FAT Brands Inc. (NASDAQ:FAT) Q2 2023 Earnings Call Transcript

FAT Brands Inc. (NASDAQ:FAT) Q2 2023 Earnings Call Transcript August 5, 2023

Operator: Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the FAT Brands Inc. Second Quarter 2023 Earnings Conference Call. At this time, all participants have been placed on mode. Please note that this conference is being recorded today, August 3, 2023. On the call from FAT Brands are Chairman of the Board; Andy Wiederhorn; and Co-Chief Executive Officer and Chief Financial Officer, Ken Kuick. This afternoon, the company made its second quarter 2023 financial results publicly available. Please refer to the earnings release and earnings supplement, both of which are available in the Investors section of our website at www.fatbrands.com. Each contain additional details about the second quarter, which closed on June 25, 2023, but before we begin, I must remind everyone that part of the discussion today will include forward-looking statements.

These forward-looking statements are not guarantees of future performance, and therefore, undue reliance should not be placed upon them. Actual results may differ materially from those indicated by these forward-looking statements due to a number of risks and uncertainties. The company does not undertake to update these forward-looking statements at a later date. For a more detailed discussion of the risks that could impact future operating results and financial condition, please see today’s earnings release and recent SEC filings. During today’s call, the company will discuss non-GAAP financial measures, which it believes can be useful in evaluating its performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP.

Reconciliations to comparable GAAP measures are available in today’s earnings release. I would now like to turn the call over to Mr. Andy Wiederhorn, Chairman of the Board.

Andrew Wiederhorn: Thank you, operator, and hello, everyone, and thank you all for joining us on the call today. Let me begin by thanking our teams, our franchisees and our employees for their hard work as we continue to grow FAT Brand. Total revenue grew $4 million in the second quarter of 2023 to $106.8 million compared to $102.8 million in the prior year second quarter. The increase was driven by a 5% increase in royalties a 4.6% increase in company-owned restaurant revenues and a 13% increase in revenues from our manufacturing facility. System-wide sales grew to $572.7 million, a 1.7% increase when compared to the prior-year quarter. Turning to profitability. Our second-quarter adjusted EBITDA was $23.1 million compared to $29.5 million in last year’s quarter.

Last year’s adjusted EBITDA included a $10.1 million benefit related to employee retention credits. Excluding the impact of this benefit, adjusted EBITDA increased $3.7 million or 19% from the $19.4 million in Q2 of 2022. During the second quarter, we continued to focus on our organic growth strategy, opening 25 new units, bringing our year-to-date openings to 66 locations. During the third quarter, we plan to open over 35 units, of which 15 have already opened. For the full year, we are projected to open 175 new units, which is a 25% increase in new unit openings from 2022. We have capitalized on high demand for our brands in the market. signing franchise development deals for over 150 new locations so far this year, bringing our pipeline to over 1,100 signed agreements for new units over the next few years.

This pipeline of organic growth is estimated to be worth approximately $60 million in incremental adjusted EBITDA, bringing our total adjusted EBITDA to approximately $150 million and naturally deleveraging our balance sheet. Also, as previously announced, we plan to take Twin Peaks public in 2024. The timing and the size of the transaction will be subject to market conditions and other factors. While we see franchisee interest across our diversified portfolio of restaurant concepts, we remain especially focused on the expansion of the polished casual segment through Twin Peaks. Units continue to produce industry-leading average unit volumes of around $6 million, with some of our highest volume locations in Florida, generating AUVs between $9 million and $12 million.

These restaurants also have very strong margins. Since our acquisition in October of 2021, Twin Peaks footprint has continued to grow in both unit count and geographically and now operates in 27 states and 2 countries. During 2023, we plan to open 18 to 20 new lodges with 8 lodges opened to date, bringing the unit count to 103 so far. We expect to end the year with approximately 115 lodges, a nearly 40% increase in unit count since FAT Brands acquisition. Over the next several years, Twin Peaks plans to double its unit count to more than 200 lodges and increased the mix of franchise locations from 70% today to more than 80%. The planned unit growth is expected to increase systemwide sales to approximately $1 billion. Let’s shift to our burger brands, where we are also seeing consistent growth.

