Carrols Restaurant Group, Inc.
Q2 2017 Earnings Call Transcript

Published: 10 Aug 2017

[Operator:]

Welcome to Carrols Restaurant Group Second Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] I would also like to remind everyone this conference call is being recorded today, Wednesday, August 9, 2017, at 8

[Paul Flanders:]

Good morning. By now you should have access to our earnings announcement released earlier this morning, which is available at our Web site at www.carrols.com under the Investor Relations section. Before we begin our remarks, I would like to remind everyone that our discussion will include forward-looking statements, which may consist of comments regarding our strategies, intentions, guidance or plans. These statements are not guarantees of future performance and therefore undue reliance should not be placed on them. We also refer you to our filings with the SEC for more details, especially the risks that could impact our business and results. During today's call, we will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with generally accepted accounting principles. A reconciliation to comparable GAAP measures is available with our earnings release. When we refer to acquired restaurants today, we're referring to those restaurants acquired from 2015 to 2017, while our Legacy restaurants include all of the company's other restaurants, including restaurants acquired before 2015. And with that said, I will now turn the call over to President and CEO of Carrols Restaurant Group, Dan Accordino.

[Dan Accordino:]

Thanks, Paul, and good morning, everyone. During the second quarter, we posted a solid 15.8% increase on overall restaurant sales reflecting our acquisition of over 100 restaurants since the start of the second quarter last year. Our comparable restaurant sales were also strong and increased 4.6% over the prior year quarter from a balance of premium products, value offerings and limited time offers. The increase in comparable restaurant sales reflected both higher average check and positive consumer traffic. Despite strong top-line sales, adjusted EBITDA was effectively unchanged, while adjusted EBITDA margin contracted 172 basis points due to continuing pressure on wage rates, higher commodity costs including a spike in beef costs in the second quarter and a higher level of promotional discounting. Adjusted EBITDA margin was further impacted by lower margins for the restaurants that we have acquired and offset somewhat by leveraging several other expense items. Promotions of premium items in the second quarter included limited time offers of new products built around the Bacon King platform, namely the Steakhouse King and the Mushroom & Swiss King. Our new Crispy Chicken Sandwich also continued to perform well. On the value side, our offerings included the 2 cheeseburger meal deal at $3.49, our 2 for $10 WHOPPER meal and the 2 for $5 Mix and Match fixing the extra-long cheeseburger and Original Chicken Sandwich. The brand also relaunched Mac N' Cheetos, which also serve as an add-on to drive check and we expanded our milkshake line with the introduction of an Oreo shake, Froot Loop shake and Lucky Charms shake. While second quarter sales growth was strong across all day-parts, our breakfast day-part experienced the highest growth with a 6% comparable sales increase. Notable promotions included the 2 for $4 CROISSAN'WICH deal, EGG-NORMOUS BURRITO offering as well as the 3 large pancake deal for $0.89. Turning to our growth strategy. We acquired 60 restaurants in the first half of the year, including 17 Burger King Restaurants in the Baltimore, Washington D.C. markets on June 6. The restaurants acquired in this latest transaction generated historical average restaurant sales volumes of almost $2 million, outpacing the Carrols system average and should have an accretive impact on restaurant margins. In June, we also closed a $75 million add-on offering to our existing 8% senior secured second lien notes. This generated incremental capital and provides us greater flexibility to selectively acquire additional restaurants as they come to market. We are currently evaluating a number of opportunities and hope to have further acquisition announcements to make in due course. Looking to the second half of the year, we believe the traction from recent product launches, coupled with Burger King's promotional offerings, will sustain moderate growth in comparable restaurant sales. However, we expect labor cost and the ongoing level of promotional activity to continue pressuring margins. Beef prices have begun to recede from the second quarter highs and we believe should continue to moderate for the balance of the year. In view of these factors, we are increasing our sales guidance for the year to reflect the recent acquisitions, while maintaining our previous guidance for adjusted EBITDA. Longer term, we continue to believe that our growth strategy is an important component of building shareholder value and can enable us to expand margins as we improve the performance of acquired restaurants and leverage our infrastructure. With that, I will now turn the call over to Paul for our financial review.

