FRG (2020 - Q3)

Ladies and gentlemen, thank you for standing by, and welcome to Franchise Group's Third Quarter Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the conference over to your host, Andrew Kaminsky, Executive Vice President and Chief Administrative Officer for Franchise Group. Andrew K

Thank you, Michelle. Good afternoon, and thank you for joining our conference call. I'm on the call with Brian Kahn, Franchise Group's President and CEO and Eric Seeton, Franchise Group's 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 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 except as required by law, Franchise Group assumes no obligation to update or revise them. Investors are cautioned not to place undue reliance on these forward-looking statements. For more detailed discussion of these and other risks and uncertainties that could cause Franchise Group's actual results to differ materially from those indicated in the forward-looking statements, please see our Form 10-K/T for the fiscal year ended December 28, 2019 and other filings we make with the SEC. The financial measures discussed today include non-GAAP measures that we believe investors focus on in comparing results between periods and among peer companies. Please see our earnings release in the News and Events section of our website at franchisegrp.com for a reconciliation of non-GAAP financial measures to GAAP measures. Non-GAAP financial information should not be considered in isolation from as a substitute for or superior to GAAP financial information, but included 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. The non-GAAP financial measures that company uses have limitations and may differ from those used by other companies. Now, I'd like to turn the call over to Brian. Brian?

Thanks, Andrew. Good afternoon and thank you for joining us. I will briefly walk you through an overview of the third quarter, provide some updates on our recent activities and discuss current trends in our markets and businesses before turning the call over to Eric to discuss our third quarter financial results. We will then be happy to answer questions. So despite the economic and political volatility and the pandemic, Franchise Group's overall financial performance and cash flow generation has remained strong. During the third quarter, we retired the balance of our $70 million acquisition term loan for the Vitamin Shoppe after 8 months. The net reduction in debt in the third quarter reached approximately $112 million, bringing our total debt reduction to $204 million since acquiring American Freight in February. We reduced this debt despite paying another $0.25 per share dividend. On October 27, we launched an opportunistic bond offering into a strong bond market. We quickly saw the capital markets weaken perhaps due to the recent uptick in COVID-19 cases and uncertainty around the US elections, and while in market we witnessed several other issuers' price transactions wide of their intended targets. So we decided to withdraw our proposed offering for now. We will continue to evaluate all of our options when market conditions warrant because every 100 basis points of interest rate reduction is worth over $0.10 annually to Franchise Group's fully taxed earnings per share. So, refinancing will continue to be a major focus for Franchise Group overall. Regarding external opportunities, we've been evaluating various external opportunities that we believe will allow us to drive increased earnings per share and discretionary cash flow. Many of these external opportunities also provide further diversification to our sources of cash flow and we believe that as we continue to diversify, we will continue to reduce our overall cost of capital leaving Franchise Group with even more discretionary cash flow to allocate to the highest and best uses for all the Franchise Group. Regarding, personnel, during the third quarter, we announced the hiring of Todd Evans as our new Chief Franchising Officer. Todd has already enhanced his team with two extremely strong executives, Scott Harvey overseeing Franchise Operations and Jason Mattes overseeing Franchise Sales. We've recently completed our revised FDD at American Freight [ph] expect to have the Vitamin Shoppe Franchise ready by year-end. We believe our brand's unit economics and economic resilience are extremely attractive for franchisees. As we've stated in the past, we will update you on our franchising progress as it materially impacts our business. Operationally, the demand for Home Furnishings offered by American Freight and Buddy's have continued to benefit from a change in consumer spending. We continue to see our customers reallocating their discretionary spending away from vacations and dining out in favor of home improvement-related spending. Historically, our deep value products and flexible payment options performed well in either expansionary or recessionary economic environment. So we don't feel the need to run the businesses differently based on changing economic outlooks. This is further evidenced by comparable same-store sales for American Freight being up approximately 15% and Buddy's up approximately 14.7% in the quarter. Vitamin Shoppe had comparable same-store sales growth of approximately 8.6% in the third quarter due to strong execution and a renewed focus on in health and wellness by the general public likely due to COVID-19. Increased revenue combined with operational changes instituted earlier in the year have driven strong cash flow at the Vitamin Shoppe. Liberty Tax's seasonality has been nominally smooth this year due to the extended tax filing deadline. Liberty had a strong finish to the tax season has been focused on preparing for the 2021 season with many enhancements to technology to ease virtual tax prep in contact with service. We believe receipt of certain government stimulus and unemployment payments could create additional complexity to protect fares in the upcoming tax season, driving more people to our locations for assistance. We look forward to serving our customers and supporting our franchise partners in the 2021 tax season. So overall, the Franchise Group of companies has performed well and our management teams are finding ways to improve their financial prospects, despite the distractions of 2020. Before turning the call over to Eric, I'd like to thank all of our associates, one more time for their hard work and dedication to our company. Our success would not be possible without you. I'll turn it over to Eric to walk through the financial details. Eric?

