Q4 2022 Franchise Group Inc Earnings Call

Speaker 1: Thanks

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Speaker 2: I would now like to hand the call over to your host, Andrew Kaminski, Executive Vice President and Chief Administrative Officer of Franchise Group. Please go ahead.

Speaker 3: Thank you, Gary.

Speaker 3: Good afternoon and thank you for joining our conference call. I'm on the call with Brian Kahn, Franchise Groups President and CEO , and Eric Seaton, Franchise Groups CFO . Before getting started, I'd like to mention that certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Speaker 3: and other provisions of the federal securities laws. These forward-looking statements are based on management's current expectations and are not guarantees of future performance. Actual results could differ materially from those expressed in or implied by the forward-looking statements. The forward-looking statements are made as of the date of this call and accept as required by law. The Federal Securities Group assumes no obligation to update or revise them.

Speaker 3: Investors are cautioned not to place undue reliance on these forward-looking statements.

Speaker 3: For more detailed discussion of these and other risks and uncertainties that could cause franchise groups actual results to differ materially from those Indicated in the forward-looking statements, please see our form 10k for the fiscal year ended December 31st 2022 and other filings we make with the SEC.

Speaker 3: The financial measures today include non-GAAP measures that we believe investors focus on in comparing our results between periods and among our peer companies.

Speaker 3: Please see our earnings release in the News and Events section of our website at franchisegrp.com for reconciliation of non-GAAP financial measures to GAAP measures.

Speaker 3: non-GAAP financial information should not be considered in isolation from, as a substitute for, or superior to GAAP financial information, but we include it because management believes it provides meaningful supplemental information regarding our operating results when assessing our business and is useful to investors for informational and comparative purposes.

Speaker 3: The non-GAAP financial measures the company uses have limitations and may differ from those used by other companies.

Speaker 3: Now I'd like to turn the call over to Brian . Brian ?

Speaker 4: Thank you, Andrew, and good afternoon to our listeners and thank you for joining us.

Speaker 4: I'll provide a general update before turning the call over to Eric to provide financial details. I'd be happy to answer questions.

Speaker 4: Our financial performance in the fourth quarter was in line with the outlook we provided in November . We told you that we were going to move inventory to American Freight, offering value that our customers expect, and we did just that. Comparable transactions in the fourth quarter were down approximately 3% of American Freight, a dramatic improvement from the negative 27%.

Speaker 4: three will be a better year for their financial performance.

Speaker 4: At Badcock, we continue to test third-party waterfall solutions that we believe will provide a better experience for our customers and dealers.

Speaker 4: We've been adjusting tests in our 68 corporate stores for most of the last 12 months before rolling out system-wide to our dealers.

Speaker 4: Importantly, later this week we are introducing a new waterfall test to seven stores owned and operated by one of our trusted dealers. This will be the first time we've moved the test into dealer locations and we intend to transition away from providing in-house credit at Badcock by the end of the second quarter of this year.

Speaker 4: Our franchising activity continued to accelerate across

Speaker 4: We finished the year with 259 new territories sold and a backlog across all brands of 482 locations. We have a substantial organic growth opportunity from converting our large backlog into new

Speaker 4: into new unit openings. And this is a priority for our store teams in 2023. It's controllable by us internally, and we have much to gain as new units open and mature over time.

Speaker 4: As costs of construction materials and labor improve, we believe our franchisees will have an easier time opening stores over the next couple of years compared to the last couple of years.

Speaker 4: Turning to capital allocation, we did not make any material acquisitions in 2022. Instead, we increased our investment in the brands that we own by opportunistically repurchasing approximately 5.9 million shares at an average cost of about $29.13 in the back half of the year.

Speaker 4: The repurchases reduced our outstanding shares by approximately 15%.

Speaker 4: The significant and rapid increase in interest rates has further reduced our discretionary cash flow and increased the bar for capital deployment into outside acquisitions.

Speaker 4: As a recap, for the full year of 2022, when we spoke to you about a year ago, we shared that we expected to produce approximately $450 million of adjusted EBITDA and $5 in non-GAAP earnings per share. Our actual performance fell short of our original expectations as we delivered $354 million of adjusted EBITDA.

