Food Franchisors Ltd

It was March 2019, and Victor Fernandez sat at his desk and contemplated the work in front of him. Victor had graduated from RMIT University in December 2018, and had been hired by an investment fund company as a junior analyst. His company provides financial consulting services to clients, and Victor's new job required him to review the financial performance of a client and make recommendations to the client. The senior analyst to whom he reported would arrange for him to meet with the client. The first company Victor had been tasked to review was Food Franchisors Ltd, known as Food Franchisors.

As Victor looked over Food Franchisors annual reports of past four years (see Tables 1-3 for financial information), he considered how to approach his analysis. He needed to thoroughly assess Food Franchisors' past financial performance; this would affect the recommendations that he gave to the client. His boss was planning to arrange for him to meet with Food franchisors' Chief Operating Officer (COO), Kim Lee. Victor's senior analyst told him that Kim had a very busy schedule and she didn't like people wasting her time.

Background

Food Franchisors1 Ltd, known as Food Franchisors, is a global food and beverage company with its headquarters in Queensland. Its business model is as a franchisor and, as such, operates nine franchises. Today, network of franchisors spans over 2,400 outlets across Australia and internationally which over 15,000 employees.

The franchises that are part of this company are all within either the cafe? and coffee shops industry or the fast food and takeaway food services industry. Food Franchises also runs. some central services providing coffee and bakery products to the various franchisees as well as procurement, warehousing and distribution operations.

Industry Outlook

Revenue for the Cafes and Coffee Shops industry has grown moderately over the past five years, supported by Australia's vibrant coffee culture. Industry revenue is expected to grow at an annualised 2.5% over the next five years to $9.9 billion, and after that at 1.7% per annum. Despite the industry's positive revenue performance over the past five years,

1

A franchisor is a person or company that grants the license to a third party for the conducting of a business under

the franchisor's marks. The franchisor owns the overall rights and trademarks of the company and allows its franchisees to

use these rights and trademarks to do business.

1

competitive pressures have pushed profitability down over the period. Australia's coffee culture and its growing number of speciality cafes and coffee shops have contributed to high industry competition, low barriers to entry and low industry concentration.

Regarding the Fast Food and Takeaway Food Services Industry, consumer health awareness has transformed this area industry over the past five years. Increased awareness of fast food's nutritional content and a conscious effort by consumers to choose healthier options have affected industry demand. Industry operators have responded by introducing a range of healthier, premium choices with less fat, sugar and salt. The change in consumer preferences has also prompted an influx of new operators offering higher quality fast food options. Whilst revenue is expected to rise at an annualised 3.3% over the next five years, traditional fast food has declined as a share of industry revenue, while revenue from premium and healthy categories has grown. Competition among industry players has been intense over the past five years, as traditional operators have fought for market share while new establishments offering healthier options have reduced demand for existing players.

Food Franchisors' operational issues

2018 was not a good year for Food Franchisors. Early in the calendar year, there was a concerted public campaign by franchisees who had been forced to walk away from their businesses because they could not find a buyer and for a multitude of reasons, some financial and some personal, could not remain in these businesses. These franchisees argued that the quality of foods provided by Food Franchisors had deteriorated, but prices had gone up, causing customers to flee and revenues to fall.

The share price reflected the general turmoil.

On December 31 2017 the share price was $2.50 but by 30 June 2018, it had dipped to $0.46

For the 2017/2018 year, Food Franchisors reported a $307 million loss after booking $427 in

asset impairments and costs associated with closing 250 stores, representing 17% of its

Australian network. Whilst revenue for the year was up by 7% when compared to the

2016/2017 results, the company had been forced in June 2018 by its lenders to restructure

its debt. However, despite this negative situation, the share price rose to $0.51 by mid-

September 2018.

The evaluation

The COO, Kim Lee, would like some advice on how to improve the company's financial performance and how to win back shareholder and franchisee confidence. Assume you are Victor Fernandez. Are you able to complete his tasks: (1) interview Food Franchisors Chief Operating Officer, Kim Lee, and (2) prepare written advice and submit to the senior analyst within 2 weeks after the interview?

2 Please note: you are required to conduct a thorough financial analysis based on the financial statements using the tools learned from the course.

