Franchise Group, inc (FRG) Q3 2021 Earnings Call Transcript

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Franchise Group, inc (FRG)
Q3 2021 Earnings Call
Nov 2, 2021, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Franchise Group's Fiscal 2021 Third Quarter Conference Call. [Operator Instructions]

I would now like to hand the conference over to your host, Andrew Kaminsky, Executive Vice President and Chief Administrative Officer of Franchise Group.

Andrew F. Kaminsky -- Executive Vice President And Chief Administrative Officer

Thank you, Fay. 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 a 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 for the fiscal year ended December 26, 2020 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 we include it because management believes it provides meaningful supplemental information regarding our operating results when assessing our business and is useful to investors. The non-GAAP financial measures the 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?

Brian R. Kahn -- President, Chief Executive Officer And Director

Thanks, Andrew, and good afternoon to our listeners, and thank you for joining us. I will briefly discuss the highlights of Franchise Group's third quarter, provide an update on recent corporate activities and discuss current trends in our markets and businesses before turning the call over to Eric to provide financial details. We will then be happy to answer questions. In the third quarter of 2021, Franchise Group continued to execute operationally and capitalize on the momentum of our brands while staying focused on driving discretionary cash flow. During the third quarter, we closed on the sale of Liberty Tax and repaid $182 million of debt. And then on September 27, we completed the acquisition of Sylvan Learning. The addition of Sylvan provides Franchise Group with another growing franchise concept and furthers our diversification into an expanding $20 billion consumer services market. Sylvan has been a leader in the educational services industry for decades and Sylvan offers attractive unit economics to its growing franchisee base.

Like all of our acquisitions, Sylvan is expected to expand our discretionary cash flow generation. Although we just closed on Sylvan about a month ago, its associates and franchisees have already seamlessly become part of Franchise Group. Financially, we are increasing our expectations for the balance of fiscal year '21, and as we look toward 2022, we see significant further growth for Franchise Group. I'm very proud of the way our management teams are navigating continued supply chain constraints and overall inflationary pressures. The momentum of the brands is strong, but nobody is coasting. We are in a dynamic environment that requires our management teams to actively manage literally on a daily basis. They have overcome tens of millions of dollars of potential profitability headwinds, and I appreciate their individual efforts that have combined to grind out strong collective performance for Franchise

Group. Regarding franchising, all of our brands have continued to enjoy robust demand from both existing and new potential franchisees due to the strength of their operating models. New store openings by franchisees are providing healthy systemwide unit growth and a continued shift on our overall mix toward franchised units. Today, our mix is roughly 50% franchised. In the third quarter, we increased franchise store count by 22 locations, and on a net basis, closed one corporate location while signing 51 area development agreements. For the first three quarters of fiscal '21, excluding Sylvan, we opened 124 new locations, signed area development agreements for 153 new franchise locations and have grown our total backlog of new stores across all brands to 339 units.

Adding in Sylvan, our backlog now stands at 365 locations. In the third quarter, Pet Supplies Plus advanced a variety of internal growth and improvement initiatives. Management rolled out an online prescription service, relaunched a new and improved loyalty program and grew its franchise backlog of store openings to over 220 units. PSP same-store sales for the third quarter were up 14.5%. The at the end of the quarter, PSP had 583 stores with 343 franchise locations and 240 corporate stores. Total revenue at American Freight was down 8.8% year-over-year in the third quarter due to comping the reopening surge in demand from last year's comparable period. If you recall, last year, A Freight comped positive 15.3% in the third quarter, this year A Freight comped negative 13.4%, the two-year stack remains positive, and we continue to see significant interest in the American Freight franchise opportunity due to its superior unit economics and unique position in the market. American Freight had 367 units at the end of the third quarter, including seven franchise locations. Buddy's same-store sales were up 1.4% in the third quarter.

Buddy's carried its franchising momentum into the third quarter by signing area development agreements for 24 new stores and refranchising eight locations. Buddy's footprint now stands at 309 units, including 272 franchise locations. Vitamin Shoppe's positive trends from the second quarter continued as well as the brand benefited from consumers focus on health and wellness and the growing demand for Vitamin Shoppe products. Once again, store traffic increased as consumers gain comfort, leaving their homes to shop on-premise. These trends are evidenced by Vitamin Shoppe's third quarter same-store sales growth of over 13%, consisting of positive 17% in-store and negative 1.7% for direct-to-consumer. Vitamin Shoppe ended the third quarter with 713 stores in the system.

