MTY Food Group Inc

TSX:MTY

Earnings Call Analysis

MTY's Q3 2024: Financial Stability Amid Declines and Opportunities for Growth

In Q3 2024, MTY Food Group reported a slight revenue decline to $292.8 million, partly due to a 3% drop in Canadian franchising, while U.S. operations saw a 1% increase. Normalized adjusted EBITDA fell 1% to $71.9 million, with improved margins in franchising to 56%, reflecting restructuring efforts. Cash flow from operations surged 29% to $66.4 million, resulting in record free cash flows of $49.3 million. While digital sales now comprise 19% of total sales, the company foresees continued focus on organic growth and acquisition opportunities in a challenging market.

Overall Financial Performance

In the third quarter of 2024, MTY Food Group reported total revenue of $292.8 million, down from $298.1 million the previous year. This decline was primarily influenced by a 3% decrease in revenue from Canadian franchise locations, largely due to lower recurring revenue streams. Conversely, the U.S. and International Franchising segment achieved a slight growth of 1%, with revenue reaching $65.6 million.

Segment Performance Analysis

Breaking down performance by region, franchise revenues in Canada continued to struggle, with street front and mall locations each decreasing by 4%. Meanwhile, the corporate-owned locations in Canada saw a robust increase of 30% to $11.2 million, attributable to a rise in the number of corporate-owned stores. The situation in the U.S. was more encouraging, where corporate-owned locations recorded a minor decrease of 1% in revenue.

Profitability Insights

MTY's normalized adjusted EBITDA came in at $71.9 million, a slight decrease of 1% compared to $72.9 million a year earlier. Notably, the U.S. and International divisions contributed 38% to total normalized adjusted EBITDA. Canadian operations saw a downturn of 6% in this metric. Despite overall revenue declines, the company managed to enhance its segment profit margins, which increased from 10% to 13% year-over-year.

Cash Flow and Shareholder Returns

A significant highlight of the quarter was the historical peak in free cash flow, which totaled $49.3 million—up from $32.1 million last year. This translates to $2.06 per diluted share, showcasing improved cash flow generation capability. The company rewarded its shareholders accordingly, repurchasing 254,700 shares for $11.4 million and declaring a dividend of $0.28 per share.

Future Strategic Outlook

Moving forward, management expressed optimism about generating organic earnings growth despite the challenging macroeconomic landscape. They anticipate that restructuring initiatives taken throughout the year will yield benefits in the longer term. The focus remains on optimizing assets and actively seeking acquisition opportunities to drive growth.

Digital Sales Expansion

Digital sales have shown promising growth, now accounting for 19% of total sales, up from 17% last year. This trend reflects investments in enhancing the digital experience for customers—a critical factor considering evolving consumer preferences.

Market Challenges and Adaptations

Despite facing difficulties, such as changes in the retail landscape and competition, MTY remains focused on adapting its strategies. Initiatives include cost management and promotion adjustments, particularly within underperforming brands like Papa Murphy's and the casual dining sector, where traffic has lagged.

Focus on Strong Brands

The management highlighted the robust performance of strong brands like Cold Stone, which continues to outperform with growth in store openings. Meanwhile, initiatives to optimize the underperforming brands are underway, aiming to replicate the success seen with Cold Stone and Wetzel's Pretzels.

Conclusion: A Balanced Perspective

In conclusion, while the third quarter saw some challenges for MTY Food Group, particularly in its Canadian operations, the overall health of the business appears stable with a strong emphasis on cash flow generation and strategic growth initiatives. Investors should consider the ongoing restructuring and potential for future acquisitions as key factors in evaluating MTY's long-term value.

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, and welcome to the MTY Food Group Inc. Third Quarter of 2024 Conference Call. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions].

Before turning the meeting over to management, please be advised this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those updated. Please note this conference call is being recorded today. Friday, October 2024. I would now like to turn the conference over to Eric Lefebvre, Chief Executive Officer. Eric, please go ahead.