Thank you, Brian. Before I address the results of operations, I would like to remind you that we will be making many references to pro forma 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. These items have been aligned and adjusted in line with our recently changed 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 a comparable period is not available due to the recent timing of the acquisition. For example, our recent 10-K/T filing reflects our new fiscal year end, a December retail year, but only includes the results of Buddy's, Sears Outlet and The Vitamin Shoppe from the respective acquisition dates through December 28, 2019. The 10-Q that we filed today contains the actual results for all businesses for the entire third quarter. When discussing our pro forma results or comparable results to prior periods, we will include American Freight's results as if we owned it since the beginning of the fiscal year. In order to confirm with SEC rules, consistent with concepts in Article 11 of Regulation S-X for non-GAAP reporting, Franchise Group will not be reporting synergies and other acquisition costs as part of pro forma adjusted EBITDA. The company will continue to report adjusted EBITDA in the same format as it has in the past and will provide supplemental information that reflects cost synergies and other acquisition impacts as discussed below. The specific amounts included in each disclosure are fully discussed in detail in the non-GAAP financial measures and key metrics. For the third quarter of 2020, total reported revenue for Franchise Group was $551 million compared to our October 26 preliminary release of at least $550 million. GAAP net loss attributed to Franchise Group was $8.6 million or a loss of $0.22 per share compared to our preliminary release of a net loss of at least $9.5 million. Adjusted EBITDA was $50 million compared to our preliminary release of at least $47.5 million. Supplemental information encompassing cost synergies and acquisition impacts was approximately $1.2 million compared to our preliminary release of at least $600,000. The GAAP net loss for the quarter was primarily driven by interest expense, which includes deferred financing costs and one-time items associated with the purchase price accounting. We have four reportable segments: American Freight, The Vitamin Shoppe, Liberty Tax and Buddy's. For the three-month period ended September 26, 2020, American Freight had revenue, adjusted EBITDA and supplemental information of $245.2 million, $24.6 million and $42,000 respectively. The Vitamin Shoppe had revenue adjusted EBITDA and supplemental information of $267 million, $21.4 million and $1.1 million respectively. Buddy's had revenue and adjusted EBITDA of $25.5 million and $6.8 million respectively. Liberty Tax had revenue and negative adjusted EBITDA of $13.3 million and $1.4 million respectively. Liberty Tax as mentioned typically records a majority of its revenue and EBITDA in the first quarter because of the timing of the tax season. But due to the extended tax deadline this year, Liberty Tax had more revenue and EBITDA in the third quarter, than it's expected to in future third quarters. Turning to our balance sheet and cash flow. For the quarter, we had free cash flow of $70.3 million, defined as operating cash flow less capital expenditures. CapEx for the quarter was $10.5 million. The end of quarter cash balance was $179.9 million. During the quarter, we received $29.4 million in cash tax refunds as a result of the IRS rule changes related to net operating loss carrybacks and within the CARES Act. During October, we received an additional $11.7 million in cash tax refunds and we are still waiting on an additional $12.4 million in tax refunds. As Brian mentioned, we repaid $111.9 million in net debt this quarter and at September 26, we had outstanding debt of $628.7 million, net of deferred financing costs. In conjunction with our balance sheet and business performance, we believe we have sufficient liquidity to continue to meet all of our obligations and support all of our businesses for the foreseeable future. I will now turn the call back to Brian to discuss our guidance for the remainder of the year.

Sure. Thanks, Eric. For fiscal 2020, we now expect our adjusted EBITDA to exceed $232 million and supplemental information of $28 million. Revenue is expected to be between $2.1 billion and $2.15 billion. Our guidance does not include any assumption for acquisitions, divestitures or refranchising activity. I'd like to thank all our shareholders and their lender - and our lenders for their support to date. And operator, you can please open the line for questions.

Thank you. [Operator Instructions] Our first question comes from Mike Baker of D.A. Davidson. Your line is open.

Hi, thanks guys. So just a couple of things I wanted to get into here. So, one, on the guidance and then specifically the EBITDA guide, is the correct way to look at it. So, previously you were saying at least $255 million. Now is the correct way to look at it to take that $232 million plus the $28 million and then that equals $260 million. So in effect, you're increasing the guidance from $255 million if we were to look at it apples-to-apples from what you were previously - the way you previously reported. Is that right?