Speaker 4: The increase in interest rates cost us about $0.47, and then the unplanned repurchase of shares added approximately $0.15 to non-GAAP earnings per share last year.

Speaker 4: Looking ahead to 2023.

Speaker 4: We believe adjusted EBITDA will be at least $355 million, up slightly from the $354 we reported last year, which included a 53rd week that contributed approximately $11.3 million of our $354 million of adjusted EBITDA last year.

Speaker 4: We expect American Freight to rebound albeit not immediately to its full potential. Pet supplies plus Sylvan and Buddies are likely to grow in 2023 and offsetting...

Speaker 4: EBITDA growth at A4A, PSP, Sylvan & Buddies will likely be a slight decline in vitamin shop EBITDA, driven by continued mix shift in favor of lower margin sports nutrition products, as well as a larger decline in badcox EBITDA as we expect the home furnishings industry as a whole to continue to struggle somewhat until fully landed inventory costs are close to the Ivanka tetexpl microscope. G

Speaker 4: 2022 and the lower share count is expected to benefit the franchise group by about 32 cents as compared to 2022.

Speaker 4: From a balance sheet perspective, earlier this month we closed on a $300 million add-on to our first name term loan.

Speaker 4: After witnessing a year like last year when credit markets were substantially inaccessible, I believe the potentially fleeting opportunity to create additional liquidity in a difficult economic environment outweighed the cost of servicing the incremental term loan. We used all of the net proceeds from the incremental term loan to pay down our able to pay our

Speaker 4: unanticipated use of cash last year. While significant acquisitions are not a priority until we've delivered, in this difficult environment there may be one-off opportunities for small tuck-in acquisitions or franchise conversions that can create step function growth in our franchise unit count and royalty contributions.

Speaker 4: Case in point, today PSP acquired 20 new locations from a competitor in bankruptcy and they expect to sell those stores to existing franchisees in the coming months. All of these locations will be rebranded under the PSP or Wagon Wash banner.

Speaker 4: Eric, I'll turn the call over to you to provide financial details and then we can wrap it up with Q&A. Thanks. Mm.

Speaker 5: Great. Thank you, Brian . Before I address the results of operations, I would like to remind you that we will be making many references to perform items throughout this call. Our press releases and filings may refer to historical financial results for the acquired businesses prior to their acquisition by franchise group.

Speaker 5: These items have been adjusted to align with our fiscal calendar and accounting policies to the extent reasonable. Comparison to pro forma results will allow us to discuss and evaluate performance of the acquired companies when comparable period is not available due to the timing of the acquisitions

Speaker 5: For the fourth quarter of 2022 system wide, Buddy's had a positive store sales comp of 3.3% with franchisee comps growing 4.2% and corporate stores declining 2.5%.

Speaker 5: For 2022, Buddies opened 25 new franchise stores and awarded 39 new locations, growing its backlog to 111 locations.

Speaker 5: Badcock comped down 14.8% for the fourth quarter. During the quarter we sold $51.6 million of Badcock consumer accounts receivable for $43.9 million and sold another $62.6 million in January for $53.2 million.

Speaker 5: The net proceeds were used to pay down our AVL.

Speaker 5: The American freight comped down 12.5% for the quarter in 2022. We sold 23 new franchises bringing total franchise backlog to 36 locations.

Speaker 5: Sylvan completed another consistent year and delivered comps of 1% in the fourth quarter. Sylvan sold 22 new franchises in 2022 and has a backlog of 16 units.

Speaker 5: We believe there's a lot of opportunity in the education market and I recently enhanced the franchise sales team at Silver to accelerate growth.

Speaker 5: TSP continues to execute well in all facets of its business as demonstrated by its continued growth and financial performance. Pet Supplies Plus generated system wide same store sales comps of 5.2% in the fourth quarter. Franchisee comps grouped 6.5% in the quarter while corporate stores grouped 3.5%. TSP continued to accelerate its growth in 2022.

Speaker 5: with the sale of 19 new franchisee locations bringing total backlog at PSP to 230 locations.

Speaker 5: We have sold 37 wagon wash locations and currently have a backlog of 34 stores.