[Eric Lefebvre, executive]

Good morning, everyone. Thank you for joining us for MTY's Third Quarter Conference Call for fiscal 2024. The press release and MD&A with complete financial statements and related notes were issued earlier this morning and are available on our website as well as on SEDAR+. During the call, we will be referring to forward-looking statements and to certain numbers that are non-IFRS measures. You can refer to our MD&A for more details. Please note that all figures presented on today's call are in Canadian dollars unless otherwise stated.

I'd like to open with a few highlights from last quarter. Normalized adjusted EBITDA for the quarter reached $71.9 million or $3.01 per diluted share. That compares to $72.9 million or $2.98 per diluted share last year. Our franchising segment generated 2% positive year-over-year growth last quarter with an EBITDA of $57.4 million. Normalized adjusted EBITDA margins for the segment grew to 56% compared to 54% in the third quarter of 2023 as our restructuring efforts are starting to bear fruit.

Cash flows provided by operating activities grew by $14.9 million or 29% over last year, reaching $66.4 million compared to $51.5 million in the same period last year. Free cash flows net of rent payments were $49.3 million in the third quarter, a historical high for MTY. On a per diluted share basis, free cash flows net of rent payments were $2.06 per share compared to $1.31 per share last year. During the 3-month period ended August 31, 2024, MTY's network generated $1.47 billion in sales, an increase of $5.6 million compared to the same period last year.

The U.S. and International segment had overall positive growth in system sales of $22 million for the quarter, while Canada recorded a decline of $16.4 million or 3%. Canada's decline was felt in all types of restaurants with fast casual concepts recording the largest drop. The U.S. snack category with brands such as Wetzel's Pretzels, and sweetFrog continued to outperform prior year. Our casual dining concepts on the other hand, continued to face declines in traffic, offsetting the good performance of our QSR brands.

Digital sales once again grew in proportion to overall sales in both countries. They now represent 19% of total sales compared to 17% in the same period last year. This is a reflection of the continued investment of our brands towards creating a smoother digital sales channel and enhancing the customer experience online as well as in stores.

As an overview of MTY's location count, the company ended the third quarter with 7,066 locations, a decline of 41 compared to the end of last quarter. During the third quarter of 2024 becomes network, opened 67 locations and closed 108 locations. Store openings were affected by delays in inspections with many new locations happening in the first few days of the subsequent quarter. Store closures were also higher than in previous quarter, mainly because of a higher number of Papa Murphy's closures once again this quarter.

Of the 7,066 locations in operation, 6,830 or 97% were franchised or under operator agreements and the remaining 236 locations or 3% were operated by MTY. I will now turn the call over to Renee, who will discuss MTY's financial results in greater details.

[Renée St-Onge, executive]

Thank you, Eric, and good morning, everyone. During the quarter, MTY's total revenue decreased to $292.8 million from $298.1 million a year earlier. Looking at the Canadian segment, revenue from franchise locations decreased by 3%. The decrease was attributed to the decrease in recurring revenue streams, which is core to the 3% decrease in system sales Eric spoke about.

Street front locations and mall locations had the largest impact on the year-over-year decline decreasing by 4% each. The U.S. and International Franchising segment, however, saw an improvement of 1% year-over-year, reaching $65.6 million. Again, this is tightly correlated to the increase in system sales of 2%.

Revenue from corporate-owned locations in Canada increased by 30% to $11.2 million during the quarter due to an increase in corporate-owned locations year-over-year, while the U.S. corporate-owned locations saw a decline of 1% due to the decrease in organic system sales of 0.6% compared to the same period last year.

Globally, food processing, distribution and retail revenue decreased by 7% due to lower sales in the Canadian Retail segment. Similar to last quarter, this is the result of market conditions and grocers focused increase on promoting house labels. However, I'd like to note overall segment profit increased year-over-year by $0.8 million, with margins improving to 13% from 10% in prior year.

The U.S. Retail segment also continues to make strides with its existing product labels, which generated $0.7 million increase over prior year. In terms of normalized adjusted EBITDA, we saw a decrease of 1% with $71.9 million in the quarter compared to $72.9 million in Q3 2023. As a reminder, normalized adjusted EBITDA excludes our SAP implementation costs.

