Papa Murphy’s Holdings, Inc. (NASDAQ:FRSH) Q4 2018 Earnings Conference Call March 14, 2019 5:00 PM ET
Nik Rupp – Chief Financial Officer
Weldon Spangler – Chief Executive Officer
Conference Call Participants
Good afternoon. And welcome to today’s Papa Murphy’s Holdings, Inc. Fourth Quarter and Full Year 2018 Earnings Conference Call. All participants are now in a listen-only mode. As a reminder, this call is being recorded. [Operator Instructions]
I’d now like to introduce Nik Rupp, Chief Financial Officer. You may begin.
Thank you, operator. 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 2019 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 December 31, 2018, that 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 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 high level remarks on the quarter and an update of progress we are making against our turnaround plan. I will then review our fourth quarter financial results in detail, as well as provide our outlook on the full year. Before Weldon provides some brief closing remarks and we open the call for your questions.
With that, I’d like to turn it over to Weldon.
Thank you, Nik. Good afternoon, everyone. We thank you all for joining us today. I’d like to begin today’s call with a high- level review of our fourth quarter results, followed by an update on our key strategies that we believe are helping return our business to profitable and sustainable growth.
Fourth quarter results included a system-wide comparable store sales decline of 1.3% and adjusted EBITDA of $5.9 million, both of which came in ahead of internal expectations. Results represented continued sequential improvement and included positive same-store sales in the month of October. We continue to believe that our comp sales improvement is being driven by the adoption of key marketing messages as well as by progress on our strategic initiatives.
In the fourth quarter, we again saw an increasing number of markets comp positively with 48 domestic DMAs showing growth in the quarter, up from 39 in the third quarter. These 48 DMAs, which have fully adopted marketing initiatives with a low, broad and consistent value message and have synchronized all marketing channels to drive traffic to the store, are outperforming the system in terms of both sales and profitability.
As these markets continue to demonstrate outside success, some DMAs increased sales year-over-year by more than 10% in the quarter. We would expect accelerated adoption and further momentum across the system. The other main driver of our improving comp performance has been progress against our key strategic initiatives. As we’ve outlined previously, our core strategy rests on two pillars: consumer-facing initiatives and non-consumer facing initiatives.
On the consumer-facing front, our strategic initiatives are focused on driving profitable sales through convenience and relevance. We’ve made great strides to make Papa Murphy’s an even more convenient option for consumers and spent much of last year fortifying and adding to our stable of digital tools. In March 2018, we successfully rolled out our new e-commerce platform, which serves as the foundation for many of our convenience initiatives. Since then, we’ve continued to see a steady increase in the mix of online orders with fourth quarter e-commerce sales seeing growth of 34% over Q3 of 2018.
Online check averages not only remained higher than in-store transactions in Q4 but were up approximately 28% higher than our in-store check average. In addition, while delivery orders are still a very small part of the overall business, mix in our top 10 stores offering delivery hit 4% during Q4 2018.
At year-end, delivery was available in 480 stores, and orders remain highly incremental. With our strategic focus on improving customer convenience, we have set a goal to double the number of stores offering delivery by the end of 2019. In the fall, we launched our new mobile app, which not only makes it quick and easy for customers to place orders and maintain favorites and payment information, but it’s seamlessly integrated into our POS system in order to minimize operational impact. The app already has over 243,000 downloads and has generated almost as many orders.
The next step is to add a loyalty program to the suite of convenience elements for our customers. We are in the process of selecting a partner for this program, and we’ll be looking to roll the program out system-wide later this year. These digital tools are not only great facilitators of driving convenience, but importantly, they are driving growth of our text and e-mail databases. These databases enable powerful targeted one-to-one marketing capabilities that will allow us to further tailor our messaging to the needs of individual customers in addition to facilitating more effective and efficient marketing efforts. Becoming more convenient has become table stakes in the restaurant industry.
In order to be successful, we also need to increase our relevance. After reevaluating our brand positioning, digital marketing and social media strategies, in August 2018, we rolled out new creative design to ensure we are making ourselves relevant to a younger consumer base without disenfranchising our current customers. We believe these new materials reinforce our relevance by focusing on our product, highlighting our do-it-yourself positioning, and clearly demonstrating our differentiation.
In conjunction with this rollout, we shifted more advertising mix towards digital marketing, which allows us to get in front of additional consumers in a more cost-effective manner. I’m pleased to say that this new creative has received great feedback, and we believe that the combination of new creative and the shifting mix will introduce our brand and elevate our relevance to a new group of customers.
Turning now to our non-consumer-facing initiatives, which are focused on improving execution through our people and processes. As I’ve said many times, the most critical component of our non-consumer-facing initiatives is further strengthening our relationship with our franchise owners. Our success is almost wholly dependent on theirs, and our job is to give them all of the tools and support they need to thrive. We’ve made significant progress in strengthening these relationships throughout 2018 and believe that most of our franchise owners would agree. The result of this work is increased buy-in from franchise owners and an enhanced agility, which makes us a stronger and more adaptable system. For example, in January, we introduced a free pizza offer that had 96% participation and buy-in from the system and all arranged within a four-week timeframe. 96%, that kind of participation would have been incredibly hard, if not impossible, to accomplish just a year ago.
