Freshworks Inc

NASDAQ:FRSH

Earnings Call Transcript 2017-Q4

[Operator]

Good afternoon and welcome to today's Papa Murphy's Holdings, Inc. Fourth Quarter 2017 Earnings Conference Call. All participants are in a listen-only mode. After the presenters' remark, there will be a question and answer session. As a reminder, this call is being recorded.

I would now like to introduce Mark Hutchens, Executive Vice President, Chief Operating Officer and Chief Financial Officer. You may begin your conference.

[Mark Hutchens, EVP, COO & CFO]

Thanks Kevin. Good afternoon everyone and welcome to our fourth 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 would refer you to the Company's Form 10-K for the year ended January 1, 2018, that will be filed today 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 is Weldon Spangler, our Chief Executive Officer. Weldon will provide introductory remarks and walk you through our strategy after which I will review our fourth quarter results in detail and offer our outlook on the full year. Weldon will then provide some brief closing remarks before we open up the call for your questions.

With that, I would like to turn it over to Weldon.

[Weldon Spangler, CEO]

Thank you, Mark. Good afternoon everyone and thank you all for joining us on the call today. First, I would like to wish you all a Happy Pi Day and encourage you to check out the great Pi Day deal we’re going across participating Papa Murphy's locations. Including a large thin crust one topping fresh pizza for $3.14159265 of course we’re going to round that down to $3.14 to make it easier on our customers.

I've now been at Papa Murphy's for about nine months and I continue to be impressed by the passion and dedication of our team members and franchise owners alike. After spending time meeting with franchise owners, all across the country and working with our team here in Vancouver and in the field to refine the strategic focus of the business, I am more convinced than ever that we can turn this business around and generate substantial value for all of our stakeholders including employees, franchise owners, key vendors and investors.

As we look to 2018, I am excited to share with you a refined and focused strategy through which we expect to solidify near-term results and build the capabilities that will return the system to profitable growth and make it sustainable. We view this strategy within the framework of two pillars. One, consumer facing, focused on driving comparable store sale; and the other, non-consumer facing, focused on improved execution through people and process.

On the consumer facing front, we believe the major keys to driving comparable store sales growth is improving both our convenience and are relevant to customers. Our consumers have repeatedly told us that while Papa Murphy's is hands down their favorite pizza, we're missing out on many other pizza occasion because sometimes convenience trumps quality. That's highly disappointing to us and we're working fast to eliminate the need for our customers to compromise by making it easier for them to order online and to have our great product delivered.

On the ordering side, we're excited to be nearly done with our system migration to olo.com digital ordering platform. The move to Olo not only provides a seamless and convenient user experience for both customers and franchise owners alike, it also facilitates integration with third party market places and provides the opportunity to accelerate our delivery initiative. We're pleased with the early result and continue to see higher guest check for orders placed online.

We're also seeing higher conversion rates on the new site and seen a slight increase in the mix of transactions online for markets that have converted to Olo even before we’ve put any marketing behind the new site. We remain on track to fully transition to the Olo platform by the end of the first quarter in fact by the end of this week and expect to sunset the legacy ecommerce platform by quarter end.

The move to the Olo platform also allows us to accelerate the ramp up of our third-party delivery initiative. As we've commented in the past, we believe our product is uniquely positioned for success in the growing home delivery space. Pizza including our award winning fresh pie tastes best when it is hot out of the oven, and because our customer get to bake our great pizza at home, in a quick 12 to 15 minute, the quality of our pizza doesn't rapidly degrade as it sweats in a warming bag for 30 minutes to an hour.

Our customer gets the same great tasting pizza whether they have it delivered through one of the many delivery services or pick it up themselves at one of our locations. Delivery is currently available in 330 of our stores through third-party providers such as Amazon Restaurants, Grubhub, DoorDash and recently added, UberEats, City-Spree, Bite Squad and GrubSouth. Orders through these third-party providers remain highly incremental with attractive profitable check.

We’ll continue to capitalize on the inherent advantage we have with delivery and aggressively expand the reach of this important convenient offering. Based on the footprints of our current and future service providers, we expect to have delivery in approximately half of our stores by year end. Lastly, the move to the Olo ordering platform will allow us to accelerate other key initiatives to close the gap on convenient including a new mobile app and a loyalty program, both of which we expect to launch this year and both of which will help us to migrate more orders online.