The U.S. and international normalized adjusted EBITDA contributed 38% of total normalized adjusted EBITDA, realizing an increase of 1% and while Canada contributed 32% of total normalized adjusted EBITDA, a decrease of 6% or $1.5 million compared to the same period last year.

For the Canadian segment, the fluctuations were primarily impacted by the changes in recurring revenue streams with operating expenses remaining relatively flat for the quarter year-over-year, while the U.S. and International segment improvement was largely impacted by cost reductions.

As mentioned by Eric, the restructuring initiatives taken in the first half of the year and continuing into the later half are starting to show their impacts on our results. These initiatives are also showing in our franchising segment margins, which improved to reach 56% compared to 54% in Q3 2023. Corporate store margins saw a slight dip to 8% compared to 10% in last year.

Turning our attention to the income attributable to owners for the 3 months ended August 31, 2024, and net income attributable to owners of $34.9 million was recorded or $1.46 per diluted share compared to $38.9 million or $1.59 per diluted share last year. The decrease is primarily attributable to an impairment charge of $3 million on property, plant and equipment and intangible assets as well as the charge for revaluation of financial liabilities and derivatives recorded at fair value, which compares to a gain on such revaluations last year.

Moving on to look at cash flows. The third quarter generated cash flow from operating activities of $66.4 million compared to $51.5 million in Q3 2023, an increase of $14.9 million mainly attributable to a favorable working capital variance during the quarter and a fluctuation in income taxes received paid year-over-year.

The free cash flow net of lease payments increased to $49.3 million in the quarter compared to $32.1 million in Q3 2023. Regarding liquidity and capital stock resources, as at August 31, 2024, the amount held in cash totaled $51 million, a decrease of $7.9 million since the end of 2023 fiscal period.

During the 3 months ended August 31, 2024, we repurchased and canceled 254,700 shares for $11.4 million through our NCIB and paid $6.7 million in dividends to our shareholders. During the quarter, we repaid $33.9 million of our long-term debt, bringing the total to $85.4 million in the last 12 months. At the end of the second quarter, we had USD 506 million drawn from our revolving credit facility.

Interest on long-term debt decreased by $0.7 million as a result of entering into fixed interest rate swaps, which have resulted in savings of USD 0.6 million or CAD 0.8 billion this quarter.

In early June of this year, we sold our fixed interest rate swap of USD 200 million for a sum of USD 4.8 million or CAD 6.6 million, which will be recognized on a straight-line basis over the period equal to the original hedge date of April 10, 2026.

As mentioned in our subsequent events note, we also entered into 2 more interest swaps in September on CAD 100 million and CAD 50 million at rates of 2.79% and 2.77%, respectively.

Finally, looking ahead, I'd like to note the upcoming quarterly dividend payment of $0.28 per share on November 15, 2024. And with that, I will turn the call back to Eric for a few words before the Q&A session.

[Eric Lefebvre, executive]

Thank you, Renee. As we enter the last quarter of our 2024 fiscal period, MTY remains focused on creating shareholder value from 2 channels. First, we remain committed to produce organic growth in earnings and cash flows by optimizing the assets we have in our portfolio. 2024 is a challenging year from a macroeconomic point of view, but we find ourselves well positioned to realize our objectives in the future.

Our cash flow generation ability has once again been put to the test, and we have delivered. There will always be hurdles like the recent Florida hurricanes, which will impact many households in many of our locations. However, our team is working today to put in place all the ingredients needed to achieve our full potential.

Second, we continue to actively seek new acquisitions to continue the growth trajectory our founder had established. We will remain disciplined in our approach to finding attractive transactions at the right price no matter the size, type of food or geography. The market works in ebbs and flows and MTY intends to be opportunistic when favorable conditions surface. I thank you for your time, and we will now open the lines for questions. Operator?

[Operator]

[Operator Instructions]. The first question today comes from John Zamparo with Scotiabank.

