MTY Food Group Inc

TSX:MTY

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the MTY Food Group Inc.'s Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions] Before turning the meeting over to management, please be advised that 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 anticipated. I would like to remind everyone that this conference call is being recorded today, Friday, February 15, 2019. I will now turn the conference over to Eric Lefebvre, Chief Executive Officer. Please go ahead, sir.

[Eric Lefebvre, CEO & Director]

Good morning, ladies and gentlemen. Thank you for joining me for MTY's Fourth Quarter and Year-end Conference Call. Today, we will discuss the financial and operating results of the company for the fourth quarter ended November 30, 2018. [Foreign Language] Press release reporting fourth quarter and year-end results was published earlier this morning and also can be found on our website and at -- on SEDAR. Before I begin, let me remind you that all figures expressed on today's call are in Canadian dollars unless otherwise stated. And please be aware that we will refer to certain indicators that are non-IFRS measures, and you can refer to our MD&A for more details.So let's start with a brief overview of our network. We finished the year with 5,984 locations. During the fourth quarter, we acquired the 331 locations of sweetFrog Premium Frozen yogurt, and we opened 68 locations and closed 105 for a net increase of 294. Most of the closures during the quarter came from sandwich and coffee categories, which experienced net reduction of 34 locations. The openings were spread across all categories, Cold Stone leading the way with 13. For the full year, we acquired 702 locations via 5 transactions, opened 269 locations and closed 456 for a net positive of 515 locations. Our network sales grew by 21% to reach a historical high of $2.8 billion. The growth of our network locations and sales went -- was entirely driven by acquisitions. Network sales for the fourth quarter were up 30% to $707 million. The growth is primarily attributable to recent acquisitions, although organic growth was marginally positive for the first time in 5 quarters. Canadian same-store sales were up slightly, making this the fifth consecutive quarter of positive growth. Most of our territories showed positive results with the exception of Saskatchewan, which remains under significant pressure; and Québec, which experienced its first decline after a series of positive periods. The sales in the United States declined by 1.9%, primarily driven by the markets of California, Arizona, Maryland and Oregon. California was negatively impacted by extreme weather, including major forest fires, which disrupted operations for a large part of the state for an extended period of time. Given the weight of California on the U.S. portion of MTY's network, the negative results in the quarter have translated into negative performance for the United States as a whole. The stores located outside North America experienced a decline of same-store sales of 8.9%, and most of the decline is attributable to our stores in the Middle East, which are suffering from rapidly declining economies and trade sanctions on certain countries in which our stores are located. Finally, same-store sales from Imvescor restaurants, which are not included in the consolidated same-store sales, grew by 1.9% in the fourth quarter, led by Ben & Florentine, Mikes and Scores.Now let's turn to MTY's financial results. Before I comment on the results, I would like to remind you of the impact of seasonality on MTY's results. Typically, the first and fourth quarter sales are slower than average while the sales in the second and third quarters are strongest given the number of locations operating in the ice cream and frozen treats categories, which have represented over 28% of our sales during 2018 and has a direct correlation with our EBITDA since most of our cost base is fixed. Our revenues for the fourth quarter increased 56% to $108.5 million, and the cost of sales and operating expenses increased by 79%, both mainly driven by the acquisitions of Imvescor Restaurant Group in Canada and The Counter Custom Burgers in the U.S. As a result, EBITDA increased 20% to $32.7 million compared to $27.2 million for the same period last year. Our EBITDA margins have declined from 39% last year to 30% this year. The decline in margins is mainly caused by a change in the accounting presentation of our retail revenues and expenses, which are now presented gross instead of net as they had been presented in the past. With the growing amount of such revenues, we have decided that this is a more accurate way to present the information to investors. There was a true-up in those numbers for Q2 and Q3 retail revenues and expenses, which caused a 4% drop in the margin.The net income attributable to shareholders decreased by 33% for the fourth quarter to $12.9 million or $0.34 a share when compared to $19.4 million or $0.91 per share for the same period last year. The decrease is due to a net impairment charge increase of $4.5 million in 2018, coupled with 2 nonrecurring items that impacted 2017 favorably: a $3.4 million gift card retroactive catch-up adjustment and a $1.9 million lease termination gain. Those figures are all before tax. After tax, they combine for a net unfavorable variance of $7.2 million this year. Turning now to liquidity and capital resources. In 2018, MTY generated cash flows from operating activities of $97.6 million compared to $93.5 million last year. Excluding the variation in noncash working capital items, income taxes and interest paid, operations generated $129 million in cash flows compared to $96.6 million in 2017. This increase was primarily driven by higher EBITDA, which was partially offset by higher working capital requirements. During fiscal 2018, our capital was primarily allocated to acquisitions and payments of dividends to shareholders, for which we disbursed $123.2 million and $14.5 million, respectively. MTY concluded fiscal 2018 with a healthy a financial position. As at November 30, 2018, MTY had $32.3 million of cash on hand and long-term debt of $275.6 million in the form of holdbacks on acquisition and bank facilities. Considering the EBITDA of $127.7 million and cash flows from operations of $97.6 million realized during the year, we consider our current debt level very comfortable. With the increase of our -- in our revolving credit facility to $500 million, we have ample access to capital to grow MTY further. Finally, on January 21, the Board of Directors of MTY approved an increase of its quarterly dividend of 10% to $0.165 per common share on a quarterly basis. This increase represents the seventh increase since our first dividend was declared in 2010. This increase further demonstrates not only our confidence in our ability to generate solid cash flows in the future but also our confidence in our brands and our franchisee network. I will now be pleased to answer any questions you may have.

