AFC Enterprises, Inc. Q4 2008 Earnings Call Transcript

Mar.12.09 | About: Popeyes Louisiana (PLKI)

AFC Enterprises, Inc. (AFCE) Q4 2008 Earnings Call March 12, 2009 9:00 AM ET

Executives

Cheryl Fletcher – Director, Finance and Investor Relations

Cheryl Bachelder – Chief Executive Officer, President

H. Melville Hope III – Chief Financial Officer

Analysts

Michael Gallo - C.L. King & Associates, Inc.

Sean Dodge - SunTrust

Operator

Good day, ladies and gentlemen, and welcome to the AFC Enterprises Q4 and full year 2008 earnings conference call. My name is [Keisha] and I will be your operator for today. (Operator Instructions)

I would now like to turn the call over to Cheryl Fletcher, Director of Finance and Investor Relations. Please proceed, ma'am.

Cheryl Fletcher

Thank you and good morning, everyone. Before I begin I'd like to read the following forward-looking statement:

Certain statements made on this call regarding future events and developments and our future performance, as well as management's expectations, beliefs or projections relating to the future, are forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to a number of risks and uncertainties.

Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are: competition from other restaurant concepts and food retailers, disruptions in the financial markets, our ability to franchise new restaurant units and expand our brand, increases in food and labor costs, and the risk factors detailed in our 2008 annual report on Form 10-K and other documents we file with the Securities and Exchange Commission. You should not place undue reliance on any forward-looking statements since those statements speak only to the date they were made.

During this call references may be made to non-GAAP terms like EBITDA and free cash flow. The company defines EBITDA as earnings before interest expense, taxes, depreciation and amortization. The company defines free cash flow as net income plus depreciation and amortization plus stock compensation expense minus maintenance capital expenses. The company's computations and reconciliation to GAAP measures of the numbers referred for these terms are contained in our earnings press release that can be found on the company's website at www.AFCE.com.

I would now like to turn the call over to our CEO and President, Cheryl Bachelder.

Cheryl Bachelder

Good morning and thank you for joining us on our earnings call today. This morning we will discuss our fiscal 2008 fourth quarter and full year performance, update you on our strategic pillars and provide you guidance for 2009.

In 2008 we did what we set out to do - we stayed on course, executing against our strategic plan that we announced in March of last year, and we met our fiscal 2008 earnings expectations at $0.76 per diluted share. We generated more than $26 million in free cash and our EBITDA margins remained strong at approximately 28%.

During 2008 we put in place a strong leadership team and together we developed a new strategic plan around four pillars of running a great restaurant company - first, building a distinctive and relevant brand for our guests, a brand that invites them into our restaurants and drives their visit frequency; second, running great restaurants by delivering service that is as distinctive as our Louisiana food; third, strengthening our unit economics by improving restaurant-level margin profitability; and lastly, better aligning our people and resources in support of our restaurant system.

In 2008 we saw good traction around these initiatives. We updated our menu and filled the menu gaps by adding three new menu platforms - Big Deal sandwiches and wraps, Louisiana Travelers, our nuggets and tenders, and Big Easy chicken bowls and sandwiches, designed to address value, portability and lunch and snack [day parts]. We used national cable advertising to expand our media reach, consolidated seven regional advertising agencies to one at GSD&M Idea City, and we created a food-focused Louisiana Fast campaign.

Although total domestic same-store sales were negative 2.2% for the full year, since Popeyes started running national cable with our new menu platforms, independent data shows our same-store sales have outpaced the chicken category by nine-tenths of a share point.

With our restructured field in place we've completed over 3,000 restaurant operation assessments in the U.S. to ensure standard processes and equipment are in place. We've implemented a new guest monitor we call [Jim], a survey which is now in virtually every restaurant in our system. We saw steady improvement in our percent of guests delighted scores, which at year end were 61%, up approximately 9 points from the start. We put new disciplines in place to strengthen our unit economics and improve our restaurant margins.

2008 was impacted by historically high commodity costs. On a full year basis, food inflation for the Popeyes system was up 11% year-over-year, impacting restaurant-level margins by 300 to 400 basis points before price increases. To offset some of these pressures we launched a program called Finding Your 2%, which provides the restaurants an extensive workbook and a set of online tools to help them improve their restaurant profitability. One of those tools was rolling out a new cooking oil management process to maintain the quality of our food while saving time and money in the restaurant.

