Carrols Restaurant Group, Inc.
Q2 2014 Earnings Call Transcript

Published: 5 Aug 2014

[Operator:]

Good day and welcome to the Carrols Restaurant Group Incorporated Second Quarter 2014 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Paul Flanders, Chief Financial Officer. Please go ahead, sir.

[Paul R. Flanders:]

Good morning. By now, you should have access to our earnings announcement released earlier this morning, which is available on our website 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 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 our results. During today’s call, we will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. Presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with General Accepted Accounting Principles. A reconciliation table to comparable GAAP measures is available in our earnings release. With that said, I will turn the call over now to Dan Accordino, our President and CEO.

[Daniel T. Accordino:]

Thanks, Paul, and good morning, everyone. Although sales were weaker than expected in the second quarter we were able to slightly improve Restaurant-Level EBITDA to increase Adjusted EBITDA and to narrow our net loss compared to the year ago period. Restaurant sales declined 2.8% from the second quarter of 2013 to $168.6 million, reflecting a comparable restaurant sales decrease of 2% as well as having six fewer restaurants in operation compared to last years second quarter. There were a number of factors affecting sales in the quarter. First, our core customer continues to be sensitive to overall economic conditions and spending within QSR and across other retail segment did not rebound as much as expected when weather conditions improved after the first quarter. Second, sales were impacted by a reduction in spending and local advertising compared to the second quarter of 2013. Burger King and non renewal of a matching contribution program impacted the advertising spending in a number of our markets. Third, we completed less than half the number of remodels in the first half of 2014 compared to the same time last year. Specifically, 28 remodels were completed compared to 71 in the first half of 2013, accordingly the impact of sales increases from our remodeling program has been lower so far this year. However, we anticipate this trend will reverse with our reacceleration of planned remodeling in the second half of the year. On a positive note our comparable restaurant sales trends improved sequentially throughout the second quarter and turned positive in July. We are optimistic the sales trends will be a little better in the second half of the year. As you know the Burger King Menu strategy is centered on a balanced marketing approach with regularly updated value options across all layers of the menu that also focuses on launching fewer but more impactful products that offer customers new product offerings without adding significant operational complexity. During the second quarter, Burger King launched four new sandwiches across various layers of the menu. On the premium side, we introduced the Barbeque Bacon [Walker] Sandwich the two for five line up was expanded with the introduction of the Chicken Big King sandwich and the extra long Barbeque Cheeseburger and lastly the bacon Cheeseburger Deluxe was introduced as an addition to the King Deals Value Menu. Burger King also continued promoting the King Deal breakfast value menu in the second quarter which expanded our value proposition into breakfast a day part where there remains an opportunity to build sales. Products include, French toast sticks and breakfast sausage burrito and a sausage and cheese muffin sandwich with prices starting at $1. Turning to profitability, Restaurant-Level EBITDA rose slightly in the second quarter this year despite our top line challenges. Restaurant-level EBITDA was $19.7 million compared to $19.6 million in the second quarter of 2013, and Restaurant-Level EBITDA margin increased 38 basis points versus the prior year period. This increase reflected a 161 basis point improvement in Restaurant-Level EBITDA margin at our restaurants acquired in 2012 from Burger King which more than offset a 75 basis point de-leveraging at our legacy restaurants caused by lower sales. Adjusted EBITDA in the second quarter was $11.4 million and grew 9.1% compared to $10.4 million in the prior year period. This increase reflected lower G&A expenses due to the lower accruals for bonus expense in the second quarter of 2014. During the second quarter, we raised $67.3 million in net proceeds from the issuance of 11.5 million shares of common stock and a public offering. We are using some of this new capital to accelerate our pace of remodeling in the second half of the year. We expect to complete the remodeling of 100 to 110 restaurants in 2014, which is about the same number completed last year. We have also begun to opportunistically and selectively acquire Burger King Restaurants, recall that there are more than 2,000 Burger King Restaurants that could be subject to our right of first refusal and we are pre approved by Burger King for expansion. We believe that our operational and financial disciplines combined with the ability to leverage our infrastructure positions us to enhance share holder value with this expansion strategy. On April 30, we completed the acquisition of four restaurants located in Fort Wayne, Indiana and on June 30, which fell in our third quarter, we closed on the acquisition of another four restaurants located in the Pittsburg area, both of these opportunities arose from us having the right of first refusal in those markets. Most recently on July 22, we completed the purchase of 21 restaurants in upstate New York in a negotiated transaction. We are also reviewing or negotiating other potential transactions which depending on the outcome could result in us completing the acquisition of as many as 100 restaurants for the full year. Now there can be no assurance that this will occur, the completed equity offering has nonetheless positioned us to move forward with our expansion plans at a more accelerated pace. To conclude, while 2014 sales trends have so far been softer than we would have preferred, we are executing in our stated initiatives and our long term strategic growth plan as intact we will provide interim updates on our acquisitions as needed. I will now turn the call over to Paul to continue our financial review.