Yes, Mike. Hi, this is Eric. Hope you're well. Yes, that would be the way that we would look at it. I think I can provide a little more color for you as well. If you looked at our last guidance of $255 million, if we split that out, that would be adjusted EBITDA of $219 million and supplemental information related to cost synergies and other savings of $36 million. So, you certainly see that the quality of the split between adjusted EBITDA and supplemental is increasing. We have less reliance on our cost synergies, which are primarily behind us and certainly the pandemic and shut down of a portion of the stores allowed us to accelerate the achievement of our synergies within the AF company. And so those are now captured within the adjusted EBITDA guide.

Okay. Sorry, go on.

No, I would also say, and just to make sure that given our change in the guidance format, we're not providing non-GAAP EPS at this time due to the reasonableness of providing a full reconciliation and it would also exclude our supplemental information side. Certainly as you mentioned, focus on the increased guide to adjusted EBITDA and the inclusion of supplemental items.

Well, okay. So that was my next question, EPS. There's no adjusted EPS number here. So I guess you're on your own for that, but I guess your point is that the 2 - I think it was $270 million adjusted EPS, that's no longer - is that no longer your guidance?

Yes, we pulled the - we pulled it from a non-GAAP perspective, because again the - if we were put together as a non-GAAP reconciliation, it would exclude the supplemental information. So it would be a little bit of apples and oranges. So at this point in time, it's up, it's essentially the same calculation we would have done before, just in a different way and we just - we don't have the ability to put it together for you.

Okay. So now you got - put out accounting [indiscernible]. Just some more on the business trends; so really strong comps, obviously. I guess a question would be how sustainable do you think those trends are? How much did they benefit from stimulus if at all? And how reliant are you on future stimulus which we may or may not get? And maybe one way to think about that is, what are the trends look like throughout the quarter and then into the early part of the fourth quarter?

So, it's Brian. I think we definitely saw a benefit at the American Freight business at the beginning of the quarter due to stimulus, but stimulus checks stopped quite some time ago and the business has continued to perform very well. We check every day, things do continue to progress. And yes, I don't - I really can't tell you whether or not they will stop or not, but right now business continues to be strong and that is without stimulus checks. And as we said before, back in the Great Recession 2008, the American Freight business comp positively went down, businesses across the land comped well on a same-store sales basis back then as well. So we feel pretty good about that. I don't believe that Liberty or Vitamin Shoppe for that matter are really impacted by stimulus. And I think Liberty was impacted by the delay in the tax deadlines, and by the month [ph] Vitamin Shoppe certainly was impacted by store closures during COVID, but then clearly also positively impacted by general consumer sentiment about health and wellness and that has not subsided either.

And when you say still strong, I mean, is it possible to sort of talk about a monthly cadence throughout the quarter or into this quarter, is it steady, as it slowed at all?

Well, it's all relatives and I don't think we want to get into a monthly cadence. I think we did that really wanted to provide people an understanding of the stores that were shut down earlier in the year, but I would say at this point, they've continued without stimulus to maintain their strength, that's -

Understood.

I'd like to leave it at that. Yes.

Okay. I'll pass it on to someone else and come back, if there's time.

Our next question comes from Susan Anderson of B Riley. Your line is open.

Hi, good evening. Nice color on the quarter. I was wondering if you can maybe give some more color around your thought process on launching the bond and then also some more color around why you decided to pull it in the end?

Sure, happy to. So we launched the bond to try to take advantage of what was a very strong credit market. The bond market in particular had been stronger than what anything we had seen in the last six months. We were also concerned about the risks around the election. So if you look back a month ago into October and the elections heating up, we didn't know what might happen to the capital markets post-election. I know all of you that know me, know I predicted '20 out of the last three market decline. So I guess today seems to be no different than the '17 that I got wrong. But we have the opportunity, we had a window, we got great support from Morgan Stanley and JPMorgan, B. Riley, Wells Fargo, CS and Citizen to get all this work done and getting offering ready. We watched how a couple of deals got executed relative to their targets. A couple of weeks ago, we felt we compared favorably, had great feedback from pre-marketing and hit the button last Tuesday. And then last Wednesday, the market just crushed us and really the uncertainty over the balance of the week, I think we just missed that window. And we didn't need to do a refi, it is an acquisition financing or anything pressing. It was an opportunity to significantly lower our cost of capital in a permanent structure but also recognizing at the price of having to pay expensive call protection to get out of our existing term loans between now and February 14. So at a price that makes sense, to lock it in for five years. But we just - we just didn't need to do it and we - and also of course we can lock it in our one hand, but with the bond, it was two year, no call. So taking something that was significantly better than where we are now but not ideal. It wasn't going to allow us to go improve ROI six months from now just because we were able to - or three months from now or three weeks from now. So look, we got a lot out of the process, we went through the ratings agencies. We've got an issuer rating of B1 B+ by Moody's and S&P. Not a ton of new banks and credit jobs that are very supportive of what we're doing and we expect to be running this business for a long time and it's great to have new friends that are interested in what we're doing and there to support us. So as I said on the pre-range remarks, we certainly will look for opportunities to refinance the leg work is done and we think we'll be able to do something that's smart for the long term. But if it wasn't just that right transaction, it just didn't make sense - just didn't make sense to go forward yet. So I hope that helps a little bit.