Table 1 Food Franchisors Ltd Income statement for year ending 30 June 2018 2017 2016 $'000 2015 $'000 Revenue from sale of goods $'000 $'000 297,719 Cost of sales 245,873 164,840 120,768 (218,832) (167,772) (97,675) Gross Profit (75,310) 78,887 78,101 67,165 Other revenue 45,458 76,315 103,422 110,257 Other gains and losses 126,477 (1,705) 6,102 (25) Selling expenses 279 (11,095) (10,167) (15,530) (17,552) Marketing expenses (6,565) (2,501) (3, 755) (27,269) Occupancy expenses (32,521) (7,952) (7,595) (10,984) Administration expenses (40,645) (25,680) (20,197) (17,882) Operating expenses (44,977) (25,660) (26,858) (26,161) Depreciation and amortisation expense (13,073) (9,338) (6,584) (3,707) Impairment loss on intangible assets (306,152) (2,950) Impairment loss on trade receivables (29,089) (2,462) (2,086) (2,056) Write down on property plant and equipment (17,498) (189) 0 Other expenses (19,235) I (6,503) (8,635) (9,970) Earnings before Interest & Tax (EBIT) (367,353) 97,173 86,157 53,683 Finance costs (12,877) (9,560) (9,574) 7,299) Profit before tax (380,230) 87,613 76,583 46,384 Income tax benefit / expense 73,537 (25,686) 23,620) (14,165) 306,693 61,927 52,963 32,219 Profit for period Cents (169.5) 22.1 Basic earnings per share 35.7 32.3 Diluted earnings per share (169.5) 35.7 32.3 22.1Balance Sheet as at 30 June 2018 2017 2016 2015 $'000 $'000 $'000 $'000 Assets Current Assets Cash & cash equivalents 15,871 9,583 16,956 14,395 Trade and other receivables, 50,325 83,392 41,012 41,077 Inventories 24,568 28,451 15,655 20,453 Other financial assets 16,266 10,167 6,018 5,215 Current tax assets 7,337 4,455 8,550 Assets classified as held for sale 9,362 Other current assets 5,719 3,215 2,210 2,338 Total Current Assets 130,448 134,808 86,306 92,028 Non-current Assets Trade and other receivables, 785 2423 3429 2832 Property, plant & equipment 64,625 95,554 51,106 42,927 Intangible assets 364,063 668,926 595,524 594,101 other financial assets 8,334 14,260 9,646 4,391 deferred tax assets 32,255 13,657 7,394 7,779 Total Non-current 470,062 794,820 667,099 652,030 Assets Total Assets 600,510 929,628 753,405 744,058 Liabilities Current Liabilities Trade and other payables 71,352 69,816 22,373 29,768 Provisions 18,443 7,422 3,518 5,558 Borrowings 264,207 722 165 50,475 Current tax liabilities 2,546 Other current liabilities 3,980 10,747 18,911 9,724 Liabilities classified as held for sale 3,769 Total Current 361,751 91,253 44,967 95,525 Liabilities Non-Current Liabilities Borrowings 49 249,248 205,735 156,169 Provisions 13,245 393 307 272 Derivative financial instruments 1,547 1,810 Deferred tax liabilities 64,187 119,433 115,908 115,908 Other 1,691 2,319 10,366 22,185 Total Non-Current Liabilities 80,719 373,203 332,316 294,534 Total Liabilities 442,470 464,456 377,283 390,059 Net Assets 158,040 465,172 376,122 353,999 Equity Issued capital 428,640 402,472 324,072 315,051 Retained Earnings -270,609 62,594 50,555 38,882 Reserves 106 Total Equity 1,495 66 158,040 465,172 376,122 353,999Table 3 Food Franchisors Ltd Statement of Cash Flows for year ending 30 June 2018 2017 2016 2015 $'000 $'000 $'000 $'000 Cash flows from operating activities Cash receipts from customers 565,701 456,000 332,754 263,555 Cash paid to suppliers and employees (535,203) (361,329) (239,623) (198,447) Interest paid (9,603) (9,416) (9,036) (7,242) Income taxes paid (10,051) (21,460) (19,298) (23,166) Net cash from operating activities 10,844 63,795 64,797 34,700 Cash flows from investing activities Purchase of property, plant and equipment (22,856) (30,650) (14,429) (6,551) Payments for intangible assets (668) (537) (575) (465) Proceeds from sale of property and plant 6,867 163 131 197 Interest received 968 801 486 265 payments for business (7,631) (67,195) (6,953) (194,280) amounts advanced to other entities (469) (5,696) (8,719) (10,086) repayments of advances previously made to other 2,106 entities Net cash used in investing activities (21,683) (103,114) (30,059) (210,920) Cash flows from financing activities Ordinary dividends paid (21,980) (42,888) (31,456) (24,122) proceeds from issue of ordinary shares 21,973 35,600 68,280 payments for share issue costs (472) (543) (47) (1,657) payment for debt issue cost (894) (223 (802) (445) Proceeds from borrowing 145,500 189,500 148,500 205,000 Repayment of borrowings (127,000) (149,500) (148,372) (68,000) Net cash used in financing activities 17,127 31,946 (32,177) 179,056 Net increase( decrease) in cash and cash equivalents 6,288 (7,373) 2,561 2,836 Cash and cash equivalents at beginning of year 9,583 16,956 14,395 11,559 Cash and cash equivalents at end of year 15,871 9,583 16,956 14,395