In 2008 our development team opened 140 new restaurants globally, exceeding our guidance of 115 to 130. These new openings consisted of 73 domestic restaurants and 67 international restaurants, evidencing the growth potential of this brand. We ended the year with 1922 restaurants globally.

Our international business continued to perform well, with positive same-store sales for the seventh consecutive quarter. For 2008 international same-store sales increased by 4.1%. This was driven by strong sales in the Middle East, Canada, Korea and Latin America, and partially offset by negative sales in Mexico.

During 2008 we made investments in talent and resources to better support our restaurant operations around the globe. Further, we've continued to meet and work closely with our franchisee leaders every quarter and we have built stronger relationships with our franchisees even in these challenging times.

And finally, consistent with our strategic plan, we successfully refranchised and sold 14 of our company owned restaurants, 11 in the Atlanta market and 3 in Nashville.

Going forward we will continue to execute our strategic plan with a particular emphasis on compelling value, improving the guest experience, and strengthening restaurant profitability. In the current environment we believe that our superior food, matched with greater QSR and service will be the recipe for our success.

Consistent with 2008, we'll continue to market our brand with national cable advertising. Our campaign will remain food focused, with an emphasis on our points of distinction  freshly prepared, hand battered, Louisiana flavor. This year Popeyes will also benefit from the softening advertising marketplace, which will increase our media impact, allowing us to reach more guests with our message.

At the end of February we kicked off the Lenten season with our new $4.99 Butterfly Shrimp Tackle Box promotion. This features eight pieces of butterfly shrimp with Cajun fries and a buttermilk biscuit in our new tackle box packaging. It reinforces portability and convenience. Seafood gives our customers the value and variety they are looking for right now and we are pleased with their response.

Beyond shrimp our promotions are designed to continue to offer superior food while providing our guests more compelling everyday value. Through end market testing we've identified an arsenal of new ways to deliver value in both national and local market messages. Our company goal is to build guest traffic and increase our market share. Given the intense value competition in the marketplace, we're conservatively projecting global same-store sales for the year ahead of negative 1% to negative 3%.

The second pillar is running great restaurants; to improve the performance of our restaurants. As I mentioned earlier, we're focused on a better guest experience with our biggest opportunity to improve speed of service at our drivethroughs. The first step is equipping the restaurants and providing training. This year our franchisees are required to invest in headsets and timers for their drive-throughs by mid-year. A well-run drive-through has immediate impact on sales by increasing car throughput in the peak hours of the restaurant.

In February our domestic operations team kicked off a 10-city tour of operations conferences. These meetings are designed for our restaurant managers and supervisors, and we have focused on three key initiatives for 2009 - first, moving our measures using our new metric scorecards; improving our speed of service with an emphasis on the drive-through; and implementing new training tools to develop crew capability at the restaurants. We've been very pleased with the attendance and the enthusiastic response from the restaurant operators.

Third, we will remain focused on strengthening the unit economics of Popeyes. As you know, our success is driven in large part by our restaurant success. 2008 was a tough year from the top to the bottom of the P&L. Our efforts in 2009 will be to continue to find ways to grow profitability for our operators. We will continue our program of Finding Your 2%, working closely with operators to identify cost saving opportunities in every area of their business.

Additionally, in 2009 we do expect to see some relief in commodity costs. In the first quarter we've seen some gradual cost improvements and we expect to see more cost improvements as we move through the balance of the year.

Our supply management services cooperative has locked in corn and soy meal prices for most of the year, so we are projecting our bone-in chicken costs for the domestic system to gradually improve by April of this year, with significant improvement in the third and fourth quarter as we'll be lapping those peak costs of Q3 and Q4 a year ago. Therefore, on a full year basis we expect bone-in chicken costs to be relatively flat year-over-year. We expect some of these savings to be offset by higher packaging costs and labor costs if minimum wage rates again increase in July of this year.

With new unit opening growth projected to slow in 2009, we're using this time to strengthen our development pipeline so that we can accelerate unit growth once the economic conditions improve. We've developed new site modeling tools using consumer and real estate data. This new system provides our operators with an enhanced predictive approach for looking at new development. Over the past few weeks our development team has held five real estate modeling meetings across the country. These meetings were attended by over 200 existing and new franchise owners interested in growing. With the use of this new predictive tool and the alignment with strong franchise operators we believe we will be better positioned for long-term growth.