[Operator]

[Operator Instructions] Your first question comes from the line of George Doumet from Scotiabank.

[George Doumet, Analyst]

I'd like to focus a little bit on the weakness in the U.S. I think, last quarter, we had some trouble pinpointing some of the factors behind that. I guess other than Mother Nature’s forces, can you maybe call out anything you're seeing on our key markets of California, Maryland, Arizona?

[Eric Lefebvre, CEO & Director]

Yes. Well, there's -- obviously, there's a lot of competition in those markets, and some of our competitors are doing really, really well. So we have to be on top of our game. Obviously, nature is always easy to blame, and it's a factor that's hard to measure, but there's other factors. And there's a brands that we acquired in the past -- and I'll name, Pinkberry and Baja, for example, where there has been some struggles, I would say, since the acquisition. And we're relaunching these brands, and we're hoping that we're going to get strong performance from these brands in the future. And they're still some of our top brands in terms of development, but same-store sales have been relatively sluggish for the past year or so.

[George Doumet, Analyst]

Okay. And shifting over to Canada. Some acceleration, I guess, in the comps compared to last quarter. I think you did call out Québec as being the first weak comp in a while. Can you maybe talk a little bit about what happened there?

[Eric Lefebvre, CEO & Director]

Yes. I think it's a little bit too premature to draw conclusions from 1 quarter. Performance in December wasn't bad for Québec, so we'll wait to see if we have more struggles in the coming months before we draw conclusions on 1 quarter. As you know, there's a lot of factors that are impacting same-store sales, whether it's the position of statutory holidays or the timing of snowfalls or the cold or whatever and the competitive activity. So I'd rather wait for a quarter or 2 before I can draw conclusions. And my hope is that we'll be back to our normal growth in Québec in the next quarters.

[George Doumet, Analyst]

Okay, that's helpful. And just one last one, if I may. On IRG, there's an improvement -- pretty good improvement from last quarter, and your MD&A calls out like a pickup in ribs and steaks at Bâton Rouge; some, I guess, normalized weather compared to last quarter. But is there anything else that you'd like to call out in some of those banners that are just performing better than expected? Or is this just the pickup in those sales?

[Eric Lefebvre, CEO & Director]

No, they're not performing better than expected. They're performing as we expected them to, yes. And that pretty much confirms that we shouldn't draw conclusions on 1 quarter. Last quarter was a little bit slower, and this quarter is a little bit better. We're not out of the woods for some of our brands, and we need to keep the effort on the ones that are successful at the moment. But yes, those brands are fantastic. We have some really good brands in our hands, and we need to make sure we maintain the current performance and then improve on it, if we can. But it's certainly a lot easier to have good momentum when the brands are successful, and it's easier to keep the pace than trying to turn around something that's struggling.