[Paul R. Flanders:]

Thanks, Dan. Restaurant sales decreased 2.8% to $168.6 million in the second quarter of 2014 from $173.5 million in the prior year period. Our legacy restaurants generated $94.4 million in sales for the quarter, down 0.9% from $95.3 million in 2013, while the acquired restaurants generated $74.2 million in sales, down 5.2% compared to $78.2 million in [2003]. Note that we had 6 fewer restaurants in operation as of the end of the quarter as we continue to close certain underperforming locations. As Dan has already explained, comparable restaurant sales decreased 2% in the quarter on an overall basis compared to a 1.4% gain in the prior year period. Comparable restaurant sales decreased 1.4% at legacy restaurants and 2.7% at the 2012 acquired restaurants. Our average check was 4.3% higher compared to the second quarter of 2013, however our customer traffic decreased 6.3%. Thus traffic was lower in parts due to fewer low priced deals such as the [57] ice cream cone that in 2013 were aimed primarily at driving traffic. The absence of similar tax rates in 2014 has however helped increase the average check. Adjusted EBITDA increased to $0.9 million to $11.4 million in the second quarter of 2014 appeared at $10.4 million in the prior year period, and adjusted EBITDA margin increased 74 basis points to 6.7% for the quarter. Although restaurant sales decreased in the second quarter, Restaurant-Level EBITDA increased slightly to $19.7 million and Restaurant-Level EBITDA margin increased 38 basis points. As Dan said de-leveraging in our legacy restaurants was more than offset by the 161 basis point improvement at the 2012 acquired restaurants. This was primarily driven by the improved management of both cost of sales and restaurant labor at these restaurants. These costs were 133 basis points and 35 basis points lower respectively as a percentage of sales compared to the second quarter of 2013. On an overall basis, cost of sales was 76 basis points lower in the quarter compared to the prior year period. In addition to the improvements of the 2012 acquired restaurants, favorable sales mix shifts [and] the effect of price increase of 1.5% helped to offset higher commodity cost particularly 12.4% increase in ground beef cost. General and administrative expenses were $8.6 million, or 5.1% of sales in the second quarter of 2014, and decreased $0.9 million compared to the second quarter of 2013 due to lower bonus accruals. Depreciation and amortization expense was $9 million, an increase from $8.4 million in the second quarter 2013 due primarily to remodeling initiatives over the past year. Interest expense was flat at $4.7 million for the quarter. Our net loss was $1.9 million, or $0.06 per diluted share and a diluted share base of $30.8 million compared to a net loss of $3.5 million in the prior year period, or $0.15 per diluted share and a diluted share base of $22.9. The increase in share count was a consequence of the public offering of common stock completed this past April. The net loss included impairment and other lease charges in both years. Such charges were $0.4 million or $0.1 million per diluted share after tax in the second quarter of 2014 and was $2.2 million or $0.06 per diluted share after tax in the prior year period. In 2014, the tax benefit includes no Work Opportunity Tax Credits since these incentives have not yet been extended since expiring at the end of 2013. The effect of tax benefit was 37.6% in the second quarter compared to 32.5% last year. At the end of the quarter, our cash balances were $76 million including $20 million of restricted cash held as collateral for our revolving credit facility. Total outstanding debt was $159 million at quarter end, which decreased about $2 million from last quarter. Our cash balances have, of course, increased considerably following the completion of the equity offering. Capital expenditures in the second quarter of 2014 totaled $11.7 million, including $9.4 million for restaurant remodeling and $0.2 million for new or relocated restaurants. We have completed the remodeling of 28 restaurants to the 20

[Operator:]

(Operator Instructions).We’ll take our first question from Wills [Slaybar] with Stevens.