[John Zamparo, analyst]

I wanted to start kind of higher level and just ask about consumer sentiment and your outlook was unchanged versus a quarter ago. But I wonder if you've seen any discernible shift in consumer behavior either on traffic or check size. I know you've got lots of formats and geographies in your network. But wondering if there's anything notable when it comes to behavior in Q3 or subsequent to it now that we're seeing a potential path to lower rates?

[Eric Lefebvre, executive]

Yes. We haven't seen a material shift in the consumer behavior, consumer is still discerning in how the spend their money. So they want the customers expect value the expecting experience, and we need to deliver -- we need to deliver on that. We need to be better than our competitors if we want to gain market share. So nothing has really changed in the past 1 or 2 or 3 quarters. It's more of the same.

[John Zamparo, analyst]

Okay. Understood. And then maybe you could get to a couple of specific brands and start with Cold Stone and Papa Murphy's. Cold Stone seems like continuing to excel, it's nearly your largest banner by system sales now. But you also mentioned the outsized closure number from Papa Murphy's. So can you add some color on net openings and same-store sales for those 2 banners?

[Eric Lefebvre, executive]

Yes. I won't go into the specifics as usual, but just in terms of the specific quarter, Cold Stone performed extremely well. We were unfortunately, bumping against the huge success we had with the Barbie movie association last year. So in terms of comps, it was a little bit more difficult in the third quarter, but still outstanding performance by the brand. And still opening a lot of stores with Cold Stone. So that brand is certainly firing on all cylinders.

In terms of Papa Murphy's, the comps were actually a little bit better this quarter. We're starting to see some traction, and we're still experimenting with certain types of promotions and offers to clients to see what gains traction and what doesn't.

But in terms of comps doing better, but obviously, as I mentioned earlier, in terms of openings and closings, there's still a number of closures. There are certain markets that are a little bit more troubled than others. So we don't see massive closures across the board. We see specific clusters of stores being shut down by their owners. And where we can, we try to save the stores as much as possible, but there are instances where we can't necessarily save the store because we don't have the proper infrastructure to run those stores in those markets where we can't find a new franchisee for them. So unfortunately, that results in some closures.

[John Zamparo, analyst]

Understood. Okay. And then on vessels and the barbecue Holdings acquisitions, you're about 2 years out from these deals that were in late '22. I wonder how you'd characterize the performance of those 2. I know at the time, Wetzel's had pretty ambitious growth targets in terms of net store openings, whereas BBQ had seen net closures. I wonder how you're feeling about the ability to grow these banners in '25?

[Eric Lefebvre, executive]

Yes, Wetzel's doing fantastic comping positive with a lot of store openings and a lot of new stores also being sold. So new stores going into the pipeline. I'm super happy with how the team is integrating into the Kahala team also, where we leverage the size and the depth of talent we have in Kahala to help accelerate the growth at Wetzel's. If anything, we're probably doing a little bit better than we anticipated with Wetzel's.

In terms of BBQ. I think the economic context has changed a little bit. So we're trying to stabilize the brands and the portfolio, some brands are doing better than others. A little bit like MTY, it's a portfolio of multiple brands with offerings.

All in all, it's performing more or less in line with what we expected, maybe a little bit less in terms of comp sales. I think the market is in a place where we could not necessarily anticipate how the consumer with consumer spending would be today 2 years ago.

But all in all, still super happy with the talent we acquired, the brands we acquired in the portfolio. So the team is all hands on deck to try to reverse some of the trends we're seeing. And again, a little bit like with Papa Murphy's, we're starting to see some initiatives gaining traction, and it's really positive for the future.

[John Zamparo, analyst]

Okay. That's good color. And then last one for me. On your restructuring efforts. I wonder if this is a cost base that you can maintain moving forward or other efforts you have underway that would see higher OpEx specific to your franchising business and I suppose your retail and processing business, too.