Starting in 2019, to further enhance our communication, we are adding five regional franchise advisory meetings per quarter with the goal of getting in front of more of our regional franchise leaders and elevating our connection to the broader franchise owner base. We realize this is a never-ending process, and we will continue to work diligently to further build and maintain trust with our franchise owners in order to fortify these relationships for the long-term. One of the keys to supporting our franchise owners is the continuous, systematic improvement of processes in our support center in the field and in our stores. This mentality of continuous improvement allows us to better serve our franchisees, who in turn are better able to serve their customers.
To that end, we’ve developed an ongoing in-store career path training program, called One Bite at a Time, which focuses on skills instead of positions. The goal of the program is to empower crew and management members, adding value to the recruitment and retention process. This training program, which began in the fourth quarter, has currently been introduced in over 700 stores with the goal of reaching the full system by the end of 2019.
Finally, our ability to consistently execute flawlessly has been an area of intense focus throughout 2018. Our teams here at the support center have done tremendous work to further strengthen internal processes and improve the lines of communication so that we can avoid unnecessary mistakes as we roll out key programs and initiatives across the system. This consistency is at the heart of building trust for both customers and our franchise owners and will remain a focus for 2019.
Before I turn the call over to Nik, I want to provide a brief update on the strategic alternatives that we announced on our last earnings call. As we noted then, 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 hired North Point Advisors as a financial adviser to assist in the process. Although we’ve made significant progress in reviewing the strategic alternatives, we are not yet in a position to make further public comment regarding the review until it has been completed. We hope to be able to provide a further update in the near future.
With that, I’d like to turn the call over to Nik to review our fourth quarter results in detail.
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 fourth quarter with 106 company-owned stores, which represents a net decrease of seven stores from the third quarter and a net decrease of 39 stores compared to the fourth quarter of 2017. The year-over-year decrease reflects a total of 10 stores that we closed over the last year and a net reduction of 29 stores that were refranchised. Our portfolio focus remains on ensuring that we find the right franchise partners to take over our company-operated stores as we work towards returning to at least a 95% franchised system with no more than 50 company-owned stores by the end of 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 three new domestic stores and closed a total of 16 domestic stores and three international stores. At the end of the fourth quarter, the franchised store count was 1,331 units, compared with 1,378 units in the prior year quarter. The decrease reflects a total of 87 franchised store closures, offset by 11 franchised store openings and a net refranchising of 29 company-owned stores over the last 12 months. As we continue to focus our attention on top line growth, we expect franchise owners to open approximately 15 [ph] new stores in 2019, comprised of 10 domestic stores and five international. We continue to believe that over the long-term, the system has significant opportunity for franchise development, both in the U.S. and abroad.
Now on to fourth quarter results. Total revenue in the quarter was $ 32 million, a 16.9% decrease compared to the fourth quarter of last year. The decrease in total revenue was driven primarily by the net reduction of 42 company-owned stores over the last five quarters, 29 of which were refranchised, 13 of which were closed, and a net closure of 92 franchise stores, as well as by a 1.3% decrease in fourth quarter system-wide comparable store sales. The decrease in comparable store sales was comprised of a 1% decrease for franchised stores and a 5.8% decline at company-owned stores.
In addition, in the fourth quarter of 2017, we had an additional contribution by all stores to the Brand Marketing Fund of 0.85% or approximately $1.9 million to help fund the national TV advertising test that took place in the first quarter of 2017. Total franchise-related revenues decreased by 4.8% in the fourth quarter to $17.8 million compared to $18.7 million for the same period last year. The decrease was primarily driven by lapping the additional contribution by all stores in 2017 to the Brand Marketing Fund, the 1% decline in franchised comparable store sales and the net reduction of 63 franchised stores over the last five quarters.
The decrease in comparable store sales for the quarter was impacted by continued competitive value dealing. But as you heard from Weldon, we are countering this with growth in our e-commerce sales, delivery and more targeted digital marketing efforts that should help close both convenience and relevance gaps versus our peers. We believe that as our key marketing strategies ramp up in terms of adoption and traction and we continue to roll our critical technology components, we will see this gap close, and the system will return to positive comp sales growth. Company-owned store revenues totaled $14.3 million, a decrease of 28.2% from $19.9 million in the prior year quarter.
The decrease was driven by a net reduction of 42 company-owned stores over the last five quarters, 29 of which were refranchised, 13 of which were closed, and as well as by the 5.8% decline in company-owned comparable store sales. Note that the refranchised stores had comparable store sales that were above the CSD average in the fourth quarter, so their transfer exacerbated the period-over-period comparable store sales decline.
Switching now to expenses. Company-owned store operating expenses as a percentage of company-owned store revenues increased 26 basis points compared to the prior year quarter to 89.7% of company-owned store revenues. The increase was driven predominantly by a 145 basis point increase in compensation and benefits due to state and minimum wage increases as well as by a 23 basis point increase in food and packaging. These increases were partially offset by an 87 basis point decrease in occupancy and other expenses and a 53 basis point decrease in advertising expenses.
