with a conservative outlook. We are very excited about the results so far in the quarter but want to make sure that we temper that with the challenging rollovers ahead of us.

[Nik Rupp, Chief Financial Officer]

I would just add to that -- this is Nik here. I do think from overall costs like in October, we do believe firmly in the strategies that Weldon laid out as well and we really believe as more and more of those owners lend in and as we have more of those behind us now coming into the fourth quarter, that really has had a meaningful impact on the anniversarying of October from the prior year.

[Andy Barish, Jefferies]

And then just finally on online ordering. Are you seeing much of a shift yet to the mobile app? I know it's new. And then it also seems like your check average list is a little bit higher. I think you initially talked about 20%, now 25%. Is that just getting a little bit more data that you were able to analyze?

[Weldon Spangler, Chief Executive Officer]

So a couple of things. The mobile app, it’s not a meaningful shift yet we are tracking it carefully. We haven’t spent a lot of time or energy pushing the mobile app. I'm guessing that half the transactions are coming from me, because I'm using it personally, and I love it. It makes it so easy to order with just couple of clicks. And on the ticket increase, we continue to see -- it continues to fluctuate and has moved around as we add more mix online, we are finding that the ticket average increase is about 25%. And again, we are monitoring that, watching for both the discount rate as well as the average ticket to ensure that we can be aggressive online from a pricing point of view without cutting into the ticket too much.

[Operator]

[Operator Instructions] There are no further questions at this time. And I would like to turn the floor back over to Weldon Spangler for closing comments.

[Weldon Spangler, Chief Executive Officer]

Thank you, Hector. Thank you everybody for attending today and we look forward to updating you in the future. Have a great rest of your day.

[Operator]

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