As we indicated in our press release, we plan to slow our global new openings to 90 to 110 restaurants in 2009, focusing on the improvement of core operations and unit economics in our existing restaurants. We believe this decision positions the company for more rapid growth once economic conditions improve. Popeyes expects systemwide unit closings in the range of 140 to 160 restaurants, resulting in a decrease of 30 to 70 net restaurant openings for 2009.

Our higher closure rate guidance in 2009 reflects three factors - the continuation of more stringent enforcement of our operating standards; as you would expect, it includes the potential closure of some units for financial reasons; and the typical annual closures due to lease expirations, trade area changes and franchise agreement expiration. I remind you that Popeyes restaurant closures typically have significantly lower sales than our system average.

Internationally, this year we've restructured our global support team into three regions, each led by a general manager. These regions have full P&L accountability backed up by a centralized Atlanta-based support team in finance, training, supply chain and development. Our international business remains focused on the same strategies we have domestically - building our brand with compelling value, strengthening our restaurant operations, and improving restaurant profitability and cash-on-cash returns to our franchisees.

Aligning our resources to support our system. Lastly and most importantly, we remain committed to a strong partnership with our franchisees. This month I've been doing my annual town hall meetings across the country in five major cities - New York, Chicago, New Orleans, Houston and Los Angeles. The town hall is a small group format where we discuss the business, share our 2009 initiatives, and take feedback from franchisees. Thus far I'm pleased with the attendance and the dialogue. Our franchisees share our passion for growing sales and improving profitability. They continue to invest in the marketing support and operations initiatives needed to improve our performance, and I'm very grateful for their commitment to our brand.

In conclusion, our strategies and our commitment to growing this brand and company are unwavering. We have made the necessary adjustments to operate in the current economic climate by stepping up our value offering and our service experience for our guests. We remain focused on managing restaurant profitability to capture savings in commodities as well as operating efficiencies. And we have positioned ourselves well to take advantage of new unit expansion domestically and around the globe.

For you, our investors, we have a stable business model that continues to generate strong free cash flow with low, tightly managed G&A and low capital investment. During 2009 we will use our cash to repay debt while implementing the strategic initiatives that will create value for all of our stakeholders long term.

I will now turn the call over to Mel Hope, our CFO, who will highlight our fourth quarter and full year fiscal performance and summarize our 2009 guidance. Mel?

H. Melville Hope III

Thanks, Cheryl. Good morning, everybody.

As Cheryl indicated, for 2008 we met our earnings expectations. Our fourth quarter diluted earnings per share was $0.10 and our full year diluted earnings per share was $0.76. If we adjust our full year earnings for the $4.6 million of net non-operating income we realized during the year, our adjusted earnings per share would have been $0.65 per diluted share.

Let's talk about the fourth quarter for just a minute. Our earnings for the fourth quarter were $2.4 million or $0.10 per diluted share, which includes half a million dollars of net other nonoperating charges.

In total, our revenues for the fourth quarter were $35.9 million compared to $39.1 million in the fourth quarter last year. Within our total revenues, sales from company operated restaurants were $15.7 million, representing a decrease of $3.3 million versus the fourth quarter last year. This decrease was primarily due to the successful sale of 11 company operated restaurants during 2008.

Franchise revenues, which are the revenues realized from royalties and fees paid by Popeyes franchisees were $19.2 million in the fourth quarter compared to $19.1 million last year. This slight increase was primarily due to the opening of new franchise restaurants which was offset by a decrease in our domestic same-store sales.

Operating profit in the fourth quarter was $6 million versus $8 million last year. This $2 million decrease is due to the effect of the $500,000 of net non-operating charges we recognized in 2008 as compared to $1 million of net other income from which we benefited during the fourth quarter of last year.

Interest expense decreased by $400,000 to $1.8 million for the fourth quarter of 2008 compared to last year. The decrease in the interest expense is primarily due to lower interest on the fixed rate portion of our term debt as a result of our interest rate swaps. Interest on $100 million of our debt was 4.87% in the fourth quarter of 2008 compared to 6.4% in 2007.

Our tax expense of $1.8 million reflects a 42.8% effective tax rate for the fourth quarter compared to 37.9% last year. The fourth quarter rate increased as we adjusted our income tax reserves, and by comparison last year's tax rate benefited from the reversal of reserves associated with expired tax statutes of limitation.