[Paul Flanders:]

Thanks Dan. Restaurant sales during the second quarter increased 15.8% to $279.5 million, with restaurants acquired since the beginning of 2015 contributing $53.3 million of sales compared to $23.6 million in the first quarter of last year. Comparable restaurant sales increased 4.6%, reflecting a 3.3% increase in average check and a 1.3% increase in customer traffic. The average check increased included 1.6% of menu pricing and 1.7% due to the changes in sales mix. In the year-ago period, comparable restaurant sales increased 0.7%. Adjusted EBITDA was $27.5 million in the second quarter compared to $27.9 million in the prior year period, while adjusted EBITDA margin decreased 172 basis points to 9.8% of restaurant sales due to the factors that Dan discussed. Restaurant-level EBITDA was $40.6 million in the quarter compared to $41.5 million in the second quarter of 2016. Restaurant-level EBITDA margin was 14.5% of restaurant sales and 268 basis points lower than the prior year period. Cost of sales as a percentage of restaurant sales was 243 basis points higher in the second quarter compared to the prior year period. This included the impact of increased ground beef prices, which at $2.21 per pound were more than 13% above the second quarter of 2016. Cost of sales were further impacted by higher promotional discounting compared to the prior year period and by negative sales mix changes due to higher cost on certain new or limited-time premium sandwiches. Menu pricing of 1.6% modestly offset some of the impact of these other costs. Restaurant labor expense increased 100 basis points to 31.5% of restaurant sales compared to the prior year quarter, due primarily to a 6.8% increase in our average hourly rate, higher management costs and some deleveraging from reduced labor efficiency due to the higher promotional levels. General and administrative expenses held steady at $14.4 million in the second quarter compared to the prior year period and decreased 79 basis points to 5.2% as a percentage of sales. Note that G&A expenses in the second quarter of 2017 included $0.4 million of acquisition cost and $0.9 million of stock compensation costs. Net income was $6 million for the second quarter of 2017, or $0.13 per diluted share compared to net income of $9.4 million, or $0.21 per diluted share in the prior year period. Net income in the second quarter of 2017 included $0.4 million of impairment and other lease charges and $0.4 million of acquisition expenses. For the same period last year, the net income included $0.3 million of impairment and other lease charges, $0.2 million of acquisition expenses, a $0.5 million gain from a partial condemnation and a $1.9 million accrual related to a litigation settlement. Adjusted net income was $6.6 million or $0.14 per diluted share compared to $8 million or $0.18 per diluted share in the prior year period. Because we had a full valuation allowance on our deferred income tax assets until the fourth quarter of 2016, we did not record any income tax expense in the second quarter of 2016. For comparability to our 2017 results, adjusted net income for the second quarter of 2016 is presented with a normalized tax provision as if the valuation allowance had been reversed prior to 2016. Total capital expenditures were $14.3 million in the second quarter of 2017 and expenditures for the acquisition of Burger King Restaurants totaled $16.2 million. On June 23, we closed on the $75 million add-on offering to our 8% senior secured second lien notes due 2022. The new notes were issued at 106.5% of the principal amount for total gross proceeds of $79.9 million including the bond premium. Net proceeds of add-on bond sale were used to repay outstanding revolving credit borrowings under our senior credit facility and to pay related fees and expenses with the remaining net proceeds to be used for working capital and general corporate purposes, including funding possible future acquisitions. At the end of the second quarter, our cash balances were $33.7 million and we had no outstanding borrowings under our $73 million senior credit facility. I will now review our guidance for 2017. As a reminder, other than the restaurant acquisitions already completed through the first half of the year, our guidance does not include any impact from other potential transactions that we might complete during the third or fourth quarters. We expect total restaurant sales to be $1.05 billion to $1.07 billion, previously estimated at $1.03 billion to $1.06 billion, which includes an estimated 2% to 3% growth in comparable restaurant sales. Commodity costs are expected to increase 2% to 4%, including an 8% to 10% increase in beef costs compared to our previous estimate of 1% to 3% increase in commodities including 2% to 4% increase in beef. General and administrative expenses are expected to be $53 million to $55 million, excluding stock compensation expense and acquisition related cost, a decrease from our previous estimate of $54 million to $56 million. Adjusted EBITDA is still expected to be $90 million to $95 million. Our effective income tax rate is still estimated to be 18% to 20%, and capital expenditures are still expected to be $65 million to $85 million, which includes remodeling of 28 to 32 restaurants, rebuilding 6 to 8 restaurants and the construction of 10 to 15 new restaurants including 2 to 3 relocations of existing units. Capital expenditures also include $10 million to $12 million for non-recurring investments in new kitchen production and product holding systems, new training systems and certain POS system upgrades. Lastly, we still plan to close 10 to 20 restaurants this year, 16 of which had been closed at the end of the second quarter. That concludes our prepared remarks. So with that, operator, let's go ahead and we'll open the lines for questions.

