MTY Food Group Inc

TSX:MTY

Earnings Call Transcript 2022-Q4

[Operator]

Good morning, ladies and gentlemen. Welcome to the MTY Food Group Inc. Q4 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. [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, Thursday, February 16, 2023.

And I would like to turn the call over to Eric Lefebvre, Chief Executive Officer. Please go ahead.

[Eric Lefebvre, Chief Executive Officer]

Thank you. Good morning, everyone. Thank you for joining us for MTY's fourth quarter conference call for fiscal 2022. 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. I also remind you that all figures presented on today's call are in Canadian dollars unless otherwise stated.

We're extremely proud of the results realized during fiscal 2022. During the year, we generated organic and acquisition growth to deliver record normalized adjusted EBITDA of over $187 million, while system sales exceeded $4 billion for the first time in MTY's history. Our operations generated cash flows of $143 million, or $5.84 per diluted shares.

All those highlights were generated during a year marked by numerous challenges, including COVID-related restrictions at the beginning of the year, labor and supply chain constraints, inflationary pressure and uncertain market conditions. Needless to say our team and franchisees have shown extraordinary resilience, creativity and dedication.

We continued our growth momentum in the fourth quarter, with both normalized adjusted EBITDA and system sales increasing 25% year-over-year to $53.5 million and $1.2 billion respectively. During the year, we closed two acquisitions, Küto Comptoir à Tartares early in the fiscal year and Barbecue Holdings in late September.

The Barbecue division therefore contributed only two months toward 2022 results. Although the full impact of the Barbecue transaction will only be measured during 2023. It's contribution to MTY's results was meaningful in the fourth quarter.

Excluding the impact of acquisitions and the impact of changes in foreign exchange rates, system sales grew 10% organically, while organic growth and normalized adjusted EBITDA was 9% in fiscal 2022. For the fourth quarter specifically organic growth and system sales and normalized adjusted EBITDA were respectively 4% and 9%.

Digital sales continued their progression growing 8% year-over-year to $208.5 million in the fourth quarter. Digital sales which includes mostly takeout orders and delivery sales benefited from the company's increased investments in online ordering and third-party delivery options in the past year.

In 2023, we intend to further raise our game [ph] by dedicating additional resources to further improving our guests overall digital experiences ranging from our websites to online ordering and to every possible way in which we interact with our existing and prospective customers electronically.

Moving onto our network. MTY completed the fiscal year with 6,788 locations, of which 6,589 were franchise or under operator agreements and the remaining 199 locations were operated by the company. 56% of our locations are based in the U.S., 37% in Canada and 7% International.

The Wetzel’s Pretzels deal, which closed December 8, as over 350 locations to MTY's network across 25 states in the U.S., Panama, and Canada. Sauce Pizza and Wine, which closed on December 15 is a smaller concept with 13 corporate-owned locations in Arizona. It's expected to be a creative immediately and offers good franchising potential in the medium and long-term.

With our three latest acquisitions, MTY's network has over 7,100 locations of which approximately 96.5% are franchised and 3.5% are corporately owned. This is slightly higher than MTY's historical average, but given the performance of the newly acquired locations in the infrastructure in place to operate them successfully, we do not intend on liquidating our portfolio of corporate stores.

However, we also do not intend on adding significantly to that number as we remain a franchisor at heart. Looking ahead to fiscal 2023, we expect a major lift in sales and profitability for Barbecue Holdings, Wetzel’s Pretzels and Sauce, Pizza and Wine.

In terms of capital allocation, MTY's priority remains to acquire quality brands and further expand its network. As such bang down some of our debt to build capacity for future deals is also a priority. The proportion of free cash flow distributed as a dividend is expected to remain within its historical range.

I will now turn the call over to Renée, who will discuss MTY's financial results in greater details.

