Carrols Restaurant Group, Inc.
Q4 2014 Earnings Call Transcript

Published: 26 Feb 2015

[Operator:]

Welcome to the Carrols Restaurant Group Fourth Quarter and Full Year 2014 Earnings Conference Call. [Operator Instructions] I would like to remind everyone that this conference call is being recorded today, Thursday, February 26, 2015 at 8

[Paul Flanders:]

Good morning. By now, you should have access to our earnings announcement released earlier this morning, which is available on 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 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 generally accepted accounting principles. A reconciliation table to comparable GAAP measures is available in our earnings release. With that said, I will now turn the call over to the President and CEO of Carrols Restaurant Group, Dan Accordino.

[Daniel Accordino:]

Thanks, Paul, and good morning everyone. 2014 was a busy year at Carrols with many accomplishments as we continue to execute on our strategic objectives. We raised $67 million in equity capital early in the year and then proceeded to execute our expansion strategy by acquiring 123 restaurants from other franchisees. This expanded our ownership to 674 Burger King restaurants by the end of 2014. We also continued to aggressively remodel restaurants completing the reimaging of 101 units in 2014 and concluded the year with 325 locations updated to the 20/20 design image. We also made considerable progress in improving the financial performance of the restaurants acquired in 2012. We increased restaurant level EBITDA margins at those restaurants by 170 basis points despite significant commodity cost pressures and increased their restaurant level EBITDA by $4.7 million or more than 25% from 2013. These contributions were though partially offset by results at our legacy restaurants which were impacted by the higher commodity costs and some deleveraging due to weak sales trends in the first half of 2014. For the full year we grew total revenues by 4.4% to $692.8 million and comparable restaurant sales increased by 0.6%. We also increased restaurant level EBITDA by $2.7 million to $73 million and increased adjusted EBITDA of $1.7 million to $36 million. These results were all within our very close to our most recent guidance. To summarize, we accomplished a lot in 2014 and our employees worked very hard to complete and integrate the acquisitions while supporting the operational and financial improvements at our existing restaurants. Unfortunately, these accomplishments were overshadowed as our overall financial results were significantly affected by a 22% increase in beef cost. To put this in perspective, higher ground beef cost negatively impacted our EBITDA by almost $10 million for all of 2014. Moving on to the fourth quarter. Total restaurant sales increased 16.5% due to contributions from the 123 restaurants acquired in 2014 along with a 3.6% increase in comparable restaurant sales, our strongest quarter of the year. Comparable restaurant sales momentum has accelerated in early 2015 as we have benefited from favorable weather comparisons across many of our markets early in the first quarter. Despite the impact over the last week or so of record low temperatures and snow in a number of regions, our quarter to date comparable restaurant sales have increased more than 9% through the first eight weeks of the quarter. While we don't expect this pace to continue through March, we are also hopeful that economic tailwinds including higher consumer confidence and lower gasoline prices will favorably impact our customers and our sales trends as we progress through the year. As you know, Burger King's menu strategy is designed to balance premium products with value offerings while minimizing operational complexity. We believe this strategy is working well and continues to drive sales and market share gains albeit with a higher level of discounting given the nature of some of the promotions. In the fourth quarter, premium offerings included the Four Cheese WHOPPER, the A-1 Bacon Cheeseburger and the Mushroom and Swiss Bacon WHOPPER. Value offerings consisted of the popular '2 for $5' mix-and-match lineup including the Extra Long Barbecue Cheeseburger, the Italian Chicken Sandwich and the new YUMBO Hot Ham & Cheese Sandwich. We also featured a 10-piece chicken nuggets promotion at $1.49 price points and continued to promote the [$1.10] [ph] deals value menu including a number of breakfast offerings. Despite our solid fourth quarter sales increase, as expected, restaurant level EBITDA margin was negatively impacted by significantly higher ground beef cost and to a lesser extent the impact from the restaurants acquired late in the year. Restaurant level EBITDA was $19.6 million compared to $20.2 million in the prior year period, and restaurant level EBITDA margin declining 204 basis points. Ground beef averaged $2.66 per pound in the fourth quarter representing a 32% increase over the prior year. The impact of this was offset to some extent by leveraging of the higher sales against most other expenses. During the fourth quarter we continued to deploy capital raised from our April 2014 equity offering. We completed two previously announced acquisitions for a total of 94 restaurants including 30 restaurants in Eastern North Carolina and 64 restaurants located primarily in the Nashville, Tennessee; Springfield, Illinois; Terre Haute, Indiana; and Evansville, Indiana markets. We also completed 47 remodels in the fourth quarter. In 2015, we plan to remodel 60 to 70 restaurants to the 20/20 design image. We are also considering a refinancing of our existing debt in 2015, which could facilitate a more aggressive remodeling plan and/or additional acquisitions. We will provide additional guidance as the year progresses. In the meantime, we are squarely focused on improving the operating and financial performance of the recently acquired restaurants. We are well underway and already making progress. Unlike the 2012 acquisition, we completed the installation of our Point of Sale inventory labor and other management systems within the first week or two following the closing of each acquisition. As Paul will discuss, we are also increasing our G&A cost in 2015 in part to expedite our integration of these restaurants and to achieve our financial and operating targets as quickly as possible. To conclude, we are generally pleased with our 2014 accomplishments. We made progress in the areas of the business that we do control and have done our best to mitigate the impact of certain cost pressures. I will now turn the call over to Paul to continue our financial review.