[Operator:]

Certainly [Operator Instructions] And we'll go first to Will Slabaugh of Stephens.

[Will Slabaugh:]

Hey, Thanks. Congrats on the quarter. First, I wanted to ask you around the beef market given that spike we saw and some of the comments that you made. Can you talk a little more specifically about what you've been seeing in the beef market in the past few weeks or months and where we sit most recently versus the lows and highs that you've seen so far this year?

[Paul Flanders:]

Yes. We came in the year a little bit under $2 -- this is Paul, by the way. And right after the first-- we talked on the first quarter about some impacts from some supply conditions from New Zealand and Australia particularly. And right after our first quarter call, we then saw domestic prices, particularly in the fresh 50s, spike up for, I don't know, a period of maybe 5 or 6 weeks. Literally the price doubled on that particular cut for a while. And it's -- builds, cents come back down receded to close to where were they were before that. I would say that our overall average cost in the quarter was $2.21. We peaked as high as $2.36 and it's been working its way down from there. And presently, we're back under $2.30 at this point and expect that to continue to go down as we go through the balance of the year.

[Will Slabaugh:]

Great. And as far as the top-line goes, the 4.6% comp was pretty impressive, especially considering what's going on in the industry. Can you talk a little more about what you've seen? Recently we've heard a lot about volatility. So, I didn't know if you'd be willing to talk about what you've seen so far maybe towards the end of the quarter and in into July.

[Paul Flanders:]

Well, I would say when we look at our second quarter numbers, I would -- we were pretty steady in terms of the performance on a month-to-month basis throughout the quarter, with 2-year trends being pretty consistent year-over-year as well. Maybe June was the lighter of the 3 months, but July has continued to be solid and I would describe it as mid single -- low mid-single digits. And August with some of the recent changes in the promotional schedule is always ratcheting up a little bit up beyond that.

[Will Slabaugh:]

That's great. Thanks guys.

[Operator:]

And we now will take a question from Bryan Hunt of Wells Fargo.

[Bryan Hunt:]

Good morning and thanks for your time. I'd like to continue the discussion on food cost. I mean beef spiked, but if we look at kind of across the board whether it's bacon, chicken breast, dairy products, there seems to be a wave of inflation, not that it's as high as what you've seen in beef, but it seems to be pretty comparable across the board. Can you talk about what you're seeing in other food cost and whether your Burger King sourcing co-op has hedged most of that stuff out for you?

[Paul Flanders:]

Yes. I mean obviously beef is the most significant cost. It has been the most volatile to your point. Yes, there are some other items moving around, not nearly to the magnitude of the change in beef costs. We expect pork prices have begun to go up, that affects bacon and sausage. It's not a huge part, but it's going to have an impact in the back half clearly. We've seen some increases in some other items. And albeit the co-op is contracted on a number of the other commodities, but that's -- although all that's reflected in our current guidance, or I should say our updated guidance.