On the relevant side over the last several months, we completed quite a bit of research on our brand, and we have confirmed that we have significant opportunity to better position the brand and are creative to tell our unique story. At its core, Papa Murphy's uniquely provide consumers with an easy way to have a high-quality home cooked meal, done their way and in their time. We believe our new position in quality, empowerment and convenient will more clearly inform us in consumer engagement strategy including creative and make us highly relevant to today's range of customers.

In order to be more relevant to younger customers, we realized the need to adjust our messaging and change the way we communicate with them. The mobile app and loyalty program I mentioned a minute ago will allow us to engage with this group more effectively and allow them to more effectively engage with us. Additionally, we're expanding our social and digital marketing effort and now have around 14% of our total system marketing budget deployed against digital marketing effort.

And like delivery, we think our product lends itself better than most to the growing food grade on a variety of social media platforms and expect to produce and share even more pizza hacks, our customers can use to make our great product uniquely their own. For example, one of our favorite hacks that you can only do with Papa Murphy's pizza is to create what we call pizza pinwheel, which involves rolling up an uncooked pizza and with a serrated knife, cross slicing it into pieces that are approximately an inch-thick, you then lay these discs flat on a cookie sheet and bake them for 12 to 15 minutes at 425 degrees. What you get are the perfect pizza snacks for parties or hungry kids. In fact this is so easy, I’ve done it myself. It was terrific and my guest loved it. We’re currently conducting a comprehensive creative agency review to address our positioning and messaging, and look forward to sharing the results with you on future calls. This creates a review as a significant focus for a new Chief Marketing Officer, Laura Szeliga, who joined our team last month. Laura fills a position that’s been vacant for over a year now and brings extensive food and retail industry experience, spearheading and executing proven marketing strategy and she's already having an impact.

Our hiring of Laura is obviously one of the more visible changes we're making on the non-consumer facing, people and process side of the business, which we see as critical enablers to support near term comp store sales growth and to make profitable system growth sustainable over the longer term. This is certainly a people led business, and we're taking steps to ensure we have the right capable people in place and that they are thoroughly briefed on the strategy and focused on execution, while also prudently managing comp.

A key part of the people aspect of the business is the relationship we have with our franchise owners. Something we talked about quite a bit on the last earnings call. This has been a key area of focus for me since I joined the Company and have been very pleased with the productive ongoing dialogue we’ve shared and the insight our franchise owners bring to our business. We continue to view our role at the Company as one of service or franchise owners and continue to believe that the Company and our investors will be successful only through the long-term success of our franchise owners.

As with people process is a key part of the execution roadmap for any successful company. And in the retail business execution is everything. We’re focused on systemic improvement on the process side of the business in the support center, in the field and in the stores. These process enhancements will enable us to better serve our franchise owners and allow our franchise owners to better serve their customers. We firmly believe that successful execution of this focused and refined strategy, improved the customer convenience and relevance enabled by improvements to people and processes, we’ll return Papa Murphy's system to sustainable and profitable growth and reward all of our stakeholders.

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

[Mark Hutchens, EVP, COO & CFO]

Thanks, Weldon. Before I jump into the financial results, I'd like to briefly discuss the happenings in our store portfolio. We ended the quarter with 145 company-owned stores, a net decrease of three stores that we closed in the quarter, and a net decrease of 23 stores compared to the end of the fourth quarter of last year, reflecting a total of 16 stores that we closed during the year, and seven stores that we refranchised.

As we've said previously, we're focused on refranchising most of our company stores and expect to be operating no more than 60 company stores by the end of the year. Towards that end, we're pleased to announce that we've entered into preliminary agreements with existing franchise owners to refranchise stores in three of the 15 markets in which the Company currently operate stores. We expect these transactions to close in the second and third quarters of this year.

Those markets would then be totally franchised owned and company store count would be reduced by a total of 23 units. We’ll then provide -- we’ll provide more details regarding the financial impacts of the transaction once definitive agreements are in play. We continue to pursue additional refranchising transaction and expect to be in the position to update you on further progress on our next call. Franchise owners opened six new domestic stores during the fourth quarter and closed a total of 21 domestic stores.