Speaker 5: Vitamin Shop comped positive 0.2% in the fourth quarter. Direct to consumer accounted for approximately 24.8% of the business. In our first year of franchising, we sold 48 stores which built our backlog to 55 stores.

Speaker 5: On a consolidated basis for the fourth quarter of 2022, total reported revenue for franchise group was $1.1 billion. And loss from continued operations was $2.5 billion.

Speaker 5: 0.7 million or 8 cents per fully diluted share. Adjusted EBITDA was $65.3 million and non-GAAP BPS was 47 cents.

Speaker 5: For the fiscal year ended December 31, 2022, total reported revenue for franchise group was $4.4 billion. Net loss from continuing operations was $68.6 million, or $1.96 per fully diluted share. The EBITDA was $354 million and non-GAAP EPS was $3.63 per share.

Speaker 5: I want to reiterate that we are still in the process of transitioning consumer financing at Baticock from in-house to third-party partners and have excluded the non-core results of the finance business from adjusted EBITDA and non-GAAP ETS. While we can perform the income statement for consumer lending, the balance sheet continues to reflect securitization debt and accounts receivable.

Speaker 5: despite most of the receivables having been sold to third parties. Once we discontinue originating customer loans, we believe the securitized receivables will be accounted for as a sale and the related assets and liabilities will no longer be reported on our balance sheet.

Speaker 5: We ended the quarter with approximately $1.1 billion in outstanding term debt and cash of approximately $80.8 million. At the end of the year we had approximately $92.2 million of availability remaining on our ABL Revolver. In conjunction with our balance sheet and business performance, we believe we have sufficient liquidity to continue to move forward.

Speaker 2: Recession.

Speaker 2: To ask a question you may press star then 1 on your telephone keypad. If you are using a speakerphone please pick up your handset before pressing the keys.

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Speaker 2: We ask that you please limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster.

Speaker 2: Our first question is from Larry Solo with CJS Securities. Please go ahead.

Speaker 4: Hi good afternoon guys. Excuse me. I think the first question is just on Pet Supplies Plus. I know one quarter doesn't make a trend but from really accelerating growth through the year strong EBITDA margin was 10% for the quarter. But I know organic growth seems to have grown with its growth.

Speaker 4: mid-tingle digit sounds like this is you know, maybe just driven more by that and just a swell of

Speaker 4: franchisee openings and wagon wash maybe mixed in there maybe just discuss that dynamic and you know sort of that grill driver going forward.

Speaker 4: Sure. Thanks, Larry. PSP has benefited from both...

Speaker 4: consistent top store growth and the additional units. I think as we look at this year, we're forecasting low single digit.

Speaker 4: comp games and the continued opening of new stores, but also the real impact comes from the maturation of doors that opened last year and the year before as they ramp up. You don't get a ton of contribution in the initial year of the openings.

Speaker 4: just looking at you don't come back and find i know you've you know you've drawn out that hundred fifty million you know sort of uh... for the eberdopp potential uh... clearly it's not gonna happen overnight could get you maybe just sort of outline the three things or that the few issues you need to get done

Speaker 6: besides just the improvement on inventory and purchasing to get the business in the right direction and

Speaker 6: how fast could that could we get back to you know 50 to 100 million I mean this year you were basically break even so we're in 22 so I know you said you expect growth in 23 I think we would all hope for that so when you get consistent meaningful EBITDA contributions in 23 or is it gonna take a couple of years and maybe a better a little better economy

Speaker 4: So it was about break even last year but if you actually look at the quarterly cadence you'll see it was negative EBITDA in the back half of the year. So if you think about how things have progressed we've gone from operating negative and we need to get from negative back to break even and then from break even continue that momentum and positive EBITDA on cash flow contribution.

Speaker 4: It's really within our control. But one of those things that we need to control is how quickly we can turn the high cost inventory that we discussed back in November and have...

Speaker 4: continued to have coming in as we've been moving the inventory out, but we still have old orders that are coming in. We need to get through that cycle. I think we did a really good job, a tremendous amount of focus, and the team really focused on moving inventory and that required us to take prices down.