[Bryan Hunt:]

I mean do have just like a general comment, Paul, on what you think food inflation might be for the year for you all?

[Paul Flanders:]

Yes. Our view is that on an overall basis, we'll be between 2% and 4%.

[Bryan Hunt:]

Okay. And kind of switching gears to price, I mean you are all up 1.6% on pricing. How do you take that stands relative to your main peers and do you think you have more room to move?

[Dan Accordino:]

Yes. Bryan, this is Dan. I look at the pricing on every other month basis and that's exactly how we do look at pricing as relative to our peers. It's not cost-based, it's market-based. And my sense is that we will be able to have another price increase at around the October timeframe.

[Bryan Hunt:]

Okay. I mean, from an index standpoint, I mean, are you trailing your peers or do you feel like you can lead in certain situations?

[Dan Accordino:]

Well, we are not -- I'd say we are comparable to our peers. But I also have to look at the pricing within the menu and also relative to what's going on in our promotional environment. So, if we are running two for $10 WHOPPERS, you have to be sensitive to what you're going to price the individual WHOPPER at because you've got the promotional activity.

[Bryan Hunt:]

Just a couple of more questions. When you look at the introduction of new products like your Crispy Chicken sandwich versus running a promotion like -- on an existing product like, call it two for $10 WHOPPERS, where do you see the greatest impact on your same-store sales growth? Do you feel like it's pulling the promotional lever or rolling out new innovation?

[Dan Accordino:]

I would tell you it's both, Bryan. I'm not -- I wouldn't say -- I would say at the breakfast day-part, certainly, the promotional activity has been much more helpful than any new products that we've rolled out. But, the new products have been very successful and the bundled meals have also been very successful for us.

[Bryan Hunt:]

Yes. I was just trying to get a handle on whether the -- you feel that consumer is much more responsive to promotions and it sounds it's somewhat the case. And then lastly, when you look at labor rate, I think the government data came out and we have the greatest number of job openings in U.S. history. How are you all in terms of labor turnover relative to a year ago and filling positions within your restaurants?

[Dan Accordino:]

Actually our team member turnover is actually lower than it was a year ago and that something that we've been dramatically focusing on because that's the best way to increase productivity given what's going on in the wage environment. So, we've been pretty good in terms of being able to maintain a pretty stable level of staffing in our restaurants, but it's been a primary focus also.

[Bryan Hunt:]

Very good. I will hand it off to somebody else. Thanks for your time.

[Dan Accordino:]

Yes. Thank you.

[Operator:]

And our next question will come from Jeremy Hamblin of Dougherty & Company.

[Jeremy Hamblin:]

Hey, good morning guys. First, a couple of housekeeping items. In terms of thinking about interest expense, Paul, in the back half of the year given the updated debt situation. What should we be looking at on a quarterly basis in terms of kind of the reported interest expense up to like $5.5 million per quarter?

[Paul Flanders:]

I'd say it might be a little bit higher than that. It's probably $5.6 million to $5.7 million a quarter. We've got the increase on the $75 million obviously. And there is an offset because to the extent we sold the bonds at a premium, the premium will get amortized under the effective interest method as reduction in interest expense.

[Jeremy Hamblin:]

All right, got it. Thanks. And then just want to come back to your cost of sales. And obviously, we are all kind of aware of the beef prices and the spike in that kind of near-term impact. But, as we look in the back half of the year and even just kind of going back to Q2, it almost appears as though the promotional discounting has had an equal effect on your cost of sales. If you could take that kind of 243 basis points that your cost of sales delevered in Q2. How much of that was related to the beef prices versus the promotional discounting?

[Paul Flanders:]

Well, beef prices were about 50 basis points, commodities overall -- I'm sorry, beef costs were about 80 basis points, commodities overall were about 150. And you're correct, the discounting level relative to last year, because it's increased from where we were middle part of last year increased throughout the back half of 2016, early 2017. And so just absolute discounting level's higher and that's probably another 50 to 70 basis points to the change.