[Operator]

Your next question comes from the line of Daniela Campo from Macquarie Capital.

[Daniela Campo, Analyst]

So my first question is regarding same-store sales growth, so can you break down what drove the flat same-store sales growth in Canada. It seems like Ontario, Alberta and British Columbia were all positive while Saskatchewan was weak. However, Saskatchewan is quite small. So what else is offsetting the positive growth in those 3 big provinces?

[Eric Lefebvre, CEO & Director]

Yes. Well, I would say that the positive growth is not as positive as it was in previous quarters. So there was a little bit less in terms of same-store sales there. And as we mentioned before, Québec was weaker than the previous quarters and Québec was negative. So Québec being one of the biggest territories we have in Canada, if Québec is negative, it affects the entire overall performance.

[Daniela Campo, Analyst]

Got it. That makes sense. Then, my second question. In regards to IFRS 16, can you talk about how it will impact your financial statements? And how should we think about our forecasting going forward?

[Eric Lefebvre, CEO & Director]

Yes. 16 is -- it's a little bit too early for us to start quantifying the impact of IFRS 16. We know the impact will be very material on our financial statements, both from a P&L and a balance sheet point of view, but it's a little bit early for us to draw exact conclusions on it. We're at the beginning of the process, trying to evaluate the impacts and trying also to come up with the math, which is proving to be extremely time consuming and extremely tedious. So it's a little bit early, but all I can say is that the impact will be very material.

[Daniela Campo, Analyst]

Okay, perfect. And then my third question is regarding delivery. We read a lot about growth in delivery among various brands, and we know that Scores, for example, is a brand where delivery is very important. Can you discuss some of the other brands in the portfolio where you're seeing the most significant impact from deliveries?

[Eric Lefebvre, CEO & Director]

Yes, for sure. And all the brands that has started delivery with some form of intensity have seen some pretty interesting spikes in their sales. I'll mention Mucho Burrito where we have introduced SkipTheDishes for the vast majority of our restaurants, and we've seen a good lift in sales. Whether those sales are incremental or not, it's hard to measure, but there's certainly a good lift in sales from those. We have introduced delivery for most of our brands now. Some brands are more -- are closer to having 100% of the network than others. But even in the U.S., we're delivering ice cream now. And I wouldn't think that ice cream would be a deliverable product, but it's proving to be very successful. So hopefully, in the summer, when we reach the peak season, we're going to see some good lifts there as well.

[Daniela Campo, Analyst]

Perfect. And I guess I'll sneak one last one since you did mention SkipTheDishes. Are you seeing an uptick in third-party delivery services? And how are you managing profitability with these services?

[Eric Lefebvre, CEO & Director]

Yes, that's the big question. We are with various providers. I mentioned Skip, but we have contracts with other providers as well. It's -- yes. So we are seeing a lift in sales, and I think as long as the sales are incremental or at least the vast majority of those sales that were generating from these platforms are incremental, the economic model will work. The day we start selling to customers that would otherwise come to the store, I think that's where we're going to have to ask ourselves questions because the fees that are related to delivery will have an impact on our franchisee's margins, and then the business model will have to shift one way or another. So we're not there yet. What we're seeing at the moment is mostly incremental sales, and it's proving to be very positive. And I don't know how long that's going to last until we have to start thinking about the shift in our business model.

[Operator]

[Operator Instructions] Your next question comes from the line of Elizabeth Johnston from Laurentian Bank Securities.

[Elizabeth Johnston, Analyst]

Just in terms of M&A, do you think there's an opportunity when it comes to, I guess, in the U.S. specifically, to try to add acquisitions that are not in the frozen treats category? Is that something that you thought about doing? Or do you really prefer to be more opportunistic? Any thoughts around that strategy?