Speaker 4: closer to the value level that the customers have grown to respect from and expect from American freight. But I think that

Speaker 4: As you go through this year, we should be through the cleaning out of the inventory for the most part by mid-year. I do expect a very significant increase in their profitability this year. I don't think it's going to get back to normalized levels, but I do expect that we will see a material increase. That's all I did and that's all I do.

Speaker 4: What are the one or two things that we need to do or that need to happen to get back to a normalized profitability level? It really has to do with being able to have fully landed costs at a level that we can price the product to make the margin that we expect to make.

Speaker 4: but at the same time have the customer find the attractive value that they're expecting from us. And it's getting better, but we're not there. If unit costs, and you've heard me talk about that quite a bit over the last couple of years, if unit costs were up 50%

Speaker 4: from pre-COVID times and you had break costs of 500%, unit costs now have been coming down, break costs have been coming down significantly. So if it was 50%, now maybe we're up 30%. So we're still not back to par, but it's going the right direction. I think that if we...

Speaker 4: had less inventory right now and we were able to convert the inventory we had to cash and flush it through, we could replace the inventory at significantly lower cost than we're even seeing now. But we've been stuffed for a while and we're not going to...

Speaker 4: buy great deals just for the sake of buying great deals. Right, it's just we need to turn our inventory and be able to operate efficiently. That's what franchisees are going to expect and that this is the business that we're going to.

Speaker 4: aggressively open company owned stores, we need to have the infrastructure and the systems in place to be able to handle that growth. So I think we'll be very careful.

Speaker 2: Gotcha. Great. I appreciate all the call. Thanks. Sure. The next question is from Mike Baker with DA Davidson. Please go ahead.

Speaker 2: Mr. Baker, is your phone possibly muted?

Speaker 3: I got you. All right, so one quick follow up on that American Freight line of questioning. How far are you through this process? Are you 50% through moving the inventory? You know 80%, 75% etc. And maybe one way to think about that is you know when you report your first quarter numbers is EBITDA going to be negative still or...

Speaker 3: I get that it's going to improve throughout the year, but is it still a drag right now?

Speaker 4: Well, it has been. I think that the calendar is probably likely to help in Q1. I can tell you we're on a 445.

Speaker 4: quarterly cadence because it's a retail calendar. The calendar because of the tax money breaking is going to be helpful but in January the business operated at negative EBITDA.

Speaker 4: the business generated negative EBITDA, but it generated positive free cash flow. So I think that just is a good example of how the accounting really impacts what you're seeing when, you know, what I'm really interested in is how much free cash flow is the business generating. As far as what inning are we in or how far through the inventory cleansing and perfecting process.

Speaker 4: Hard to say because we still, I think we've done a great job moving out inventory we have, but we still have.

Speaker 4: Drifts and drabs coming in at higher cost. If I was to pick a number, I'd say 50% through, but that wouldn't be scientific, and I wouldn't take it to the bank. I certainly don't think it will be dealing with this issue at the same time next year.

Speaker 4: but I guess probably going to take to mid-year to really get through the majority of it.

Okay. You talked about, you commented on free cash flow, so that will segue into my next question. What is your free cash flow outlook in total for 2023? You can sort of maybe bridge the gap between your EBITDA guidance of 355 and what you expect for free cash flow. And as part of that, and really the important point is, give us the confidence that you will have enough free cash flow to pay your dividend.

So you'll have to draw your own conclusions on the dividend or not, but I can certainly help you with how we look at free cash flow generation. The good news is it's going to be better this year than it was last year, but that's pretty easy to beat last year. Thank you.

355 million of EBITDA, we will have interest expense, which issues specific ranges ofchem Hoffman.

probably around 145 million. We'll have a cash tax expense perhaps of 20 to 30 million and we'll have cap backs, both maintenance and growth cap backs and I think a total of about 50 million and 10 million of that is.

give or take is to complete the new distribution center for PSP which certainly is funding significant growth for them and for FRG as a whole.