Reported selling, general and administrative expense in the quarter was $13.6 million versus $15.5 million in the prior year quarter and $49.7 million for the full year in 2018 versus $64.6 million in 2017. Excluding CEO transition and restructuring, litigation settlements and strategic alternative costs in all periods, SG&A expenses were $13.3 million in the fourth quarter of 2018 versus $11.4 million in the prior year period and $47.6 million for the full year 2018 versus $57.5 million in 2017.
The reduction in SG&A for the full year was driven by cost reduction initiatives as well as lapping the national TV advertising test that took place in the first quarter of 2017. EBITDA in the quarter was $5.4 million. Excluding the effect of store divestitures, closures and transition costs and other non-recurring expenses, adjusted EBITDA in the quarter was $5.9 million or 18.5% of total revenue. This compares to adjusted EBITDA of $9.3 million or 24.1% of total revenue in the prior year fourth quarter.
The period-over-period decrease for the fourth quarter was driven primarily by the additional contribution by all stores to the Brand Marketing Fund of approximately $1.6 million in 2017 as well as by CSD sales declines in the fourth quarter of 2018 from refranchising and store closures. For the full year, EBITDA was $18.3 million dollars in 2018 compared to a loss of $4.8 million in 2017.
Adjusted EBITDA for 2018 was $22.3 million compared to $20.5 million a year ago. 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 $1.6 million, approximately $0.5 million less than the prior year quarter. Net interest expense in the fourth quarter was $1.4 million, up 8.8% versus last year.
Net income in the quarter was $2 million or $0.12 per diluted share, compared to net income of $12.2 million in the fourth quarter of 2017 or $0.72 per diluted share. Note the reported net income in the quarter was reduced by CEO transition and restructuring, store closures and impairments, litigation settlements, strategic alternatives and debt refinancing. Excluding these unusual items, pro forma net income in the quarter would have been $2.4 million or $0.14 per diluted share compared to pro forma net income of $3.1 million in the fourth quarter of 2017 or $0.18 per diluted share, which included a $12.4 million positive effect resulting from the enactment of the Tax Cuts and Jobs Act of 2017.
Pro forma net income for the full year 2018 was $7.3 million or $0.43 per diluted share, compared to a pro forma net income of $1.9 million for 2017 million or $0.11 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 20.4%. At the end of the fourth quarter, we had net debt of $76.3 million comprised of approximately $5.8 million of cash on the balance sheet and total long-term debt of $82 million. The $7.5 million revolver was undrawn at the end of the quarter. We ended the quarter in full compliance with all covenants under our amended credit facility, reporting a leverage ratio of 3.43 times compared to a maximum committed leverage ratio of 4.75 times and a reported interest coverage ratio of 4.66 times, compared to a minimum permitted coverage ratio of 3.5 times.
We continue to believe that in the current business environment, it is prudent to maintain an even more conservative balance sheet and expect to use operating cash generated by the business and net proceeds from refranchising to further pay down debt. Subsequent to the end of the quarter, we paid down an additional $3 million in debt and currently have $79 million in total long-term debt and a leverage ratio of 3.3 times.
Based on our current growth plans and financial forecasts, we believe that 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 within our amended credit facility.
Turning now to guidance. Based on current information, we are providing the following full year outlook for fiscal 2019, which ends on the 30th of December 2019. Full-year system-wide comparable store sales growth in the range of flat to low single-digit positive; domestic franchise new store openings of approximately 10 units; full-year selling, general and administrative expenses of approximately $48 million, excluding non-recurring items. This includes approximately $23 million of expenditures in the Brand Funds and excludes certain non-recurring costs totaling approximately $2 million, adjusted EBITDA of at least $22 million; cash flow from operations of approximately $15 million, which includes non-recurring payments totaling approximately $2 million, cash used in investing activities of approximately $2 million; full year effective book tax rate of approximately 25.6%; and diluted share count of approximately 17 million.
Note that the 2019 financial outlook does not reflect the impact of any additional refranchising during the year. We will continue to update our outlook for refranchising 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.
Thank you, Nik. 2018 was a year where we built a solid foundation for long-term sustainable growth. Towards that end, we launched our new e-commerce platform and app, rolled out delivery and developed new creative in conjunction with enhanced social and digital marketing efforts. We also took great strides to rebuild trust and engagement with our franchise owners and solidified executional processes. Our goal remains to provide the highest quality pizza and guest experience in the industry and drive renewed growth in our customer base through our strategic initiatives. We continue to believe that we have the right strategic initiatives in place to drive long-term success for Papa Murphy’s, and we’re extremely excited for the year ahead. We look forward to bringing news of our continued successes as we progress through the year. Thank you, again, for joining the call today. We will now turn the call over the operator for the Q&A session.
This concludes the question-and-answer session as well as today’s teleconference. You may disconnect your lines at this time. Thank you again, for your participation.