[Eric Lefebvre, CEO & Director]

Yes. We're -- yes, that's a good question. And I think it just happened this way for us that we're so focused on frozen treats. But we are looking at various other opportunities in the U.S., and there are ways for us to try to improve and diversify our portfolio. We acquired this year The Counter Custom Burgers, which was one example of our focus to try to acquire something else. We also acquired Grabbagreen. But you're right, there needs to be some form of diversification in our portfolio. And we're very opportunistic, and we're very agnostic when it comes to the type of food that we're acquiring, and it happened that we had more opportunities in the frozen treats category for now. But you're absolutely right that there's certainly -- with over 1/4 of our sales being in frozen treats, there's certainly a way for us to diversify away from it.

[Elizabeth Johnston, Analyst]

And when it comes to geographic representation, again, in the U.S., specifically, is it possible that you could look to -- even within frozen treats, if you were to add locations or additional banners more in the Central U.S., would that help with some of the diversification? Or do you feel that the best diversification still would be to go outside of the frozen treats category?

[Eric Lefebvre, CEO & Director]

No, we're also agnostic when it comes to the geographical region. We acquired sweetFrog, which is mainly on the East Coast. That was a fourth quarter acquisition. It happened that California was big for us. It's also a big territory, and it's also an important one to cover for us. But if we have opportunities in California or somewhere else, if the opportunities are good, we'll go for it.

[Elizabeth Johnston, Analyst]

Okay, great. And just in terms of the impairment taken in this quarter specifically, any additional color you could provide with respect to what exactly that was in Canada and in the U.S.?

[Eric Lefebvre, CEO & Director]

Yes. The brands are all U.S. They're brands we acquired with Kahala, and they are smaller brands that we have acquired. And it's a reassessment of our performance. Unfortunately, some brands are performing a lot better than we thought, and we can't increase the value of those brands. And the brands that are performing a little bit less than our forecast, we have to take an impairment. So overall, it's still a very positive acquisition even though it looks bad from the impairment standpoint. But it's -- we have impaired for smaller brands, and we have also impaired some corporate stores. As you know, we've impaired the Tosto stores last quarter, and we have impaired 1 corporate store that we built this year. We've impaired it in Q4 also for about $0.5 million. So there's a few brands that are impacted, and there's a few other brands that are still on the bubble. So I'm not saying there won't be an impairment next year. It depends on how the brands perform.

[Elizabeth Johnston, Analyst]

And some of those smaller brands that aren't performing as well, do you see an opportunity to potentially divest those brands? Not to say they'd be any better in someone else's hands, but then at least you wouldn't have those impairments on your books. Is that something you consider as a divestiture?

[Eric Lefebvre, CEO & Director]

Yes. Well, everything is for sale if the price is right, so I'm not going to close the door on it. This is not something we've done traditionally, selling brands, and it's certainly not something we're trying to do. We're not actively seeking buyers for some of our brands. But yes, if somebody comes up and says that "We'd like to acquire X brand and give you X amount of money for it," we'd consider it, and that's for all our brands. Whether we love them or not, there's a price to everything.

[Operator]

[Operator Instructions] Your next question comes from the line of Derek Lessard from TD Securities.

[Derek J. Lessard, Research Analyst]

I was just wondering -- you had mentioned about the relaunching of Pinkberry and Baja. When do you expect to relaunch those brands?

[Eric Lefebvre, CEO & Director]

Yes. Well, relaunching might not have been the best choice of words. I would say probably changing the trajectory on certain initiatives that we're taking. Pinkberry is actually doing fantastic. Where it's doing great, it is really doing great. The -- I think the stores, the designs are very relevant. The products are very relevant. Pinkberry, we're talking about a brand that we acquired that was really troubled, and we acquired this brand after 2 or 3 years of not having any advertising done, no contributions to the advertising fund. So it's hard to gain the momentum again from the marketing initiatives that we're doing. So I think, this year, we're bringing some new ideas to the table that will help generate positive same-store sales. As I said, the product is amazing, and the store designs are very relevant. I think the brand is still very strong in the U.S., and it's one of the brands that we're seeing good development potential for. We've opened a lot of stores for Pinkberry, and I still see it for the future. So relaunching might not have been the right choice of word. For Baja Fresh, a slightly different situation. Again, it's a brand that we acquired. It was declining rapidly when we acquired it in late 2016. And it's -- we're trying to turn the tide on it. So there's a renovation program that's in place for the franchisees that's very similar to the rejuvenation plan that we have at Imvescor, and we're trying to renovate our stores and be as relevant as possible for the consumers. We are also developing Baja Fresh pretty aggressively. We reintroduced the brand in the Phoenix market, and the stores are very successful. The customers are very happy with the stores, the food, the design and everything. So it's just a matter of trying to refresh our stores and give some new energy to the brands. So relaunching, again, might not have been the right choice of words.