You know this year though. We're gonna have the benefit if we operate Well, we'll have the benefit of working capital being converted into cash And you've heard me say before we've got about a hundred million of cash tied up in excess working capital I don't think that we'll get all of that back this year It'd be great if we do, but we should get the majority of that back. So when you add all those

numbers together, I think you'll see a healthy amount of free cash flow. But it's still not to the levels that we were used to a year ago. JM L monkey.

The next question is from Ian Zaffino with Oppenheimer. Please go ahead.

Just wanted to follow up on the comments on badcock and inventory there. I guess this is sort of, I guess we always thought American freight was the inventory problem but now it seems like badcock is as well or can you maybe

to help us out understanding what the severity of it might be. Are we following the same playbook that we did at American Freight? And maybe what kind of drove that excess inventory situation?

Yeah, so Ian, I'm not, I don't think I referenced anything about bad clock inventory situation. I'm happy to tell you that American freight having excess inventory was not unique in the I think that.

American Great, Badcock, Vitamin Shop, and PSP all have inventory that are not necessarily at optimal levels. We do expect inventory on an Apple DApple basis to be reduced at all four of those businesses this year.

But I don't think I'm not sure if you're referring to my comment about badcock EBIT dobbing down this year, or if you're specifically thinking about an inventory comment that

But I'll just throw that back over to you to clarify and I'm happy to help either way. Okay. No, that's fine. I guess I might have misunderstood. I thought you mentioned that inventory was sort of elevated at Badcock. Alright, that's good, no problem anymore, but regardless.

Well, if I said it, it's true because it's elevated everywhere, but it's not nearly the same situation.

So yeah, I hope that clarifies. Okay, so one of the mill elevated as opposed to me. Correct. Okay, correct. And then I don't know if this has been asked, but I'm a dividend. How do we think you have the dividend? Just give more guidance. Are we comfortable here?

How are you thinking about it right now as far as investors? And what we should expect maybe gone forward, thanks. Yeah, so each quarter the board is going to analyze the information we give them and the recommendations that I make and determine the outcome. We don't set an annual dividend. We do determine another.

orders and the board approved that and we've declared it and issued that today. As far as what happens down the road, I don't know. I think that I certainly understand and I think that the board also understands that the dividend is...

highly valued by our shareholders. So it's important to us, it's important to you. But I certainly wouldn't want to forecast what's going to happen with the dividend point in time.

Okay, thank you very much. Sure. The next question is from Vincent Kantic with Stevens. Please go ahead. Okay, thank you very much.

Hi, good afternoon. Thanks for taking my questions. First one, just kind of going back to that. So if you could talk about your kind of leverage in the quality targets when you're kind of going into 2013, you kind of laid out already a bit of the cast generation, maybe one of some of the competing uses of.

cash as well, but you did have a share buyback this past quarter that would stump pretty positive and nowhere else of kind of talking about the dividend now. But maybe you can talk about the equity targets and kind of given the actions you've taken so far.

that the uses for potential capital return. Thank you. Sure. So, financial policy remain at the same, you know, our sweet spot for leverage is under three terms of EBITDA. Two to three terms is I think we're comfortable. I think that the...

the higher interest rates, and that we've experienced the cost of capital that has gone up, the cost that we're paying to service our debt, really shows why we belong ultimately two to three turns being very comfortable. We did take advantage of the credit markets opening in January to launch that upsizing. So we did increase our liquidity, and I'm glad to have it because you never know.

big deal because that's going to be a large chunk of our free cash flow overall, you know, really offsetting the additional cash interest expense that we now have to pay on the entirety of our debt because it's not just the new 300 million that we have to pay interest on. We've got to pay a higher rate on the 1.1 billion that we had before.

So, look, I think that if we operate, we'll generate enough cash to cover all of our responsibilities. If we fail to operate, then anything could happen at that point.

Okay, I appreciate that. Thank you. Sure. And second question, kind of another financial one. So the difference between GAAP and adjusted EPS, I've been getting some investor questions about it. It seems to be the bad clock adjustments here.

If you could delve into that in more detail, should we be expecting more of those I guess losses being and then being adjusted out?

I'm just kind of wondering how long that lasts. Thank you. Yeah, Eric, I will let you handle that because you understand it much better than I do.