At the end of the fourth quarter, the domestic franchise store count was 1,338 units compared with 1,369 units in the prior year quarter, reflecting a total of 69 domestic franchise store closures offset by 31 domestic franchise store openings, and a net acquisition of 77 company owned stores over the last 12 months. As we focus on refranchising, we expect franchise owners to open only 10 new stores this year. However, we continue to believe this system has significant franchise development opportunity both in the U.S. and internationally.

Now turning to financial results, the following results are for the fiscal fourth quarter which ended January 1, 2018. As a reminder, the fourth quarter of 2017 contains 13 weeks compared to 14 weeks in the fourth quarter of 2016. Total revenue in the quarter was $30.7 million a decrease of 13.4% compared to the fourth quarter of last year. Excluding approximately $2.7 million of revenue generated during the 14th week last year total revenue in the quarter decreased by 6.2%. The decrease in total revenue was driven primarily by a net decrease of 58 domestic stores over the prior five quarters, as well as the 2.6% decrease in domestic system comparable store sales.

Franchise royalties in the quarter totaled $9.9 million compared to $11 million in fourth quarter of last year. Excluding approximately $900,000 of royalties attributable to the 14th week of last year franchise royalties decreased 2%. The decrease was driven by the net decrease of 38 franchise units over the previous five quarters as well as by the 2.6% decrease in comparable store sales at domestic franchise stores.

Franchise and development fees in the quarter totaled $472,000 compared to $739,000 in the prior year quarter. This decrease was driven by a fewer franchise store openings in the quarter.

Sales and company-owned stores totaled $19.9 million, down 14.5% from the prior quarter. Excluding approximately $1.8 million generated during the 14th week last year, sales at company-owned stores decreased by 7.3%. The decrease was driven by a net decrease of 21 company-owned stores over the last five quarters as well as by a 2.3% decline in company-owned comparable store sales.

Switching over to expenses, reported company store operating expenses in the quarter as the percentage of company-owned store sales decreased by 70 basis points compared with the prior year quarter and totaled 91%. The decrease was driven primarily by 160 basis point decrease in other store operating costs. The result of having no new store preopening cost in the current year quarter, as well as by decreases in food and packaging and advertising. These decreases were partially offset by increases in occupancy and compensation and benefit.

As we’ve done in the prior quarters, I’ll now discuss the results for 73 stores in 10 markets that have been unaffected by the portfolio changes we've made at the Company store division over the last 12 quarters. Comp store sales performance at these stores declined 1.1% in the quarter, outperforming the broader company store portfolio by 119 basis points. We did see some margin compression of around 43 basis points in these stores compared with the prior quarter with total operating costs as a percentage of sales totaling 84%.

Overall stores opened by the Company over the previous 12 quarters negatively impacted third quarter EBITDA by about $330,000 and reduced per share earnings by approximately $0.1.2 Reported selling, general and administrative expense in the quarter was $7.7 million including a non-cash litigation reserve of approximately $4 million at around a $100,000 related to CEO transition and restructuring. Offset by a deficit recovery of $3.4 million in the national advertising fund or ADF.

Excluding these items SG&A expense would have been $6.9 million or 22.6% of total revenue compared to $6.9 million or 19.6% of total revenue in the fourth quarter of last year. EBITDA in the quarter was $4.7 million excluding the legal reserve cost associated with company store impairment and closure and CEO transition and restructuring costs adjusted EBITDA on the quarter would have been $9.3 million or 30.4% of total revenue. This compared to EBITDA of $7.2 million or 20.4% of total revenue in the prior year fourth quarter, including approximately $500,000 of EBITDA generated in the 14th week last year.

The increased period over period was driven primarily by the ADF deficit recovery in the quarter, offset partially by the quarterly decline in comparable store sales. A reconciliation of EBITDA to GAAP net income is included in our earnings release. Depreciation and amortization expense in the quarter was $2.1 million, $1.4 million less from the prior year quarter. Net interest expense in the fourth quarter was $1.3 million, flat to the prior year quarter. The reported net income in the quarter was $13.5 million for $0.79 per diluted share compared to net income of $1.5 million in the fourth quarter of 2016, or $0.09 per diluted share.