[Paul Flanders:]

Thanks, Dan. Restaurant sales increased 16.5% to $192.9 million in the fourth quarter of 2014 from $165.5 million in the prior year period with 123 restaurants acquired in 2014, adding $25.4 million in sales for the quarter. Comparable restaurant sales increased 3.6% compared to a 1.7% increase in the prior year period with comparable restaurant sales increases of 3.2% at our legacy restaurants and 4.1% at the restaurants acquired in 2012. We also had a good balance between the average check which increased 1.5% and customer traffic which was 2.1% higher compared to the fourth quarter of 2013. Adjusted EBITDA was $10.1 million in the fourth quarter of 2014 compared to $10.4 million in the prior year. However, adjusted EBITDA margin decreased 109 basis points to 5.2% for the quarter. As Dan discussed, restaurant level EBITDA was $19.6 million in the fourth quarter and restaurant level EBITDA margin decreased 204 basis points. This was directly related to the 32% increase in beef cost over the fourth quarter of the prior year which caused a 215 basis point increase in cost of sales. The 1.7% effective price increase and additional operating efficiency improvements were partially offset by the higher level of discounted promotions. Restaurants acquired in 2014 contributed $1.4 million to overall restaurant EBITDA in the fourth quarter. However, initial restaurant level EBITDA margins at these restaurants had a negative impact on our overall margins for the quarter. This was offset, however, by the effect of leveraging of the fourth quarter sales increase against most expenses other than cost of sales. General and administrative expenses were $11.1 million in the fourth quarter of 2014 including $1.2 million of acquisition and integration cost compared to $9.9 million in the fourth quarter of 2013. These expenses increased due to additional cost related to the recently acquired restaurants, including district manager, training and other support costs. The impact of this was muted in the fourth quarter since we recorded no management bonus expense for the quarter in comparison to $1 million of expense in the prior year period. As a percentage of restaurant sales, general and administrative expenses improved 23 basis points to 5.7%. Depreciation and amortization expense was $9.8 million in the quarter, an increase from $8.6 million in the prior year period, due primarily to remodeling initiatives and our acquisition activity over the past year. Interest expense was flat at $4.7 million for the quarter. Income tax expense was $19.3 million in the fourth quarter of 2014, reflecting a $24.3 million non-cash charge to establish a valuation allowance against net deferred tax assets. These assets include our federal net operating loss carryforwards or NOLs which do not begin to expire until 2033. We believe it is likely that we will utilize the NOLs long before their expiration, although we cannot assure this. However, this valuation allowance was required based on the relevant accounting guidance which does not permit us to consider our projection of taxable income as more persuasive evidence than our recent operating losses when evaluating recoverability. The related charge resulted in a net loss in the fourth quarter of $27 million, or $0.78 per diluted share. At the end of the quarter, our cash balances were $21.2 million. We amended our revolving credit facility late in the fourth quarter which freed up $20 million of previously restricted cash. Total outstanding debt was $159.9 million at year-end. Capital expenditures in 2014, excluding acquisitions, were $52 million, including $38.2 million for remodeling. In the fourth quarter of 2014, total capital expenditures were $19.3 million including $14.9 million for remodeling. Cash expenditures for the acquisition of the 123 restaurants acquired in 2014 were $52.2 million, including $16 million for 13 fee-owned properties that we acquired. By the end of 2014, we completed sale/leasebacks for all but two of the acquired properties, one of which was sold right after the fiscal year ended. Net proceeds from sale/leasebacks totaled $13 million in the fourth quarter and $19.6 million for all of 2014. Let's now turn to our outlook for 2015 which is a 53-week fiscal period. Total restaurant sales are expected to be $810 million to $830 million including a comparable restaurant sales increase for the year of 2% to 4% on a comparable 52-week basis. Commodity cost are expected to increase 2% to 3% due to higher year-over-year beef costs primarily in the first half of the year. Although we have experienced some sequential moderation in beef prices early in the year, these prices are still above the levels from the first half of 2014. General and administrative expenses are expected to be approximately $44 million to $46 million excluding stock compensation cost. Increases from 2014 reflect, among other things, higher incentive compensation costs versus minimal expense in 2014 and the full year impact of district managers training, recruiting and other support costs related to the recent acquisitions. As Dan alluded to, we also plan to add a few new positions in the field to focus on financial and operating improvements working alongside our existing regional and district managers, a number of which are still relatively new to Carrols. This investment is intended to help us reduce the time required to achieve targeted improvements with our recent acquisitions and we believe will be further leveraged as we continue to execute on our future expansion plans. Adjusted EBITDA is projected to be $44 million to $48 million. Capital expenditures excluding acquisitions are expected to be approximately $37 million to $44 million, including $25 million to $30 million to remodel a total of 60 to 70 restaurants and for final expenditures on certain 2014 remodels. Further expansion of these remodeling plans may be considered if we complete a possible refinancing of our debt. And lastly, we expect to close between 15 and 20 restaurants in 2015. That concludes our prepared remarks and with that we will now open the line for questions.