During the second quarter, we opened a Fatburger in Greater Tampa, which is the first of 4 locations that we’ll be opening in the area over the next 5 years. Additionally, we plan to open 10 locations in Orlando within the next 7 years with the first location slated to open by the end of the year. Johnny Rockets has also enjoyed continued growth around the globe with new locations in Arizona, Chile, Peru, India and multiple locations in the UAE. The brand also signed a development agreement to open 20 new franchise locations throughout Texas in the coming years. Great American Cookies continues to expand to new territories, most recently making its debut in the State of Alaska. We are also pleased to have hit a key growth milestone for the brand, our 400th location to date.

Additionally, we opened our second Pretzelmaker drive-thru location in Cedar Rapids, Iowa, expanding the drive-through model continues to be an important objective for the brand, thanks to the strong returns we have generated right out of the gate. Co-branding is another key strategy to drive sales and leverage margins. This spring and summer, we signed several new development deals to open over 30 new co-branded and franchised locations in Iraq. This deal includes 12 co-branded Fatburger and Buffalo’s Express locations, 10 co-branded Great American Cookie and Marble Slab Creamery relocations and 10 Hot Dog on a Stick locations. They will open throughout the country outside of the Kurdistan region over the next 5 years with the first unit set to open in 2024.

Currently, Fatburger has 4 units already operating in the Kurdistan Region with a strong following there. In the coming months, we will also unveil the first co-branded Fatburger and Round Table Pizza location in Texas. This is just the beginning of the growth that we anticipate for this first-of-a-kind co-branded concept. Our next area of focus is the growth of our manufacturing facility. As you know, our Georgia-based manufacturing facility produces pretzel mix and cookie dough for several of our brands. We believe our factory business today is in its early stage of growth, operating at only about 40% to 45% of its capacity, up from 33% 2 years ago. To drive capacity at our plant, we’ve completed the introduction of cookie offerings at Elevation Burger and have begun to roll out cookies across our other burger brands in our portfolio, namely Johnny Rockets and Fatburger.

The rollout is now complete in the key markets of Las Vegas and Los Angeles, and the nationwide rollout for both brands should be complete by the end of the summer. During the second quarter, our manufacturing facility generated $9.7 million in sales, a 13% increase over last year’s quarter. We are in the final stages of rebranding Nestle Toll House Cafe by Chips to Great American Cookies. As a reminder, in May of 2022, we acquired the Nestle Toll House Cafe by Chip franchise business. To date, we have converted over 50 stores to Great American Cookies and expect to complete the remaining conversions by late 2023. Now let us turn to FAT Brand’s second strategic pillar, growth by acquisition. When evaluating potential acquisition targets, our focus remains on strategic acquisition opportunities of brands with a proven track record of long-term sustainability and profitable operating performance.

We are particularly focused on the high-growth sports lodge category and would consider acquiring concepts with locations that can be converted into Twin Peaks. We’re also looking at other categories to round out our portfolio, such as salad sandwich or coffee brands. And finally, we continue to evaluate acquisitions that will leverage our existing manufacturing capacity and will increase our EBITDA. As a result of our robust growth over the last several years, in June, we strengthened our leadership team with the promotion of Jenn Johnston to CMO and added 2 new brand presidents. Prior to Jenn’s promotion, she was the President of our Quick Service division at FAT Brands. Her unique marketing and operations background will allow her to develop impactful campaigns that will increase brand visibility and drive profitable sales across our 17 concepts.

We are excited to welcome Jenn to the C-suite. As a result of this promotion, Allison Lowenstein now serves as the new Brand President of Great American Cookie, Marble Slab Creamery and Pretzelmaker. Allison brings over a decade of experience working with the respective brands having previously served as Executive Vice President of Brand Operations and Marketing at Global Franchise Group. Prior to joining the Global Franchise Group, Allison spent 13 years at Dunkin’ and Baskin Robbins in various leadership positions. Given Alison’s track record with Great American Cookies, Marble Slab and Pretzelmaker, we expect her to provide great value to the brands that she is leading. David Pear was also hired to assume the role of Brand President at Round Table Pizza.

David brings to the company’s strong strategic insights from his diverse restaurant background. He most recently served as Vice President of Strategic Initiatives at Desert De Oro Foods, a multi-unit franchise organization with 360 restaurants, including Taco Bell, KFC, Pizza Hut, Watteburger, Dickey’s Barbecue Pit and Dave’s Hot Chicken. Prior to that, David served as Senior Vice President of Operations at Del Taco. He brings experience from his time at Yum! brands, Taco Bell and Domino’s Pizza, where he led operational transformation through a combination of key initiatives focused on culture, continuous improvement of operational elements and the elevation of the guest experience. Looking at our balance sheet. In July, we sold an aggregate principal amount of $100.58 million of $105.8 million of new securitized notes with a 10% coupon rate, of which 6% is paid current and 4% is paid on a maturity date.