Excluding approximately $100,000 of net income generated in the 14 week of 2016, net income in the fourth quarter of that year would have been $1.4 million or $0.08 per diluted share. The CEO transition and restructuring expenses, store closure and impairment costs and a litigation reserve reduced net income in the quarter by $3.4 million or $0.20 per share. This was offset by a $12.6 million benefit from the impact of the federal income tax rate change.

Excluding these unusual items pro forma net income in the quarter, would have been $4.2 million or $0.25 per diluted share. Due to the non-cash impairments taken in the quarter and the resulting swing to a full year pretax net loss, our effective tax rate in the quarter excluding the impact of the new tax law was 35.5%, compared tp a prior year quarter effective tax rate of 40.5%. We ended the quarter with approximately $2.2 million of cash on the balance sheet and net debt of $93.2 million, $6.3 million less than the prior quarter, reflecting net positive cash generated in the quarter. The $20 million revolver was completely undrawn at quarter end.

We ended the quarter in full compliance with all covenants under our amended credit facility reporting a leverage ratio of 4.39 times, compared to a maximum permitted leverage ratio of 5.25 times and reported interest -- an interest coverage ratio of 4.33 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 continue to 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 do expect to be in the market in late spring to refinance the amended credit facility, which expires in August of 2019, and have already begun preliminary discussions with our existing bank group to that end.

Based on those conversations, we expect to complete our refinancing prior to the existing credit facility going current in August of this year. Based on current information we're providing the following expanded full year outlook for fiscal 2018 which ends on December 31 of 2018, and introducing limited guidance for Q1 which ends on April 2nd. We continue to expect full year domestic system-wide comparable store sales growth in the range of flat to low single digits positive, including a low single digit decline in Q1. We continue to expect company owned store count of no more than 60 units by year end. 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 $26 million, excluding certain nonrecurring costs totaling around $4 million. We expect adjusted -- we continue to expect adjusted EBITDA of at least $21 million. We continue to expect cash used in investing or CapEx to be no more than $1 million. We continue to expect cash flow from operations less cash to investing activities of around $12 million, exclusive of expected dispute resolution payments of approximately $4 million. We now expect our full year effective book tax rate to be approximately 25 .5% and we continue to expect diluted share count to be approximately 16 .9 million shares.

Note that the 2018 financial outlook provided does not reflect the effects of two new accounting standards ASC Topic 606 Revenue from Contracts With Customers and ASC Topic 842 Leases that we expect to adopt for 2018 financial reporting or reflect the impact of any refranchising occurring this year. We expect to update our financial outlook to reflect the full impact of the accounting changes when we report Q1 2018 result, and 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, CEO]

Thanks Mark. We have an incredible opportunity here at Papa Murphy's to create a uniquely positioned, profitable and growing brand that can reward all stakeholders. We have a great product that the customer love, a highly differentiated position and a passionate team of employees franchise owners and vendors. We’ve a sound focused strategy in place to drive profitable and sustainable comp sales growth through consumer convenience and relevance people and process. We’re confident we can execute and the successful execution of the strategy will drive positive results and create long-term value for all our stakeholders through the success of our franchise owners.

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

[Operator]

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Will Slabaugh of Stephens. Your line is now live.

[Hugh Gooding, Stephens]

This is Hugh on for Will this afternoon. I just want to start with given the increasingly competitive and value-oriented environment we’re seeing, how do you view Papa Murphy's value strategy in 2018? And can we expect this to become more aggressive and also keeping in mind franchise profitability at the same time?

[Weldon Spangler, CEO]

Great question, this is Weldon. So your last point about franchisee profitability is something that we do spend a lot of time working with the franchise owners and certainly evaluating with marketing team as we look at offers. It is highly competitive out there. And we have a number of value initiatives that we’re starting to see some pretty positive traction on.

We've got a pizza out there, the XL New Yorker is a great value priced pizza; we priced it in some market at $7, some markets at $8 and some markets at $9. It’s a family size pizza. So it’s a great value but it's also great pizza, something that people really like, it’s a foldable crust, and it really for those markets that have adopted it early on, they see some good results.

We’ve also got a couple of other tests out there where we’re trying a variety of things from texting to Facebook to some program we have for bringing in lapsed customers at a good value. So we are getting better at this. I think we are seeing some signs of really good performance in some market. We’re taking that learning and sharing it with the other owners. So I expect that we will continue to get better at this as the year goes on.