Speaking to the 2008 full year results, for 2008 our earnings were $19.4 million or $0.76 per diluted share, which includes the benefit of $4.6 million or $0.11 per diluted share of other nonoperating income. Total revenues for the full year decreased by $500,000 to $166.8 million. Our sales from company operated restaurants were $78.3 million, representing a decrease of $1.7 million compared to last year and that decrease was principally due to our refranchising of certain of our restaurants.

Franchise revenues were $84.6 million in 2008 compared to $82.8 million last year. This $1.8 million increase was primarily due to the opening of new franchise restaurants which was offset by a decrease in our domestic same-store sales.

In prior periods we've reported rental expense as a component of our G&A expense. Beginning with this reporting period we've presented rental expenses associated with restaurant properties we sublease to other operators on a separate income statement line item entitled Rent and Other Occupancy Expenses.

Our G&A expense $53.9 million or 3.1% of our systemwide sales compared to $47.2 million or 2.7% of systemwide sales last year. This increased rate reflects our investments in national cable advertising, expanded international operations, new management talent, and new marketing and menu initiatives.

Our guidance during 2008 was based upon G&A including the rent expense which we've broken out and that totals $56.3 million or 3.2% of our systemwide sales compared to the company's previous guidance of 3.3% of systemwide sales. Our G&A as a percent of systemwide sales remains among the most efficient in the restaurant industry, where the median average for public companies is 4.7% of systemwide sales.

Likewise, our full year EBITDA was $46.6 million or 28% of total revenues, among the highest EBITDA margins in our industry. Last year EBITDA was $52.5 million or 31.4% of our total revenues.

Operating profit in 2008 was $40.3 million versus $45.6 million last year. This $5.3 million decrease is primarily due to the higher G&A investments I mentioned earlier.

Interest expense was $8.1 million, a decrease of $600,000 compared to last year. As we mentioned earlier, this decrease reflects the favorable impact of our interest rate swap agreement which we entered into mid-year and which lowered the interest cost on $100 million of our debt, from 6.4% to 4.87%.

Our income tax expense for the year was $12.8 million, an effective tax rate for 2008 of 39.8% compared to an effective tax rate of 37.4% in 2007. Last year's effective tax rate - the 2007 effective tax rate  benefited from the reversal of tax reserves due to the expiration of certain statutes of limitation. Had the statutes not expired during the prior year, the effective tax rate for fiscal '07 would have been 38.5%.

This year's rate was elevated almost a full point due to our impairment charges, which included goodwill that was not deductible for tax purposes. Our ongoing effective tax rate should approximate 38% to 39%.

Let's talk about our usage of cash and our debt covenants for just a minute. Even in these economic times, our highly franchised business model continues to generate strong free cash flow. During the year we generated $26.2 million in free cash flow. We used this cash to repurchase 2.1 million shares of our stock for $19 million and we repaid $13.4 million on our credit facility, ending the year with $119.2 million in total debt.

Our cash balance at the end of the year was $2.1 million. At the end of 2008, our total leverage ratio  that's net debt to EBITDA - was 2.7, which was comfortably below our debt covenant of 3.25. During 2009 the total leverage ratio covenant will step down to 3 in quarters one and two and 2.75 in quarters three and four. We intend to use the cash generated from our operations and the planned cash proceeds from the sale of selected restaurant properties for voluntary debt prepayments. We expect these prepayments will further secure our planned compliance with the total leverage ratio covenant of our credit facility.

The term of our credit facility extends into 2011 and our first significant principal payments do not mature until the third quarter of 2010. The company expects to refinance the existing credit facility prior to the date of those maturities.

With regard to the sale of our company operated restaurants as Cheryl indicated, as of today the company has completed the sale of 11 restaurants in the Atlanta market and three restaurants in our Nashville market. The company continues in negotiations to sell the remaining 14 company operated restaurants in the Atlanta market. At this time, we're unable to predict the timing of the completion of the sale of those stores.

Before we open the lines for Q&A, let's revisit our full year guidance for 2009, which appears in both our press release and the 10-K. We expect global same-store sales for fiscal 2009 to be in the range of negative 1% to negative 3%. During 2009 we'll continue to tightly manage our G&A expenses, we'll invest in key strategic initiatives which management believes are essential for the long-term growth of the brand, and as a result we expect fiscal 2009 G&A expenses to be consistent with 2008 expenses at 3.1% to 3.2% of systemwide sales.