[Derek J. Lessard, Research Analyst]

So Baja, like how far along are you in the rejuvenation process?

[Eric Lefebvre, CEO & Director]

Yes. We're at the beginning. I'm not going to lie to you. We're at the beginning. We have renovated a certain number of stores, but there are more stores that need to be renovated. And I think that's going to go a long way for us to achieve better performance in the future. Unfortunately, the renovation is possible only if you have term on your lease, if the franchisee is willing to do it and has trust in the franchisor that this is going to help sales and that the franchisor is going to support them in the future. And it takes time to gain that trust and go with the franchisees and reinvest in the stores. So it's a process that's going to happen over a few years. But the brand is still very well received by the customers, and I think it answers a need in the market where you might not have much direct competition to the brand. And we're predominantly in California but also in other parts of the U.S.

[Derek J. Lessard, Research Analyst]

Maybe just to touch back on to the U.S. same-store sales. Could you rank the headwinds in order of magnitude, whether it's the forest fires, competition or operationally?

[Eric Lefebvre, CEO & Director]

Yes. I wish I had a good accurate measure for all these factors. There's hundreds of factors that play into same-store sales, and it's really hard to measure one at the expense of others. But for sure, weather is a big impact. It was a very cool fall in California and other parts of the U.S. The forest fires certainly made a huge impact where you have stores in regions that are evacuated or that are filled with smoke, so it does play into our sales. Tourism was down massively during those periods. The locals were not really spending in restaurants. So it does play a role. And I would say weather is probably the one that has the highest correlation of all the factors, and we're seeing it again. If you look at the month of November, it was pretty snowy in the Northern U.S. and even in Eastern Canada, for that matter. We are seeing the extreme cold conditions now in January and February that we've seen in some parts of the U.S. Those are all impacting our sales for sure. But I'm hopeful that as we get through February and March, last year, those were not very good weather-wise. So hopefully, this year, we'll comp with better weather and we'll have better results to show for those months.

[Derek J. Lessard, Research Analyst]

Okay. And maybe a few more for me. Can you maybe just explain what was driving the weakness in Québec? I don't know if you have a good answer for that.

[Eric Lefebvre, CEO & Director]

No. I wish I had one, but I don't. I want to wait for at least a quarter or 2 before we draw conclusions. I'm hopeful that the weakness was caused by external factors and that our initiatives that we have and the hard work that the teams are putting to each of the brands and to each of the stores, that the positive same-store sales will come back, hopefully, in Q1 and Q2. We don't have numbers yet, but hopefully, it was just a short passage of negative.

[Derek J. Lessard, Research Analyst]

And maybe just to follow up that -- on that. Maybe could you just update us on your growth-from-within initiative, where you're at with that initiative? And are you seeing some initial positives?

[Eric Lefebvre, CEO & Director]

Yes. Well, it's going to be a process. It's not going to happen overnight. There's certain initiatives that we are taking internally that will start paying off this year. But I think, for the most part, it's going to happen over 1 or 2 or 3 years even. So hopefully, we will be able to reap some of the harvest this year, but it's a process. But yes, we are putting everything in place. So I'm happy with where we're at, at the moment. We are doing certain things that we haven't done in the past. And hopefully -- some of it hurts in the short term because we're taking initiatives that are a little bit more drastic with some of our brands, but hopefully, they're going to pay off in the long run.

[Operator]

There are no further questions at this time. Mr. Lefebvre, I turn the call back over to you.

[Eric Lefebvre, CEO & Director]

Well, thank you for joining me on this call. I look forward to speaking with you again at our next quarterly call. Thank you.

[Operator]

This concludes today's conference call. You may now disconnect.