[Hugh Gooding, Stephens]

And just switching gears a little bit to your guidance, since you’re expecting 1Q comps to decline slightly I am just curious, what top line drivers do you see taking hold later in the year, that kind of gets you excited and gives you confidence in that flat to slightly positive guidance for the year?

[Mark Hutchens, EVP, COO & CFO]

Yes, I'll take this and feel free to jump in Weldon. The first thing we're doing is lapping over our first national TV test in the prior year. So in a lot of markets we're substantially down in the first part of the year, as we just don’t have the advertising horsepower. So that's what's driving some of the near term. As Weldon said, we're trying to see traction on some of the value offerings we are seeing, traction on some of the digital spending that we talked about. So, it's really a combination of some of the things that are working or going to continue to work, and then we’ll lap some of the unusable level of spending we had in the prior year.

[Operator]

Thank you. [Operator Instructions] Our next question is coming from Jon Tower from Wells Fargo. Your line is now live.

[Jon Tower, Wells Fargo]

Just a couple of questions for you, curious in the delivery stores that are already out there the 330 you mentioned. Where is the mix coming in for delivery to the store base?

[Mark Hutchens, EVP, COO & CFO]

I mean like the level of -- yes, it's still early days, so it's not a substantial mix; we do expect it to continue to grow obviously as we start to put some marketing and we get it out or our plan right now is really to get it out to the stores. So our focus really has been on the breadth and launching delivery capability. We would expect the mix to then drive an increase as we turn our attention to growing that part of the segment.

[Jon Tower, Wells Fargo]

And then in terms of the incremental costs to the consumer, how much is that delivery be relative to what say a traditional chain pizza restaurant would charge?

[Mark Hutchens, EVP, COO & CFO]

It varies, I think quite substantially depending on who the provider is. Most of them -- the consumer is paying, he is paying menu price. So, the one thing you get with third party marketplaces, as you go in there and you don't get to buy pizza on a deal like you get to buy in some of our competitors, now as we fully transition to Olo, and we start to build delivery capability ourselves, using those same providers as delivery agents instead of us effectively fulfilling our pizza order, that will give us more control to really drive the economics and the engagement with the consumer more directly. I don’t know if you want to add anything to that Weldon.

[Weldon Spangler, CEO]

Yes, so what I would add is we are learning a lot as we go along. And I would say we're at the infancy stages of this, as we see organically some stores are performing really well, and organically some stores are not getting much attention at all from the consumer. So as we learn what's working and what's not working, we’ll be able to keep adjusting so that we can maximize -- maximize the opportunity. And what we are finding as in a lot of cases the consumer is willing to pay. And if a $4, $6, $8 kind of delivery fee in a lot of those from a lot of those providers and the consumer seems okay with that because they are convenient.

[Jon Tower, Wells Fargo]

Okay, and then just lastly switching gears on the company ownership by year-end, it’s a fairly big drop in terms of numbers and I believe you said on the call in the prepared remarks, seeing about 23 stores in place for refranchising, as of now set to close in the second and third quarter but that would imply you got well over 60 remaining to hit that 60 target by year end. So what gives you confidence that you can hit that no more than 60 units owned by the company by year end.

[Weldon Spangler, CEO]

So were just coming out early in the quarter around the marketing process. So the things we talked about are the transactions that we've gotten to the point where we think it's prudent to talk about them. I will tell you that we went out with a broad marketing of substantially all of our company stores in our more mature markets. So those conversations continue to progress.

[Jon Tower, Wells Fargo]

Okay and then just for clarification say the 60 stores that you’re talking about getting down to 60, you mentioned later on in the prepared remarks that your guidance for ‘18 does not include any refranchising, is that correct?

[Mark Hutchens, EVP, COO & CFO]

Yes, I said we didn’t modify the guidance, so as we - because as you don’t know exactly when can predict the pricing, the proceeds more fully than we can predict exactly when it might happen. So it’s difficult to impact or to guess today, what the impact on the adjusted EBITDA. So we will update that as we get more precision around timing.

[Operator]

Thank you. We’ve reached end of our question-and-answer session. I will turn the call back over to management for any further or closing comments.

[Weldon Spangler, CEO]

Thank you very much. Thanks everybody for attending the call today and look forward to speaking again next quarter.

[Operator]

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.