We have a healthy liquidity position consisting of both cash and $156.1 million of marketable securities in addition to the cash. These securities consist of bonds that were issued but not yet sold and bonds that we have repurchased, all of which are available for sale or resale to third-party investors. Before we close, I would like to share an update on the FAT Brands foundation and a new initiative that just kicked off. First, I would like to congratulate the FAT Brands Foundation Board for successfully launching the foundation for making an immediate impact only a few months in. To date, over 25 grants have been awarded to a wide range of nonprofit organizations in areas, including food and security, mental health, education and more. What makes it even more rewarding is that the grants hit close to home, all near FAT Brands locations.

I’m also pleased to update you on FAT Brand’s commitment to DEI. Mark Avery was recently appointed to Senior Vice President, DEI, in addition to his existing supply chain and global partnerships role. Under Mark’s leadership and in partnership with the multicultural foodservice and hospitality alliance, MFHA. We have launched an idea council, IDEA standing for inclusion, diversity, equity and accessibility. The council consists of 15 individuals, including support from our partner at PepsiCo. We look forward to sharing more updates on the work of the council in the coming months. Finally, I wanted to share that last month, Marble Slab Creamery celebrated its 40th anniversary and was also named as a top dessert treat chain by the USA TODAY. We are proud of the team for continuing the legacy of this brand and striving for outstanding achievements.

In summary, the opportunities ahead for FAT Brand are considerable, and we are well-positioned for growth. That brand is built on providing an authentic superior dining experience. We have a seasoned senior leadership team, coupled with a strong and dynamic brand management platform capable of seamlessly and cost-effectively integrating new brands. Our healthy and growing development pipeline will fuel growth for many years to come and will naturally de-lever our balance sheet. We look forward to updating you on our progress on future calls. We sincerely appreciate you joining us today and for your interest in FAT Brands. And with that, I would like to hand it over to Ken Kuick to talk about our financial highlights from the quarter.

Kenneth Kuick: Thanks, Andy. Total revenue during the second quarter increased 3.9% to $106.8 million, driven by a 5% increase in royalties, a 4.6% increase in company-owned restaurant revenues and a 13% increase in revenues from our manufacturing facility. Cost and expenses remained largely unchanged in the second quarter, decreasing 1.4% from the year-ago quarter. During the second quarter of 2022, we recognized $10.1 million of employee retention tax credits, which was primarily reflected as a reduction to cost of restaurant and factory revenues. During the fourth quarter of 2022, we fully reserved the entire $22 million of employee retention tax credit that we claimed during the year until such time that it has been determined that we have reasonable assurance that the credits will be realized.

During the second quarter of 2023, we reached that determination on a portion of the credits, representing cash received from the IRS and reversed $12.7 million of this reserve. For the second quarter, all of this resulted in cost of restaurant revenues being $10.1 million lower than normal in the second quarter of 2022 and general and administrative expense being $12.7 million lower than normal in the second quarter of 2023. And it’s important to note that the reversal of the reserve in the second quarter of 2023 is reflected as a reduction of adjusted EBITDA. Included in cost and expenses, general and administrative expense decreased to $9.9 million in the second quarter from $20.8 million in the prior year period. Excluding the reversal of the $12.7 million reserve I just referenced, general and administrative expense was $22.6 million in the second quarter of 2023, an increase of 8.6% over the prior-year quarter, and this increase was primarily due to higher professional fees related to certain litigation matters.

Cost of restaurant and factory revenues increased to $59.5 million in the second quarter of 2023 and compared to $49.8 million in the prior year quarter, driven by the $10.1 million of employee retention tax credits recognized in the second quarter of last year. Depreciation and amortization expense increased to $7.1 million in the second quarter from $6.7 million in the year-ago quarter, primarily due to depreciation of new company-owned restaurant property and equipment. Advertising expense was flat at $11.6 million in both the second quarter of this year and prior year, and advertising expenses vary in relation to advertising revenue. Other expense for the quarter was $24.2 million compared to $21.6 million in the year-ago quarter and was primarily comprised of interest expense on our securitizations.