We expect full year earnings per share to be in the range of $0.62 to $0.67 per diluted share compared to the adjusted 2008 earnings of $0.65 per diluted share. That figure excludes $0.11 of other non-operating income.

Thank you very much, and we will open the lines now for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Gallo - C.L. King & Associates, Inc.

Michael Gallo - C.L. King & Associates, Inc.

Your commentary around comps for 2009 was conservatively down 1% to down 3%. I was wondering if you could elaborate at all on what makes you think that's conservative. Is that based on the trends you've seen to date? Are you seeing any improvement in the marketplace? Is it strength of the plan for '09? What gives you confidence that you say conservatively?

Cheryl Bachelder

Well, Mike, if you look at how we closed out the year, both in the fourth quarter and in the total year of '08, we felt at this early stage in the year it was appropriate to be conservative in our guidance as we watch what happens in the marketplace. So our guidance is consistent with the trend we delivered in the 2008 marketplace.

Michael Gallo - C.L. King & Associates, Inc.

Again, I come back to what makes you say conservatively? Have you seen any change in trends to date - I guess we're a couple of months into the first quarter now - from the Q4 trends or are things relatively the same?

Cheryl Bachelder

I think, as you would observe, the intensity of value in the marketplace in QSR is about as intense as it's ever been. We're getting in that fray and we've got good offerings. The one I just talked about that's on air right now, our $4.99 shrimp, is getting good traction. I think it's because it's a very compelling value for seafood, so I'm encouraged by that.

But I do think until we get through the first six months of this year we should be conservative in our sales forecast.

Michael Gallo - C.L. King & Associates, Inc.

To come back to value, obviously you launched three platforms last year to help fill a segment of value that really had been lacking at Popeyes. I was wondering whether you think you need to go a step further in terms of more of a value menu, more products in that dollar range. Obviously, KFC seems to be rolling that out, as are a lot of other players in quick service. Do you think Popeyes ultimately needs a value menu or do you think what you're doing with some of the platforms is sufficient?

Cheryl Bachelder

Mike, we've been testing in the last 90 days three or four different ways to give the customer what I'd call everyday values, including dollar menu-type options, and we're looking at a local level of implementing those across the country, so I think our approach to that will differ by market. But we have seen some good traction; I'll give you an example.

In Chicago, for example, they've been offering a lunch every day for $3 and that's been very good. In Los Angeles our franchisees have been doing $0.99 Tuesdays, which is two pieces of chicken for $0.99 on Tuesdays and, of course, people buy a side and a drink with that, and that's been very, very successful there. So it will vary by market, but absolutely, compelling value is what it's all about right now and we're very much stepping into that game.

Operator

(Operator Instructions) Your next question comes from Sean Dodge - Suntrust.

Sean Dodge - Suntrust

According to the NPD data you guys put in your releases it looks like the amount by which Popeyes is outpacing the rest of the chicken QSR category kind of slowed during the fourth quarter from what we saw in the third and the second despite the fact that you have the three new menu platforms in place, and I was curious to know why you think this may be the case - because of more intense competitive discounting or more competitive advertising?

Cheryl Bachelder

Well, we're talking about chicken QSR when we make that relative statement and we outpaced chicken QSR more than 80% of the time in the back half of the year once we went to national cable and that was up significantly over the first six months of the year.

But there are value competitors in chicken QSR as well. Church's would be one, for example. So there's definitely been a step up both at KFC and Church's in value, and I think it's remarkable that we continue to outpace them and stay in front of that.

Sean Dodge - Suntrust

The national advertising plan for 2009, I know you guys said you plan on maybe getting some more bang for your buck because prices have come down a little bit, but I was just curious to know what the overall spend for the year for 2009's going to look like compared to 2008?

Cheryl Bachelder

We have announced previously that we are investing in national cable in 2009 as we did in 2008, so our spending level is up over prior year. And since we went to national cable, our media reach is up over 2.5 times what it was prior to that.

Operator

We have no further questions. At this time I would like to turn the call back over to Cheryl Bachelder for closing remarks.

Cheryl Bachelder

We're grateful for your time this morning. We appreciate these questions and your support of Popeyes, and we'll look forward to talking about our first quarter with you when we close that out. So thank you and have a very good day.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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