Regarding M&A, we continue to evaluate M&A opportunities that will either further diversify Franchise Group's revenue and cash flow streams, accelerate our growth or both. We believe that each acquisition opportunity that we are reviewing provides a clear path to enhancing Franchise Group's discretionary cash flow, and we expect to have more to discuss on M&A in the near future. Before turning the call over to Eric, I would once again like to thank all of our dedicated associates for their hard work, for their support of each other and their support of our franchisees.

Thank you very much. Eric?

Andrew F. Kaminsky -- Executive Vice President And Chief Administrative Officer

This is just Andrew stepping in for a minute, Brian. I just want to reiterate, the PSP same-store sales for the third quarter were up 14.5%. There was a glitch in your speaker at the time and it sounded at 4.5%. So I just wanted to correct that.

Now I'll turn it over to Eric.

Brian R. Kahn -- President, Chief Executive Officer And Director

Thanks.

Eric Seeton -- Chief Financial Officer

Thank you, Brian, and Andrew. 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 [Technical Issues] for the acquired businesses prior to their acquisition by Franchise Group. 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 a comparable period is not available due to the timing of the acquisition. As a reminder, in our SEC rules consistent with concepts and Article 11 of Regulation S-X for non GAAP reporting, Franchise Group will not be reporting synergies and other acquisition costs. The company will continue to report adjusted EBITDA in the same format as it has in the past. At this time, we do not anticipate reporting any supplemental information for 2021. The specific amounts included in each disclosure are fully discussed in detail in the non-GAAP financial measures and metrics section of our earnings release. For the third quarter of 2021, total reported revenue for Franchise Group was $828.8 million. Net income from continuing operations was $36 million or $0.83 per fully diluted share.

Adjusted EBITDA was $80.8 million, and non-GAAP EPS was $0.97 per share. We currently have four reportable segments; American Freight, Vitamin Shoppe, Pet Supplies Plus and Buddy's, and report Liberty Tax as a discontinued operation. For the quarter ended September 25, 2021, American Freight had revenue and adjusted EBITDA of 223.6 and $16 million, respectively. The Vitamin Shoppe had revenue and adjusted EBITDA of 300.8 and $35.9 million, respectively. Buddy's had revenue and adjusted EBITDA of 17.8 and $4.4 million, respectively. And PSP had revenue and adjusted EBITDA of 286.6 and $25 million, respectively. For the quarter, consolidated cash flow from operating activities for FRG was $10.9 million and capital expenditures of $12.2 million netting free cash flow of negative $1.3 million, defined as operating cash flow less capital expenditures. Within these amount of cash flow from operating activities of $2.7 million and capital expenditures of $0.2 million. Cash flow attributed to Franchise Group continuing operations was $8.2 million from operating activities, plus $12 million of capital expenditures, adding to a free cash flow of negative $3.8 million.

We ended the quarter with approximately $1.1 billion in outstanding term debt, which included a $182.1 million repayment and an undrawn $150 million ABL [Technical Issues] approximately $160 million. We used approximately $81 million of this cash to pay for the Sylvan acquisition on September 27. 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. As of today, we are increasing our expectations for annual adjusted EBITDA for fiscal year 2021 from at least $320 million to at least $325 million. Non-GAAP EPS from at least $3.45 per share to at least $3.80 per share, and revenue from at least $3.05 billion to at least $3.1 billion. In calculating EPS, we are using approximately 41 million weighted average shares outstanding, and our expectations for the balance of 2021 includes 1/4 of Sylvan, but does not include any assumptions for additional acquisitions, divestitures or additional refranchising activity. I want to thank all of our shareholders and lenders for their support to date.

Operator, please open the line for questions. Thank you.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Your first question is from Mike Baker from D.A. Davidson.

Mike Baker -- D.A. Davidson -- Analyst

Okay. Hi. Just want to follow-up on that very last thing. You said that the guidance includes 1/4 of Sylvan. So the guidance is up on all the important line items. But is, can you just help us understand, is the guidance increase just on the Sylvan acquisition? Or does it include what looks like a little bit of a better-than-expected third quarter here? And then I have some follow-ups?

Eric Seeton -- Chief Financial Officer

Mike, this is Eric. So yes, the $0.35 per share non-GAAP EPS raise you're referencing, it's a combination of [Technical Issues] one, certainly, the ongoing business performance, which incorporates our latest forecast for the year. We've chewed up tax estimates, while we expected to be initially minimal cash tax payer for the year, we now expect not to be a cash tax payer from a continuing operations standpoint, which is driven by our updated forecast and the post Liberty sale.

So obviously, those tax aspects that came from that, but trued up our forecast. And then certainly, a true-up -- the last part was the true-up of estimates from our purchase accounting, which positively impacted our GAAP EPS. So it was a combination of those three items were led to the increase in the guidance for the full year.