Yes, got it. That's very helpful. And then I guess just a follow-up on Vitamin Shoppe, it sounds like fourth quarter strong trends to continue. I guess, any thoughts around this post-COVID environment? Do you think consumer awareness around health and wellness will continue? And then also, what do you think it would mean for next year if Vitamin Shoppe trends continue and the strong cash flow continued?

Sure. Well, cash flow would be great if those trends continue, there is no doubt about that. The strength has continued but we're learning a lot. We had plans - I'm just giving an example, we had plans at the - when we acquired the business at the end of last year, there was a plan to aggressively exit stores that were losing money. And because of what we've seen with COVID and the impact on the business, there are stores that you might have been slated for non-renewal of leases or closures, because they were marginally profitable or losing money actually, that now are not losing money or no longer marginally profitable, but nicely profitable. So, if we are going to give it till the end of the year, feel very good about where we're situated, management has done a great job of running the business and actually exciting - 5,000 associates in helping busiest [ph] at Vitamin Shoppe. So it's a very different business than it was a year ago. We feel very good about that. We're going through the budgeting process now for next year. I don't have anything to say about that because we're not even done with it but we do know - as you know, the first half of the year is going to anniversary weak comps pre-COVID, it's going to anniversary store shut downs that took where we had zeros on the Board for revenue in 90 stores for a period of time during COVID as well as reduced hours for, even after the stores reopened and the stores that were opened, we are operating at reduced hours. So now since the start of this quarter, we've been back to a regular - when I say this quarter, I mean the third quarter, we've been back to normalized operations and you've seen the numbers, the incremental margin from comps positive or negative is over 40% in store and a little under 30% on average free commerce. So positive comps would have a big impact, but it's too early to tell whether or not these trends will continue. But so far so good.

Great. I guess just one little follow-up there in terms of GNC liquidation any impact either way that you're noticing yet?

So GNC, the GOBs we will assume they're doing the - going out of business sales that had a negative impact on the product category where we directly compete with them. They took out a significant chunk of supply from the market probably $650 million or so of supply that somebody has to fill. So we do think that we should benefit from that, but it is still too early to tell they have new ownership group, new management. I'm sure that business will be very different. But definitely, it has not - it has not hurt us about that.

Yes, that's helpful. Thanks so much. I'll hop off and let someone else in.

Sure.

Our next question comes from Vincent Caintic of Stephens. Your line is open.

Hey thanks, good afternoon and thanks for taking my questions. First, I wanted to just get an update on the potential acquisition pipeline as the recession has progressed. And sort of what you might be looking at in terms of something that might fit into your existing businesses or maybe a new segment. And then, just to confirm that you mentioned that the debt raise that you were planning to do, that is not acquisition financing raise that's just kind of opportunistic. Thank you.