[Eric Lefebvre, executive]

Yes. Yes. Everything we're doing now is not something that we're doing for the short term. We're trying to position the company in a place to be aligned with our long-term objectives. So we're certainly not doing the restructuring with a short-term vision where we want to do everything so that we're successful in 3 years and then 5 years from now, trying to position the people where to have the best chance of success in trying to the brands in the best -- under the best leaderships for them to thrive, to help our franchisees be successful as well.

So there's probably a little bit more to go on this restructuring, but it's more or less over at this time. We've done the major changes that we wanted to make. And the rest is going to be mostly the maintenance part. So -- but yes, we're happy with our team. We're happy with where we are now. And I think the restructuring is going to bear fruits in a few years from now.

[Operator]

The next question comes from Vishal Shreedhar with National Bank.

[Vishal Shreedhar, analyst]

In the commentary that you provided, you indicated that organic growth was one of your focus and focus areas. And you seem to express some optimism that the business is gaining traction. Just wondering if you can highlight for us the reasons behind that optimism? And what of your initiatives are tracking well that's underpinning that?

[Eric Lefebvre, executive]

Yes. Well, we've always been confident in our ability to generate organic growth. That was the message I conveyed as soon as I started on the job in 2018 that it was going to be one of the primary objectives. So that hasn't changed. And we were able to deliver, unfortunately, a number of things happened with COVID and different market situations.

There's always going to be some ups and downs, but we think that over a long period of time, we have the brands, the franchisees and the team to be able to generate that organic growth. What we're seeing right now in the company is for the most part, positive. There are brands that are a little bit more trouble. There are brands that are hugely successful.

But all in all, we're happy with where we are. We're happy we're in a good place with everything that we do, and we're seeing a lot of positive for the future. So I can't necessarily point out to one specific item, but the feeling inside the business is that we're doing well. We're producing cash flows. We're delivering on most of what we wanted to deliver and we don't control the macroeconomic environment, but over a long period of time when everything stabilizes, we feel really confident about our ability to generate organic growth.

[Vishal Shreedhar, analyst]

Okay. And in that organic growth question, and I'm sure this has been asked before in different ways, but Cold Stone success, just -- it seems to be building on success year after year. And I know there's been a number of initiatives implemented at Cold Stone over the years that has contributed to that.

But is there something that's unique about that brand where some of those -- some of that momentum can be transferred to the other brands? Or is it just the scale and the operational strength within that, that eventually will be transferred? Or is it the strength of the brand, the category? How should we contemplate that and consider versus the other brands?

[Eric Lefebvre, executive]

Yes. Well, we always talk about Cold Stone because this is one of our larger brands, but there are other brands that are in similar situations with a long track record of success. I wish it was a one-size-fits-all type of solution. It's not. But you look at Cold Stone, we have an incredible product. We have incredible R&D being gone. We have new products all the time. Our marketing group is doing an outstanding job.

We were ahead of our time when we started doing digital with Cold Stone, and we're trying to stay ahead of the curve. We have outstanding PR opportunities like the Barbie movie last year was a really good one. So -- and operations are good. So everything is going in the right direction for that brand, and we put all our efforts also to make sure we don't lose momentum. And that can certainly be transferred to some other brands.

You look at sweetFrog, for example. SweetFrog, especially in Q2 and Q3 is an important brand for MTY. And the performance has been stellar in terms of same-store sales as well in terms of profitability. There are more brands that are that are successful than just Cold Stone.

And now we're putting Wetzel's under the same leadership, and we believe that Wetzel's can also build momentum on the same build momentum and good years over, good years over good years. So we have a lot of brands in that situation. We talk about Cold Stone, but it's not a unique proposition in our portfolio.

[Vishal Shreedhar, analyst]

And lastly, could you just update us on your acquisition thinking if there's been any incremental changes and how you see the market and the prices?

[Eric Lefebvre, executive]

Yes. Well, I'm sure you've seen what's on the market. There's been a lot of troubled companies that have been on the market recently. So obviously, you look at those and then you look at some other companies as well that are either on the market or just testing whether there's an interest or not. And it's always -- it goes into waves and sometimes the market has higher expectations for the sellers. Sometimes the sellers become more reasonable. And we just need to be opportunistic when that happens.