Mike Baker -- D.A. Davidson -- Analyst

Okay. That's helpful. two more quick one, well, I might be quick. Sylvan, can you talk about, when you acquired it, it looks like the numbers are pretty good, strong margins. They're all franchises and mostly franchises already. So what do you bring to this company to make them better? It's not like one of these cases where Vitamin Shoppe where you refranchise them because they're already franchises. So I'm just curious, how do you drive incremental value to that acquisition?

Brian R. Kahn -- President, Chief Executive Officer And Director

Yes. Mike, it's Brian. I think that we will help them accelerate their growth of units and potentially add additional services that they can offer in their units. But Sylvan was well-run business. It would have been fine without us. We think that we can accelerate their growth, and I guess we'll see if we can.

Mike Baker -- D.A. Davidson -- Analyst

Okay. One more, and then I'll turn it over. Just switching gears. American Freight, obviously, the business was a little bit weaker here, but on a two-year basis, it's pretty good. Can you talk about the supply levels there? That's where I think you were seeing the biggest supply issues in the last two quarters.

Brian R. Kahn -- President, Chief Executive Officer And Director

Yes. So look, supply chain is generally still a mess. But the management team, both at American Freight and frankly, everywhere else, they continue to fight the fight. Inventory levels are actually sufficient at American Freight, mix may not be ideal, but we've invested significant dollars in inventory. They are well inventoried. We wouldn't expect to miss a lot of sales, but it's not that it's easy, either having to grind it out and find ways to switch vendors and get inventory into the system, but they have done that, and they are ready for the high season, which, as you know, is around tax season next February.

Mike Baker -- D.A. Davidson -- Analyst

Okay. Fair enough. I'll turn it over to someone else.

Brian R. Kahn -- President, Chief Executive Officer And Director

Sure.

Operator

Your next question is from Larry Solow from CJS Securities.

Larry Solow -- CJS Securities -- Analyst

Good Afternoon. Thanks for taking the questions. Sort of sticking with the supply chain and inflationary theme. Any impacts of Vitamin Shoppe? Obviously, you had really nice top line growth and incremental margins still look pretty good. Actually, I think, within historical range of like 40%. So has there been any impact on that business? And part two of that question is, do you continue to see -- I know you sort of gave an outlook for 2022, and maybe you don't want to give specific segment or company outlooks, but do you still think this business could grow as you look out over the next few years?

Brian R. Kahn -- President, Chief Executive Officer And Director

Sure. So I would say as a blanket statement, there's wage pressure in every business that we're involved in. So I think that, that would include Vitamin Shoppe as well. On the inventory side, there's inventory, there's cost pressures in inventory as well, but Vitamin Shoppe isn't -- they don't have the magnitude of the issues that maybe others have that are waiting for containers coming across the ocean. But they have made, I think, the right decision to carry excess inventory, safety stock, so that to the extent that certain categories that are very popular, they see a rush of demand that they have them. I think it's the right move. When we bought Vitamin Shoppe a couple of years ago, one of the goals was actually reduce inventory because they had so much in the system.

Now we're actually increasing inventory, and it's not insignificant. They're certainly carrying eight digits more than typical levels might be. But I think that's permanent from my seat. So I don't think that's just a temporary increase that will ultimately be worked down. I think that having safety stock matters and is useful and can be a competitive advantage to them. So that's how I would look at that. And as far as the growth there, look, their business is growing. They've had tremendous amount of success over the last couple of years. It has continued. Extremely encouraged by -- for the first time and forever, actual customer counts increasing. And as those customer counts increase, they hang on to those customers, you've got a whole new level of business. So very encouraged by what we see there. It's certainly no guarantees, but I think that their prospects for being able to continue to grow the top line look very promising.

Larry Solow -- CJS Securities -- Analyst

Okay. Great. If I could just make one follow-up. It sounds like franchise interest is strong across your businesses. The 22 openings this quarter, can you just give us a little more color on that? Was that mostly at Pet Supplies or actually it looks like Vitamin Shoppe went down a couple quarter-over-quarter. Did they close a couple? Just trying to get a little...

Brian R. Kahn -- President, Chief Executive Officer And Director

Franchise stores for Vitamin Shoppe?

Larry Solow -- CJS Securities -- Analyst

For Vitamin Shoppe you had said total stores were 76, I think, were down 3% quarter-over-quarter, I think, about 716 to 713.

Brian R. Kahn -- President, Chief Executive Officer And Director

Yes, that's correct. So we had three corporate stores that we closed at Vitamin Shoppe. The franchising was strong. We opened 10 PSP stores and 11 Buddy's stores. That's the bulk of it. That's 21 of them.