[Unidentified Analyst:]

Yeah thanks guys. Regarding the improvement you saw throughout the quarter and then to date in July is there anything you can point to as far as doing differently operationally or due to simply credit that same store sales improvements to delay in I guess improvement of the consumer in your territories?

[Daniel T. Accordino:]

I think it’s probably more due to holiday local store marketing sales. Last year reinvestment spends roughly 1% of sales in our local investment spending and maybe many of our major DMAs and Burger King matched that spending with another 1%. This year they didn’t have the corresponding match and consequently some of the DMAs were reinvestment spend last year were reluctant to do so in the first part of this year and that investment spending has now begun in July and will continue for the balance of the year. So I think it probably has more to do with the fact that we’ve got more of our major DMAs that are now seeing some television and some outdoor work in most of the second quarter that was not the case.

[Unidentified Analyst:]

Got it. And regarding that match -- do expect that lumpiness in terms of when they match and when they don’t to continue or is that something that look you can count on from here or now or should we think about year-over-year lapse as being – I’m sorry year-over-year comparisons in spending to be a little bit different as you go forward?

[Daniel T. Accordino:]

I don’t think that you are going to see another Burger King match would be my guess. So that was not match this year so – we’re now comparing no match to a match last year. In 2015 we’ll be comparing no match to no match.

[Unidentified Analyst:]

Got it. And then just one more quick one if I could, can you give us an update on the margins of the acquired stores or where you think you are in that process and then on a follow up there can you talk about the margin structure of the newly acquired stores?

[Paul R. Flanders:]

You know if we recall, we just closed down these transactions, so its quite a little premature to talk about where we are necessarily. But I’ll give you – some broad metrics on what these transactions look like. We said that we closed three transactions the units in Fort Wayne are averaging about $1.2 million in sales, the Pittsburg units are about $1.5 million average unit volumes and the transaction in Rochester and Western New York those averages are between $1.2 million and a $1.3 million. We’ve historically said that our experience has been that we tend to pay about four times restaurant level cash flows for these restaurants and that’s why I would say that in general is consistent with these transactions and our projections after we make certain improvements and so forth would suggest that those they have multiples below three times. In total, we paid about $11.5 million for this group of stores.

[Unidentified Analyst:]

Got it. Thanks guys.

[Operator:]

We’ll take our next question from Byran Hunt with Wells Fargo Securities. Byran Hunt - Wells Fargo Securities. Thank you, good morning.

[Paul R. Flanders:]

Hi, Byran.

[Byran Hunt:]

When you look at the three transactions that you closed, have any of those stores been remodeled at this point or is it pretty much you have to go in and redo the whole store base.

[Daniel T. Accordino:]

No. In the Rochester acquisition which was 21 restaurants, 8 of those are current image, so and of the balance of the 13 we are going to re-image probably 6 of those 7 of those and Fort Wayne and Pittsburg they are in reasonably good in shape which don’t require immediate remodeling but they will have to be brought to the 20 image over the next two years.

[Byran Hunt:]

Got you. Looking at the re-imaging spending, your previous remodeled per unit guidance in the last quarter in the Q1 press release was about 3/10 per unit at the mid point and now it looks more like 370 per unit at the mid point CapEx per location. What changed in the guidance to raise the cost by roughly 20%?

[Paul R. Flanders:]

The restaurants that we did initially and many of them were in reasonably good shape and they were what’s called the rock version, so in order to bring those to current image we could do that for a little over $100,000. Most of those are done and the restaurants that we’re re-imaging now are tend to be an older version and they haven’t been remodeled in some case 20 years. So the building cost and the scope of work on that is essentially the same, when the difference that we are seeing in the cost structure is primarily in the site work where we’ve got to do more taping kind of accrete work, parking lots, trashing closures that sort of thing.