So MTY is ready to pounce as always. And I think we're in a good place now with our balance sheet and with the cash flow production that we have, and we've shown our resilience once again that we can produce cash flows and more difficult macroeconomic environment.

So we're ready to bounce. We're ready when the market is going to be ready for us. And as always, there are a number of opportunities that are shown to us. They're not always interesting. Sometimes they're not realistic, sometimes they're just not a good fit. But when the time comes, we'll be ready to pounce.

[Operator]

[Operator Instructions] The next question comes from Derek Lessard with TD Cowen.

[Derek Lessard, analyst]

Eric, I just wanted to maybe hit on the margin side of the EBITDA equation. Obviously, great performance there, but it has bounced around quite a bit. So I guess, number one, I was wondering if you can maybe just talk about the sustainability of those margins in the U.S. and Canada? And second, more specifically, just maybe wondering if you could address the lower labor costs and the much lower controllable expenses in the U.S.?

[Eric Lefebvre, executive]

Yes. Well, they go hand in hand. So in terms of the margins, they do bounce around. There are a number of items that impact our margins. The seasonality of our business obviously is one. As you know, our business is a little bit seasonal. Our cost basis for the most part, fixed because it's mostly labor. And this is -- we don't change our labor depending on the season.

So I would say, yes, on this seemingly adjusted basis, margins are certainly sustainable. They're in the right place. If anything, I think there's probably still room for some improvement.

And in terms of our costs. I don't see what's not sustainable on the structure at the moment. So I feel pretty confident that we can maintain that cost structure.

[Derek Lessard, analyst]

Okay. And you did sort of note in the -- well, you did note in the MD&A, you discontinue the rejuvenation program. Is that temporary or maybe some of the reasons or some of the reasons why you would have stopped that?

[Eric Lefebvre, executive]

Yes. We stopped the rejuvenation, I'll say, probably over 2 years ago. So that was just a decision where we felt the network was in a good place, and we can -- we still work with our franchisees to try to help them renovate their stores. We don't necessarily have a subsidy program in place to renovate the stores, but we do try to encourage our franchisees via different methods, different brands will have different processes to do that.

But we just chose to stop subsidizing the rejuvenation for the stores. And we haven't necessarily seen a slowdown in the pace of renovations for franchisees. So it shows to me that our alternative ways for us to get to where we want without necessarily having to take out our checkbook.

[Derek Lessard, analyst]

Okay. And on the ERP, you've spent, I guess, year-to-date about $1 million, and I think you've guided about $7 million to $10 million. Just wondering how we should be modeling the balance of those expenses going forward? And I guess when do you expect to see or start seeing some of those ERP benefits?

[Renée St-Onge, executive]

John, it's Renee. The ERP, we're expecting to see some of the benefits starting in March right now. We have an expected go live for one of our divisions. In March, we actually already launched our budgeting 2 years ago, and that went extremely well. So we were really happy about that. And we're launching our CRM now actually. So hopefully, that will be a success. But so far, everything is going well.

As for the future of costs, as Eric mentioned in past quarters, our budget is not something of great scale compared to other companies. We expect it to fall between $7 million to $10 million. And right now, we're faring really well. We're still on budget to hit our time line and our budget. So we're really happy.

[Derek Lessard, analyst]

So we should still expect $7 million to $10 million overall.

[Renée St-Onge, executive]

Yes. Yes. That was always our expected total budget. We've capitalized so far about $2 million with about $800,000 hitting our P&L.

[Derek Lessard, analyst]

Okay. And so I guess that would be my follow-up question is how much do you expect to capitalize versus expense of that $7 million to $10 million?

[Renée St-Onge, executive]

Yes. With cloud technology is always a bit tricky. There's a very specific accounting guidelines regarding anything that goes on the cloud, but we're expecting to capitalize between 60% to 70% of that.

[Operator]

[Operator Instructions] There appear to be no further questions, which concludes our question-and-answer session and also concludes our conference call.

Thank you for attending today's presentation. You may now disconnect.