[Renée St-Onge, Chief Financial Officer]

Thank you, Eric, and good morning everyone. As previously mentioned by Eric, MTY delivered amazing normalize adjusted EBITDA of $53.5 million in the fourth quarter of 2022, which excludes $3.6 million in acquisition related expenses related to the acquisition of Barbecue Holdings and Wetzel’s Pretzels.

Most of the improvement came from the corporate store segment in the U.S., as well as the processing distribution and retail segment in Canada. Excluding the acquisition of Küto Comptoir à Tartares, the Canadian segment realized an impressive organic normalized adjusted EBITDA growth of 27%.

In the U.S. and international segments, normalized adjusted EBITDA increased by $7.8 million, mainly due to the acquisition of Barbecue Holdings, which generated $5 million in normalized adjusted EBITDA. This level of profitability for Barbecue Holdings is highly encouraging, given us representative two months contribution in a seasonally soft quarter for this portfolio of brands.

The additional weight of corporate locations arising from the acquisition of Barbecue Holdings caused the fourth quarter consolidated normalized adjusted EBITDA margins to decrease from 29% to 22%. The newly added corporate location fueled the corporate location segments, which went from a loss in the fourth quarter of 2021 to a $7.4 million profit in 2022 with a normalized adjusted EBITDA margin of 9%.

The processing, distribution and retail segment, has margins increased from 11% to 16%, While the franchising segment saw a drop from 55% to 44%, year-over-year, the decrease in the franchising segment margin is mostly due to the higher expected credit loss provisions taken on leases receivable, as well as higher amount of low margin revenues generated such as turnkeys and sale of various supplies, equipment and materials to franchisees.

And terms of net income attributable to owners, it amounts to $7.1 million or $0.29 per diluted share in the fourth quarter compared to $24.9 million or $1 per diluted share in the same period last year. The decrease in both cases was mainly due to acquisition costs higher non-cash impairment charges on intangible assets, as well as higher interest paid on long-term debt.

Company revenue grew 65% year-over-year to $242 million in the fourth quarter, mainly driven by the Barbecue Holdings acquisition. The two months impact following the deal delivered growth for franchise operations and corporate restaurants of $4.3 million and $67.6 million respectively, in the U.S. and international segment. In Canada franchise operations and food processing, distribution and retail were the major revenue contributors with year-over-year growth of 25% and 22% respectively.

Turning to liquidity and capital resources, cash flow from operations totaled $35.5 million in the fourth quarter of 2022 compared to $31.9 million in the fourth quarter of 2021. The increase of 11% and operating cash flow stems mostly from the strong adjusted EBITDA we generated during the quarter.

Free cash flows amounted to $32.9 million or $1.34 per diluted share in the fourth quarter, compared to $35.6 million or $1.44 per diluted share in the same period last year. The decrease in free cash flows is due to the sale of two portfolio of Papa Murphy's corporate owned locations in 2021.

In the fourth quarter, we reimbursed $23.9 million of long-term debt and paid $5.1 million in dividends to shareholders. For the full fiscal year, we paid $80.2 million in long-term debt and $20.5 million in dividends to shareholders. We also repurchase 256,400 in shares for $14.6 under our NCIB program in fiscal 2022.

Following the year end, we raise our dividend by 19% to $0.25 per share. This marked our 10th increase since we first declared a dividend in November 2010. At the end of the fiscal year, MTY had a healthy cash position of $59.5 million and long-term debt of $561 million, mainly in the form of bank facilities and promissory notes on acquisition.

During the fourth quarter, we raised our revolving credit facility to $900 million in anticipation for the acquisition of Wetzel’s Pretzels. The additional capacity also gives MTY added flexibility for future acquisitions.

Following the acquisition, we anticipate the debt-to-normalize adjusted EBITDA ratio will fall between 3 and 3.5 times EBITDA, which is around the comfort level we have communicated in the past. Given MTY's cash flow generation ability, the current leverage does not impair the possibility of realizing more acquisitions in the future.

And with that, I thank you for your time, and we will now open the line for questions operator?