Larry Solow -- CJS Securities -- Analyst

Got it.

Brian R. Kahn -- President, Chief Executive Officer And Director

So that was really driven there.

Larry Solow -- CJS Securities -- Analyst

Got you. Perfect. Thanks. i appreciate the color. All good. Thanks.

Operator

Your next question is from Susan Anderson from B. Riley.

Susan Anderson -- B. Riley -- Analyst

Hi. Good evening. I just wanted to follow-up on your EBITDA payout. I guess, now with the addition of Sylvan and the increase in EBITDA and then maybe another acquisition in the works. Are you guys still looking to pay out 25% of EBITDA? And also just curious when that is calculated?

Brian R. Kahn -- President, Chief Executive Officer And Director

Sure, Susan. Thanks for the question. And yes, EBITDA has grown. The long-term target is a 25% dividend rate as a percentage of EBITDA. And as you know, we have paid out the same rate for the last four quarters, and we are readdressing the dividend for next year. As we sit here now in November, we're going through the annual budgeting process. And management will submit a dividend recommendation to the Board shortly. And after a plan is approved, we'll declare that next dividend. Yes, certainly makes sense based on the revenue and profitability growth that we see today, it's reasonable to expect that at least management's recommendation will be for a significant increase in the dividend.

Susan Anderson -- B. Riley -- Analyst

Great. And should we expect that to go closer to that 25%? I guess that that would be more forward-looking given Sylvan won't be in it really till next year?

Brian R. Kahn -- President, Chief Executive Officer And Director

Yes. We'll look at next year's budget. So we don't look at last year's. So we look at what next year looks like. Maybe we'll leave a little bit of cushion. We did this year, it turned out that the EBITDA growth was a little higher than we expected. So the gap was wider. And as we sit here now, unfortunately, as long as EBITDA keeps going up, the ability to close the gap on the 25% and the EBITDA going higher leads to healthy dividend growth. So I mean I wouldn't guarantee it would be exactly 25%, but I also can't guarantee exactly where EBITDA will shake out for next year. So -- but we'll get -- do a good job as we can.

Susan Anderson -- B. Riley -- Analyst

Okay. Great. And then I guess just on PSP, nice same-store sales increase there. I guess maybe if you could talk about the drivers of that increase among the categories? Or also, are you seeing new customers come into the business? Then also, I think you mentioned the online prescription service, is that fully rolled out to all of the stores now? And I'm just curious, do you have to go into the store to pick it up? Or is it delivery?

Brian R. Kahn -- President, Chief Executive Officer And Director

Yes. So the prescription, it's brand new. So it's not a very big driver right now. It's just an example of the initiatives that they are working on. As far as the categories, I would -- I think for competitive reasons, we're trying to stay away from getting too deep into any of the specific businesses. We've seen, especially, I'd say, in the pet industry, a significant increase in advertising among the competitors and everybody is planning their own strategies, including PSP, and we'd like to let them continue to run their business as quietly as possible since they aren't a separate publicly traded company that can keep things a little bit closer to the vest.

Susan Anderson -- B. Riley -- Analyst

Got it.

Eric Seeton -- Chief Financial Officer

And just to add to Brian's answer on the prescription, it is an online model. So it's -- you would log in online, you'd set up your account, you put any information. The system then checks with your vet to make sure that it's a valid prescription then they ship. So you don't go into the store, it gets delivered.

Susan Anderson -- B. Riley -- Analyst

Okay. Got it. And then just curious if there's any -- like have you -- I mean, the 14.5% comp, obviously very nice. Do you know if consumers are just spending more in the stores? Or are you guys getting new stores to come in -- or new customers to come into the stores?

Brian R. Kahn -- President, Chief Executive Officer And Director

Yes. So it's a combination of both. And certainly, I think that one of the -- one variable that helps them as well as they've opened so many younger stores that as those stores ramp up to mature levels, they get the benefit of kind of outside comps. And as long as they continue to have new stores, they'll continue to have that benefit over the first few years. And generally speaking, the basket sizes across the board are higher and customer counts are higher as well.

Susan Anderson -- B. Riley -- Analyst

Got it. Okay. And then I think you guys had said last quarter, there's no supply issues within PSP, like some of your peers had seen that maybe it was in some categories that you guys don't play in?

Brian R. Kahn -- President, Chief Executive Officer And Director

They've had to fight it out as well. They're not at 100%. They haven't had this, I'd say the severity of their struggles haven't been quite as large as others may be, but they have been below par all year long as well. And there are certain categories that are a bigger struggle than others, but they've figured out how to grind it out and make sure that the customers are getting served. And of course, dealing with the customers that come in looking for something can't find it and then call in to say, where is it. So it's a constant grind.