Net loss for the quarter was $7.1 million or $0.53 per diluted share compared to a net loss of $8.2 million or $0.60 per diluted share in the prior-year quarter. And on an as adjusted basis, our net income was $3 million or $0.08 per diluted share compared to a net loss of $3.1 million or $0.29 per diluted share in the prior-year quarter. And with that, Carolyn, please open the line for questions.

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Q&A Session

Operator: [Operator Instructions] The first question comes from Joe Gomes with Noble Capital.

Joseph Gomes: Good afternoon. Congrats on the quarter. So the first question I wanted to ask in terms of the openings during the quarter, you did 25 at the first quarter call, you had said you were projecting 45. So I just wanted to see what happened there. You’ve kept the full-year guide at that 175. Was just wondering what happened in the quarter that come in at 25% as opposed to the projected $45 million.

Andrew Wiederhorn: We thought we’d end the quarter around 80 units, and we just had some slip into July and August, we’ll be at over 100 by the end of this month. So just a very mild slippage. The other thing about the quarter is that the quarter ended on June 25. And so there’s another week in June that some of the openings slipped into that last week of June, and that’s why it’s a big of a difference. We don’t see it changing in the full year.

Joseph Gomes: Okay. And I just got to ask, I think last year, there was some supply chain issues with getting equipment and everything. Does that have any role in some of the slippage?

Andrew Wiederhorn: It’s always an issue. It’s not a huge issue any more like it was before, but it is an issue. It’s also just getting the managers hired and trained. We’ve seen — that’s the area that you’re feeling the most pressure is at the manager level today. It’s not the line-level worker, which thank goodness, there’s plenty of again at a price.

Joseph Gomes: Pardon me. One of the other goals, as you mentioned, is getting the utilization of the factory up and you’ve done a commendable job with that. One of the things last year, you hired someone specifically to start going after third parties as opposed to in-house. Just wondering if you can give us a little color as to how that effort is progressing.

Andrew Wiederhorn: You bet; we’re just rounding the 1-year anniversary of that strategic initiative. And there’s 2 elements to it. One is rolling out the cookies and pretzel program across as many of our brands as we can. And that’s going to see an uptick in utilization over the coming rest of the year. Plus we also have this 1,100-store pipeline now, and many of those new restaurants will be selling cookies and pretzels as well as whatever else they’re selling. So that’s going to chew up a bunch of capacity as those restaurants open. In terms of third-party contracting, we’ve entered into several RFPs we’re in negotiations with several different groups about producing cookie pretzel mix for them. And it’s really just trying to carefully balance our margin on that production.

We have a very high margin producing for our own brands with the quality of the ingredient and the wholesale pricing that we can offer our franchisees is a very, very healthy margin in the 30% range or more for cookie dough and pretzel mix. And some of the third-party manufacturing some of those contracts have like a 10% margin. So we don’t want to use up capacity for low-profit business when we can save it for more of our own business or a richer, better third-party contracts. So we’re just trying to be thoughtful about which contracts we enter into. There are plenty of them out there.

Joseph Gomes: Okay. And you mentioned the recent debt raise, maybe give us a little color on your thoughts on the uses of some of that cash that has been raised. You didn’t haven’t mentioned anything about the preferreds that were up for redemption. I think there’s roughly $90 million of that left. Any thoughts on maybe paying off those preferreds? Or do you have other intentions for the cash that was raised?

Andrew Wiederhorn: Right. So we did raise a fair amount of additional cash just to have a ton of liquidity going into the second half of the year and being well-positioned for anything that comes along. In addition to that, we now have $156 million of marketable securities of bonds that we can trade with. And it’s certainly our intention to sell some of those bonds over the balance of the year. We are in discussions with some of the preferred shareholders, and these are private equity firms that we bought brands from. This is not the same holders that are publicly traded preferred shareholders, where we have a different obligation to the private equity firms to ultimately buy back some of that preferred at some point in time.

We are in negotiations with them. We’ll see if we get something done. Alternatively, we’ll sell the bonds, raise some cash and buy back that preferred that we’re obligated to redeem in the long run. There’s a lot of different options for liquidity for us. And so we’re trying to just as quickly as possible, reduce that preferred dividend expense and the cost of capital from the bond position is far less than from the preferred. So we’re eager to retire that if we can.

Joseph Gomes: Okay. And then noticed going through the release, litigation costs have increased substantially. I think they’re roughly running $7 million a quarter in the first 2 quarters of this year, which is kind of double what they were in 2022. Any expectations that those should start to come down? Have we seen the peak? Do we think they’re going to go higher? Just your best guess, Andy?