[Operator]

Thank you, ladies and gentlemen, we will now begin the question and answer session. [Operator Instructions] Your first question comes from John Zamparo from CIBC. Please go ahead.

[John Zamparo, CIBC]

Thanks. Good morning, I wanted to ask about the integration of your two large recent acquisitions. Is there anything you've learned as you've now run those banners, at least for a short period of time. Is there anything you've learned about those banners that you can share about potential for accelerating growth, either same-store or unit or margin expansion?

[Eric Lefebvre, Chief Executive Officer]

Yes. Well, in terms of integration, it's going extremely well. We have two teams that are completely engaged and really wanting to work with the rest of MTY doing exactly what you mentioned is, which is accelerating growth, and improving profitability for our franchisees and for the company, so it's going extremely well. In both cases, we're really happy with what we're seeing. So, in terms of growth plans, and everything, they remain intact, we're trying to accelerate. The plans, we're not necessarily changing the plans. But if we can push and help to accelerate everything, and we will. So we have a number of initiatives that we're working on. Nothing we can announce at this point yet. But there are a lot of things that we're working on that we feel are very promising for the future in both cases.

[John Zamparo, CIBC]

Okay. And on BBQ, is it fair to assume there's no change in plan on potential refranchising of your corporate stores, not in their portfolio?

[Eric Lefebvre, Chief Executive Officer]

Yes, that's correct. The corporate store portfolio is really well run. We have a good team of corporate store performance, people that really manage the corporate stores. They're among the best stores we have in a network and that's what we want to do. If we have a corporate store, it should be run as the example, and these stores are run really well. We have the infrastructure in place to run them. So, the profitability we derived from those restaurants is really something we don't want to park [ph] with. So, although we don't intend on building more corporate stores, or necessarily requiring a large number of corporate stores in the future, we also don't necessarily want to park with the portfolio. There might be stores here and there that we might sell if geographically it doesn't make sense for us, because it's a little bit harder to operate, but other than that, we'll probably keep the portfolio intact

[John Zamparo, CIBC]

Okay, understood. You mentioned franchisee profitability. I know there's a lot of puts and takes on this. But any measurement you can give or even just qualitatively on overall franchisee profitability in 2022 compared to either 2021 or pre pandemic?

[Eric Lefebvre, Chief Executive Officer]

Yes. Well, obviously, for franchisees, especially in certain areas, and maybe certain brands more than others, obviously, with the number of brands we have, they're not all affected the same way. But there is inflation on cost, whether it's labor, food or packaging. There's also a shift in the way kinds of consumers go about the business and delivery orders for example, that could drain on our profitability. So, we have regular discussions with our franchisees, for the most part we have access to their P&L as well and we try to work with them to improve profitability as much as possible.

The good news is, so far we've been able to adjust prices to offset the increase in costs that we're going through, and the customers are accepting the price increases. But, it's not easy. We need to react fast. The cost increases happened a lot faster than they used to happen. And it's a little bit more complicated in that type of environment. But that being said, we're a nimble team. We're all entrepreneurs. And we're reacting fast. So, to what we're seeing now is that for the vast majority of our franchisees, the profitability is very satisfactory. And obviously, there are exceptions to that, but -- and for the vast majority of the network, the profitability is good. And the customers are taking the price increases relatively well. So, no impact on traffic for the moment.

[John Zamparo, CIBC]

Okay. That's helpful. Thanks. Just a couple more. One is on closures. It was relatively high this quarter. I don't imagine you're going to guide us on this. But I wonder if you feel confident that closures will decline and 2023 versus 2022?