Sure. Yes, in reverse order, the bond offering that we did was very much not specifically for any acquisition. I think that consolidating our capital structure will certainly give us more flexibility had opportunities come up down the road, that's one of the reasons why we find that attractive on top of the lower cost of capital. But there wasn't anything today that we needed to get financing for that or frankly that we probably be having a different discussion and we would have closed on a financing. And we're used to actually having to close on a financing in order to get an acquisition done. This was just purely opportunistic and to the extent that something of size comes up where we need to access the debt markets, we're certainly happy to do that. If you recall, we did kind of pre-fund the balance sheet with an equity offering earlier this summer as well as a little prefer that we did later in the summer, which as we have tons of liquidity and we have cash, which has been very helpful for us in some - while exploring some extracurricular external transactions. We have been very active. You haven't seen much or anything, but we have been very active and part of being active for us is saying no. So there - we've spent few months now deep into many processes and some that weren't even processes, but just fit businesses that are very attractive to us, things that we think that we can franchise businesses that are good add-ons for existing assets. But at the end of the day, our capital is precious and we need every transaction we do to be very obviously accretive to our earnings and our available discretionary cash flow, which is what we get to decide what we're going to do with later whether that's paying dividends, retiring debt or redeploying that cash into other assets that we have or further diversification. And so we've been very careful. I just think there will continue to be - I think there'll be more opportunities as time goes on. Then fewer, I don't feel the need to jump out and overpay for anything and things just come up. And by the way, that's how Franchise Group really was put together. Over the last couple of years, it was opportunities that came up that fit, there was nothing that we went out to search for. And we've got the powder to be able to do that. I think we've got some great lenders that are willing to support us. So we'll be there when the time is right. I do think that you'll see some activity sooner than later. Wish we had something to talk about on today's call. We've been much more convenient but we don't. But we are very active and I expect that the pipeline will continue to grow and not shrink. I think one of the things that we've learned beyond any doubt over the last several weeks and talking to lenders about Franchise Group and what we're doing, there will be a significant benefit to the overall Franchise Group from additional diversification. And that's - that doesn't mean you just do what you have to do to be diversified, but as we continue to build out our business and that includes cash flows from different kinds of assets, I think that there will be a real benefit and open doors up, things that we could do that we probably wouldn't have been able to do otherwise. So I'd just say stay tuned.

Okay, that's very helpful. Another question about cash and potential usage. So the $180 million of cash you have available, is that all deployable and whether you sort of thinking about doing there? And then lastly, just your comments about franchising just what's the pace and how much cash do you think you can generate there? Thank you.

Sure. Yes. So we have - some of that cash is operating cash within the operating businesses, so Vitamin Shoppe has cash on their balance sheet that they use to operate their business, they've been generating cash and paying down the revolver, they generate cash as well. But there will always be some amount of cash on their balance sheet period. Also Buddy's, American Freight, Liberty tax, there is operating cash on their balance sheet, which I would say, yes, you could use. Some of them we have, there been small acquisitions 80 buybacks at Liberty Tax for example that are small, but in the several million dollars that you're funded with cash at the operating entity. But the majority of the cash $140 million or so resides up of that Franchise Group which is completely unencumbered and has the freedom to do whatever it wants. So, I'd say that's really other than smaller transactions where we're adding something small to an existing business. I would think that as being the equity portion of an acquisition check. Does that make sense?

Yes, that's very helpful. Thanks.

And I think you asked something else that I - do you have another question?

Yes, just about the - what you're thinking about in terms of the franchise opportunities and how much franchising you could do in the near term and the cash available to generate from that?

Yes. Look, the key part of our strategy, when we do have company-operated stores is being able to use refranchising to delever the balance sheet, which we will lever up to acquire assets, but then we always have to have a plan to delever fairly rapidly. And we want to be in the 2 to 3 times leverage ratio. But we can extend possibly up to 4 times to stretch to get a great transaction done if we think we can delever pretty quickly and re-franchising is a key piece of that strategy, but it's also key part of the strategy to grow. We're trying to re-franchise company-owned stores and add development agreements to those. I think that there are - the different businesses or a different stages of their called franchise maturation cycle, you've got Buddy's and Liberty that they've been franchising for a long time and that's very simple. American Freight with right now 8 franchise stores out of 300 plus, it's new and those are really outlet stores originally and now that outlet has become American Freight. And I think I said earlier, we just completed the FDD and we'll be ready to go on that. Unit economics are fantastic, and we know that there is a lot of demand. For franchising the American Freight business and with only 300 stores, I think we've got room to grow 4 or 5 times store count where we are right now. So that we'll be very aggressive about that and just bringing Todd, Scott and Jason on which was just during this quarter, we're really ready to go there. And then, Vitamin Shoppe, which is 100% company-owned; this was definitely not the year to be aggressively trying to franchise. I think that this business, as I said and really do believe it's a very different business than it was a year ago. And I think we need to own that right now. And we have been, we took freight during COVID and now we're getting that franchise-ready and we're weeks not months away for being ready to go there. And I think that just the environment and as well as just generally people's passion for all things health and wellness is just so many of them out there, I think that will be a very attractive brand for our perspective franchisees. So, it's coming. This year was a very different year than I think we all expected. We have re-franchising transaction ready to go back in February, March, when we closed American Freight, COVID hit, and things changed, but I think that you'll see progress there very shortly.

Okay, great. Thanks so much.

Sure.

I'm not showing any further questions. I would now like to turn the call back to Brian Kahn for any further remarks.

Okay. No further remarks from me. Thank you all for joining. And operator you can conclude the call. Thank you.

Ladies and gentlemen, this concludes today's conference. You may now disconnect. Everyone have a great day.