Susan Anderson -- B. Riley -- Analyst

Great. Okay, well, thanks so much and nice job on the quarter and for the rest of the year.

Operator

Your next question is from Ian Zaffino of Oppenheimer.

Ian Zaffino -- Oppenheimer -- Analyst

Great. Tank you very much. Question would be just can you maybe help us understand the quantification of inflation versus price? And how much are you able to offset it? How much would it impact you, third quarter, how much should we expect in the fourth quarter and beyond?

Brian R. Kahn -- President, Chief Executive Officer And Director

Yes. I'll speak to it generally, but not specifically and certainly not by brand. And it's been different. We have some brands that have been able to pass it on because that's how their pricing model works and the customer accepts the higher pricing. But there are others that it's a struggle, and there's margin pressure because of it. Costs are going up. There's no doubt about that. Pricing has gone up as well, but there are some instances where the price increases are not fully offsetting the cost increases, and that's temporary -- and that's what we have. And it's amazing that the businesses are continuing to do as well as they are despite that. But I think that at some point, if your costs go up too much, you just can't keep raising price because you're going to price the customer out.

So I think you need to be very careful about that, and the management teams are. I would, I guess, trying to add to that to help you out, the pricing pressure is as high today as it has been. So what you're seeing now and is the worst that it's been, it's also informing budgets for next year because you can't count on things reversing, and still very optimistic about what next year looks like. I can't imagine what it would look like if the inflationary pressures subsided. But right now, I think we've got to continue to believe that inflation is here and it's going to be an issue.

Ian Zaffino -- Oppenheimer -- Analyst

Okay. And then just finally, and this was sort of touched on before. Sylvan's contribution in the fourth quarter, what should we expect? Is $3 million the right number? Or would it be less than that because of incremental costs?

Eric Seeton -- Chief Financial Officer

Yes, this is Eric, Ian. So generally in that ballpark, yes, for Q4.

Ian Zaffino -- Oppenheimer -- Analyst

Okay. Thank you very much.

Operator

Your next question is from Brian Hollenden from Aegis Capital.

Brian Hollenden -- Aegis Capital -- Analyst

Hi guys, thanks for taking my call. Just a follow-up, I guess, to the last question, the $3 million impact for 4Q. Is that the right -- if we annualize that, is that the right way to think about sort of the next 12 months impact from Sylvan?

Brian R. Kahn -- President, Chief Executive Officer And Director

Go ahead, Eric.

Eric Seeton -- Chief Financial Officer

Yes. I mean, I think that's about right, they are right now. We'd expect some moderate growth from out of that before we start to grow the franchise base with our efforts.

Brian Christopher Hollenden, Aegis Capital Corporation, Research Division-MD of Financial Institutions & Cannabis Equity Research

Okay. And then what was it particularly about Sylvan acquisition that made it appeal and just given that most locations were already franchised?

Brian R. Kahn -- President, Chief Executive Officer And Director

Well, the ability to add locations, the efficiency of their model and the free cash flow that we get out of that business for the amount that we had to pay for it, I think that business ultimately will be a much larger business. And our entry point was very attractive at $81 million.

Brian Hollenden -- Aegis Capital -- Analyst

And then last quick one for me. Are any of your segments working on adjusting their supply chain in the future kind of producing closer to the customer?

Brian R. Kahn -- President, Chief Executive Officer And Director

I think our -- we have businesses that have already adjusted significantly how they look at supply chain, moving countries, that's the one thing. That's a hard thing to do, also adjusting their vendors, but that's been an ongoing battle, and I think that, that will continue. And I wouldn't even want to predict how much additional change will come over the next year or several years. But, because you don't know what forces you're going to be fighting against. But yes, there's been significant adjustment in many ways.

Brian Hollenden -- Aegis Capital -- Analyst

Alright. Thank you.

Operator

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

Brian R. Kahn -- President, Chief Executive Officer And Director

Sure. Well, again, thank you all for joining us this afternoon. And operator, you may conclude the call.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Andrew F. Kaminsky -- Executive Vice President And Chief Administrative Officer

Brian R. Kahn -- President, Chief Executive Officer And Director

Eric Seeton -- Chief Financial Officer

Mike Baker -- D.A. Davidson -- Analyst

Larry Solow -- CJS Securities -- Analyst

Susan Anderson -- B. Riley -- Analyst

Ian Zaffino -- Oppenheimer -- Analyst

Brian Hollenden -- Aegis Capital -- Analyst

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