[Eric Lefebvre, Chief Executive Officer]

Yes. Well, they need to. No, this is certainly not a number we're happy with. We had some better quarters earlier in the year. And then in Q4, the number of closures was lot higher. So, this is not a number we're proud of. This is not a number that we expected to be that high. So obviously, we're addressing the situation with our teams. And we make it a priority to focus on our existing stores, it's a lot easier to keep an existing store and to open a new one. So we need to preserve the integrity of our network. And that's been a main area of focus for the team. And everybody understands what we need to do to keep those doors open. So, as long as it's a priority, it's communicated. We have conversations with our franchisees also a little bit more regularly to make sure that we understand where they're at. And if we can help them, sell their assets instead of closing their assets, then it's better for both our franchisee and the franchisor. So, but yes, their closures were high in Q4, there's no doubt about it.

[John Zamparo, CIBC]

Okay. Understood. And then my last ones on the food processing segment. I wonder if you can give a sense of how many points of distribution you're in right now and how that's grown? That business is has grown well into double digits for years. And just would like to get some sense of how large you think that business can get over time?

[Eric Lefebvre, Chief Executive Officer]

Yes. The market is huge. So, we're only addressing a very small portion of the network. At the moment, we're predominantly in Eastern Canada. We have some business in the U.S. as well. But the runway for us is huge. So, as you know, this is a more cyclical market, we go up and down depending on the performance of grocers. So, if they generate a lot of traffic it will tend to go better. And if they don't, then it's going to be a little bit softer. But the runway is huge. And this could well become a very, very important. It is a very important segment for MTY, but it could become even bigger as the year go by, and we certainly have aggressive targets for our team.

[John Zamparo, CIBC]

Okay, great. That's all for me. Thank you very much.

[Operator]

Thank you. Your next question comes from George Doumet from Scotiabank. Please go ahead.

[Unidentified Analyst]

Go. Good morning. This is [Indiscernible] calling on George's behalf. Congrats on the quarter. Following up on retail and distribution, it seems to me that you have a high margin here during this quarter. I was wondering if you could provide some color on that and the sustainability of this going forward?

[Eric Lefebvre, Chief Executive Officer]

Yes. These margins always depend on a lot of different things. They depend on the sales mix we have, depending on whether we're selling a certain product to another, the margins will shift. They also depend on the price of commodities. As you know, we can't change the price very rapidly with grocers. So, we tend to absorb a little bit of the price increases or decreases for a certain amount of time. I would say, the margin is probably higher than the normal in Q4. Do we hope we'll be able to repeat it? We do. Is this something that's going to happen every quarter going forward? Probably not. As we increase our revenues, we will continue to absorb the fluctuations of the market. So, where we're going to land? I'm not sure. But this is this is on the high side for sure.

[Unidentified Analyst]

Thank you. Very helpful. Also, can you provide some color on Papa Murphy's performance? How do the comps, how the competition is working around on that part?

[Eric Lefebvre, Chief Executive Officer]

Yes. For Q4, the sales of Papa Murphy's were down low single-digit. We closed a lot of stores also in 2022, unfortunately. So the performance was not exactly where we wanted it to be. But we felt that the curve was softening. And what we're seeing now since the beginning of Q1 is a much better performance from Papa Murphy's. Our sales are up. Our same-store sales, system sales are both up compared to last year. We just had a really good Valentine's Day. So, we're feeling pretty good about where Papa Murphy's is. Q4 was kind of a soft landing. And hopefully now we're past that point and we're on the rise now.

[Unidentified Analyst]

Thank, Eric. It’s helpful. Thank you.

[Operator]

[Operator Instructions] Your next question comes from Derek Lessard From TD Securities. Please go ahead.

[Derek Lessard, TD Securities]

Yes. Echo the congratulations on navigating a difficult year. But just I think you alluded, thanks for the color on the organic system sales growth. I was wondering, Eric, if maybe you could add some color to both in Canada and U.S. around pricing. You did touch on it. But I was wondering if how much of that 4% organic growth is pricing versus traffic?