[Daniel T. Accordino:]

The other thing I would add Bryan is that the other thing we’re seeing is obviously these restaurant is perhaps a little more distressed to begin with is we’re seeing that the sales lift in general has increased whereas we sort of started out saying that the lift we’re seeing was 8% to 10% has steadily creeped up, and the most recent there’s a [indiscernible] we’ve done last 9 to 12 months that the average lift now is upto about 13%. So I think when you look at the economics of that the return on the invested capital is pulled out the same.

[Byran Hunt:]

Okay. Great. Next when I look at the same store sales performance last quarter and Dan you mentioned the opportunity at breakfast, so won’t you give us an idea what’s happening across the day parts?

[Daniel T. Accordino:]

We are actually a bit positive in breakfast, even though the percent of sales has stayed about the same because the other day parts have decreased. So when you looked across the day parts, it’s a reasonably consistent trend across the lunch snacks and dinner and breakfast is actually been consistent at about 14.5% 15% of sales, so what has been a little bit of an increase over the prior year. So I think it has not been a specific day part, it seems to be more stressed than another Bryan.

[Byran Hunt:]

Okay. And then my last question and we’ve talked about it in the last couple of calls is the Virginia Beach market. Have you seen any discernible turn in the same store sales trend there and if you what do you attribute it to?

[Daniel T. Accordino:]

And Norfolk is actually positive now. So we see there are two separate markets there, Norfolk and Virginia Beach they are doing a bit better and Richmond is still laggered but not as much as it was historically. We’ve now in the product, we’ve remodeled most of Norfolk and Virginia Beach and we’re now in the process of remodeling Richmond. So we would expect to see a bit of an improvement there as well.

[Byran Hunt:]

Okay, very good. I’ll turn it over to somebody else and get back in the queue, thanks.

[Operator:]

(Operator Instructions) We’ll take our next question from Bryan Elliot with Raymond James.

[Bryan Elliot:]

Actually they have all been asked by faster finger, thank you.

[Operator:]

(Operator Instructions) We’ll take another question from Bryan Hunt with Well Fargo Securities. Byran Hunt - Wells Fargo Securities. Thank you. Just maybe now looking at the balance sheet, your net leverage is roughly 2.5 times. It doesn’t look like you are going to burn those all that excess cash that you have on the balance sheet unless you get really aggressive with acquisitions in the next 12 months thinking about the time period when the bonds become [callable]. What should we assume the capital, would this capital structure look like, given one, the needs for remodeled CapEx and two, the needs potentially for capital for acquisitions, is this a bond capital structure or think that’s capital structure as you move into next year?

[Paul R. Flanders:]

I think our sense is that we – we obviously want to evaluate this as we get a little closer to the call which we obviously want to take advantage of as quickly as possible to refinance existing balance given the interest rate. I think the question with regard to the capital structure, I think is a function of what we see growth opportunities being – my sense is that once and first of all once we get through the remodeling phase the cash flow of the business is such that it should be able to fund the acquisitions and – those transactions are lumpy or come in some points in that others my sense will be probably when at some part of the capital structure where we have prepayable debt so that we can pay down in periods where we remain happy buying stores or borrow under more traditional bank type financing if we do have opportunities. I think with regard to the [bands] the question becomes how great are the opportunities, and is there going to be room in the capital structure for a slug of high yield. I mean our sense is that if we can do that given where the markets have been and it will be a good time to fix or fix that component of the capital structure, but I think we’ll evaluate it obviously as we get closer to that date.

[Byran Hunt:]

Okay. Thank you.

[Operator:]

We have no further questions at this time. Now I’ll turn things back over to Mr. Paul Flanders for any additional or closing remarks.

[Paul R. Flanders:]

We have no further comments, but we certainly appreciate your attention and time today and we look forward to speaking with you soon. Bye.

[Operator:]

That does conclude today’s conference. Thank you for your participation.