[Jeremy Hamblin:]

Okay. And then, as a way of thinking about this in the back half of the year, commodity impact. What should we be thinking in terms of commodity impact on your cost of sales in the back half of the year?

[Paul Flanders:]

Well, as I said, I think the main driver here is beef cost, which in our view is that those are going to recede gradually through the balance of the year. There are some other increases, such as pork, which I talked about. But I think the overall impact of commodities is likely be much, much less than it was in the -- particularly in the second quarter.

[Dan Accordino:]

And relative impact, promotional stuff will be lower too.

[Paul Flanders:]

Correct.

[Dan Accordino:]

Jeremy and the relative impact of the promotional items -- this is Dan, the relative impact of the promotional items will be lower as well because the promotional activity started to ramp up in the third and fourth quarters of last year.

[Jeremy Hamblin:]

Got it. Okay. And then, as a follow-up to that, you also saw your ramp in labor costs really take hold in Q3 and Q4. And obviously, you've had at least 100 basis points or roughly 100 basis points in Q2 and 140 in Q1 in terms of deleverage on labor. As we get into the back half of the year, should we assume that, that impact, on a relative basis is going to be significantly lower than what you've seen in the first half of the year?

[Paul Flanders:]

Yes. I think that's a fair assumption. I mean we're still going to see some deleveraging, I think. But, it's on a relative basis, absolutely correct. It should be lower.

[Dan Accordino:]

It will be lower until we get to January. And then, we've got these minimum wage increases that take effect again.

[Jeremy Hamblin:]

Okay. And then, in terms of you've done, obviously, some recent acquisitions that are exciting. As we look at the pipeline moving forward, you've mentioned that you've got some other things you might be working on. Is that kind of piggybacking off of these deals in the mid-Atlantic? Can you maybe discuss a little bit about how fertile that pipeline looks today and whether there's opportunities given the number of units you've already acquired to even further accelerate from here?

[Dan Accordino:]

Many of the opportunities or some of the opportunities that we're looking at, yes, are correlated to the acquisition that we made in Baltimore. We knew of other opportunities before we did this deal and we are continuing to work those opportunities. In addition to that, we have other opportunities in our current footprint, primarily in the Southeast.

[Jeremy Hamblin:]

Okay. And is the pricing environment, the multiples you're having to pay for those deals, still pretty attractive in that kind of 4x, 4.5x sellers cash flow range?

[Dan Accordino:]

Yes.

[Jeremy Hamblin:]

Great. Thanks guys. Good luck.

[Paul Flanders:]

Thanks Jeremy.

[Operator:]

[Operator Instructions] We'll go now to [indiscernible] of Raymond James.

[Unidentified Analyst:]

[Brandon] [ph] filling in for Brian. Just to circle back on the 2Q labor costs. Looks like cost per operating week was up almost 8% year-over-year on excess wage inflation. Could you guys give some color on what's driving that? Were there any one-time insurance or other items on that line or was that perhaps a function of higher labor costs in the recently acquired? Thanks.

[Paul Flanders:]

I'm not sure I totally understood that question. I mean you talk about the overall labor cost? I mean the average wage rate was up about 7% -- 6.8%, which is primarily what's driving. As well as -- there has been similar increases in manager wages as well.

[Unidentified Analyst:]

Okay. And then, just quick housekeeping question. Can you provide the breakout of the store count at the end of 2Q between the legacy and acquired units?

[Paul Flanders:]

Yes, hang on a second. The acquired units, which is from 2015 through 2017, there's a 170 of those, the balance would be considered Legacy.

[Unidentified Analyst:]

Okay. Thank you. Good for me.

[Operator:]

And with that, that does conclude today's question-and-answer session. I'd like to turn the conference back to our presenters for any additional or closing comments.

[Paul Flanders:]

We have no additional comments other than to thank you for your time today. And we look forward to updating you in approximately three months. Thanks a lot and have a good day.

[Operator:]

And with that, ladies and gentlemen, that does conclude today's call. We'd like to thank you again for your participation. You may now disconnect.