[Eric Lefebvre, Chief Executive Officer]

Yes. It's hard to quantify, because we, I mean, our systems and the number of different POSs we have, don't allow us to be able to know exactly what pricing versus traffic is. But a good portion of that is certainly in pricing. We did have to increase our price compared to last year and different brands had to increase prices by different amounts. But there is pricing that was taken for every single one of our brands. So a good portion of the increase in sales for the organic increase in sales for the fourth quarter is driven by traffic. Although, we do have much fewer stores than we had Q4 last year, unfortunately. So, the individual stores we have did much better than they did last year. So it's a mixed bag, I would say.

[Derek Lessard, TD Securities]

Okay. You think you're - I know it's a difficult question to ask. But in terms of future pricing, like how well-positioned are you? Or do you think you're going to -- do you need to take more price going forward?

[Eric Lefebvre, Chief Executive Officer]

That's the big question mark. We don't know what the market is going to be like in the future. I wish I had a better crystal ball. But mine doesn't really work that well. So, but we'll need to react to what the market throws at us. If we see a stabilization of the costs for our restaurants, maybe we'll be able to keep the prices intact. But if we see a major rise in our costs, then we'll need to adjust price. If you look at the certain territories in which we operate, we're going to see some pretty massive raises in minimum wage.

And although we're not necessarily paying minimum wage in most of our restaurants anymore, it does have an impact on the salary structure. So in these cases, we'll have to adjust prices slightly. So, we'll see how the market goes for 2023. But we're ready to react. Our teams are prepared. We have all the science behind what we need to increase and when and by how much. So hopefully, the market stabilizes, and we don't need to do it. But if we do need to do it, we'll be ready.

[Derek Lessard, TD Securities]

Okay. And maybe just a follow-up on that. You just alluded to minimum wage increases. What are the, I guess, the -- what are the biggest markets that you're expecting those increases?

[Eric Lefebvre, Chief Executive Officer]

Yes. Well, a few markets already announced their increases. So for example, Quebec, which is an important territory for us, is going to increase on May 1st by a material amount. So that's going to have an impact for sure. And then, we're always watching California. That's also a little bit more unpredictable for California, and we don't know where that territory is going to go, but they might have some influence on the rest of the market. So, we'll be watching those. I would say those are the two main ones that we're watching at the moment.

[Derek Lessard, TD Securities]

Okay. And I'm curious too, given the level of inflation and the price increases, you've had to push through and everybody's had to do it. Were you seeing in terms of promotional or competitive activity overall in your markets?

[Eric Lefebvre, Chief Executive Officer]

It depends for which products. You can tell for example, on Pizza, which is a very competitive market. There tends to be a little bit more extreme value offers in the markets. But for other types of restaurants, we don't see it that much. I think everybody is trying to protect their margins now, the traffic is pretty good in general. So, this is not a time when you need to really go aggressive on the price point to drive traffic. So, there is some promotional competition. Nothing -- that's not normal. So, nothing unexpected there. But I would say, it's a pretty good times in terms of the extreme value offers that might be offered out there in the market.

[Derek Lessard, TD Securities]

Okay. That's helpful. Eric, one last one for me. Just maybe you just talk about the write-down, and I think in the press release, you talked about five brands or five banners. What banners are they or were they?

[Eric Lefebvre, Chief Executive Officer]

Yes. I don't necessarily want to talk specifically about the banners in this case. The impairment charges we had to take are mostly related to the change in the discount rate, not necessarily in the performance of the brands. As you know, the interest rates have been going up and there's been speculation about a potential recession also, which makes our risk premium go up a little bit. So the write-downs are mostly caused by the increase in our cost of capital more than because of the performance of the brands. So in the context, I'd rather not necessarily discuss about the brand specifically, because we do believe those brands are good, and they're not necessarily impaired. But obviously we need to comply with the rules and there are a certain number of parameters that we need to abide by and that's one of them.

[Derek Lessard, TD Securities]

Okay. That's fair and appreciate the color. Thanks, Eric.

[Operator]

Thank you. [Operator Instructions] There are no further questions at this time. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a good day.