Yeah, thanks Ryan. Yeah, so what we essentially do with that delta between GAAP and adjusted EVA is to strip out all the components related to badcock financing and so that's what you'll see on a, we've broken out into three lines this time instead of lumping it all into one to better describe where it comes within the...

It shows up where it shows up within the P&L. Then as Brian mentioned earlier, we expect to exit the financing business in the middle of the year by the end of Q2. Before we, those add-backs would essentially go away at that point in time.

So the effect of the adbacs is just to normalize base operations. Okay, got you. So I guess right now it's on the balance sheet, or the lines are as if it's on the balance sheet. Second quarter, once you sell the business off the balance sheet, we don't see it anymore. And that's sort of...

So, but the addback is just a live space operations. Okay, got you. So, I guess it's right now on the balance sheet or the lines are as if it's on the balance sheet. So I can quarter once you've sailed the business off the balance sheet, we don't see it anymore. And that's sort of already planned.

away as well or will that linger into subsequent quarters? I guess you know the question is what quarter do those go away? A second part of that question I presume when you talk about your leverage you know less than three sweet spot less than three times etc you're excluding the

debt related to the receivables. Is that correct? And then last part of that is, how confident are you that you get rid of it by the end of the second quarter? I know that you had done some tests that weren't, you know, you were having some trouble finding, you know, ways to offload those, the receivables.

Sounds like you have some tests that are maybe heading in the right direction now, but dare I say it hasn't been as easy as you originally thought. So how much confidence do you have that this is gone by the second quarter? I'll try to take the last two and then Eric if you can handle the first part and you may need to repeat some of that.

I don't include the securitization because it is not recourse. It's a balance sheet item. It's not anything that we owe money on. I include in my calculations for leverage, the debt that we actually have incurred and that we have to pay back. That's what I count.

And I think you said pretty eloquently, if we are out of the...

in-house financing altogether, the secure type debt just leaves our balance sheet like magic. So I think that's really the illustration that you've got. So when I'm talking about two to three turns of leverage being where we want to be as a target, that does not include anything having to do with back-up receivables. As far as confidence level, I think that's really the first step.

And how we've gotten here with the transition to third party waterfall from the in-house offering, I didn't expect that as we sit here today at the end of February 2023 that we would be continuing to test, that we would be continuing to write in-house bad cop credit, but we are. So that was... Thank you very much.

a bad bet by me. We're just not there. I think there comes a time that you have to just figure it out and you make decisions and I think that's where we are. I think that by the end of June we should know what we need to know. I think that this test, moving into the dealer stores right now with one dealer in particular, seven stores.

that the end of June is realistic? Absolutely. Would I bet my life on it? Absolutely not.

So I think that's probably the best qualitative summary I can give you as to my personal views of where we are and where we need to be.

Well, I don't want you to give away... Hey, Mike. Oh, yeah, sorry. Go on. No, Mike, sorry. I was going to just answer your first question around the accounting. So essentially, because this is one of those nuances where it's a sale from a legal perspective, it's a true sale, but from an accounting perspective, it doesn't get counted as a sale until we stop...

at some point in the second quarter, but it'll still be on the two-Q balance sheet if it's not done by the end, because you'll have some of that within the quarter, but by the third quarter, if you're right, we're not gonna bet Brian's life, but if you're right and you're done with it by June , then it won't be on the third quarter balance sheet. Correct.

Okay. One more thing on that, though. I don't want you to give away your negotiations here, but when you say at some point you just got to make a decision, I mean, is the implication that you're just going to have to make a deal to, with a third party that's just not as good for you as you would have wanted? And where would that show up?

Yes, that's a fair question and I'm not really sure how to answer it. I'm absolutely certain that whatever deal we do strike,

will leave me wanting more, but that's where we are right now. And so I don't know how to really answer other than to say that we have multiple options remaining to consider. We continue to test, we're expanding the test, and we're hopeful. But...

We've still got four months to get it sorted out. I mean our self-imposed deadline. Understood. All right. Thank you for your time. I really appreciate it. Yeah, anytime. This concludes our question and answer session. I would like to turn the conference back over to Brian Kahn for any closing remarks. Great. Well, thank you all for joining us and thank you for your interest.

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