[Operator:]

[Operator Instructions] And we will take our first question from Brian Hunt from Wells Fargo.

[Brian Hunt:]

I was wondering if you could talk about same store sales for your 2013 class of remodels versus the 2014 class of remodels. I just want to get an idea if the previous remodels are continuing momentum in line with the rest of the chain.

[Paul Flanders:]

I would say generally, when we started this program we were seeing sales lessen to 8% to 9% range and over time that has crept up a little bit, as high as, I would say on an average we might be 10% to 12% at this point. I think in terms of breaking out by year, frankly, it's getting more difficult to look at this more recently because historically we were comparing the remodeled units to the rest of the market. And we have completed so many remodels at this point that that methodology creates some anomalies sometime. But I think in general we are still seeing absolute sales increases in the 10% range.

[Brian Hunt:]

Great. Also when I do the rough math on the upcoming remodels for 2015, it looks like it's a little over $400,000 per unit. Is that a good number to think about going forward as well and does that make sense?

[Daniel Accordino:]

Yes. I think Brian that that is a good number and most of the reason for that is, since when we first started this remodeling program back in 2012, since then there has been some new approved equipment that we are putting into these restaurants that didn’t exist then. So we are replacing the PHU units, the fry dump station, some of the soft drink systems. The new [drive thru] [ph] menu boards. So most of that increase is being driven by equipment that ultimately will be going into Burger King restaurants but it wasn’t available when we first began the remodeling program a few years ago.

[Brian Hunt:]

Great. Shifting gears and looking at the sales number you just posted in Q4 and maybe what's going on Q1. There was some drag in specific markets earlier in the year. I think you called out Virginia as a market that was lagging the rest of the chain. Can you talk about maybe what you are seeing geographically and whether this is a broad-based uplift in same store sales?

[Daniel Accordino:]

In the fourth quarter, I would say that the geographic difference remained much the same as it was through most of 2014. Our strongest markets tend to be in the Midwest and the Southeast. The Northeast is still doing fairly well. In the first quarter, because of the difference in the weather, all the markets are doing very well. But our best performing markets continue to be Ohio, Michigan, Kentucky and the Carolinas.

[Brian Hunt:]

Great. And one last question and I will hand it off and get back in the queue. When you look at inflation and you talk about inflation, does that contemplate any mix changes going into 2015 or are you using a static mix from 2014? I just want to better understand how you kind of calculate the inflation outlook.

[Paul Flanders:]

Well, obviously the biggest component that’s driving the inflation is the beef cost which we are estimating are going to be up 6% to 7% this year. Which basically means flat to up slightly for the full year when you have hedged the major components. In terms of how we calculate, the sales mix does shift around from time to time but I would say the only major variable that would affect it is the level of discounting. And we have assumed similar level of discounting, which are probably a little bit high, similar levels as 2014.

[Brian Hunt:]

And I [indiscernible]. Looking at your potential refinancing, it sounds as if the refinancing that you are contemplating maybe larger than the existing bond deal, because you are talking about accelerating remodels and potentially accelerating acquisition activity. Am I reading into that correctly as well as can you talk about the maybe the contemplated mix of bond versus bank debt in any financing going forward. Thanks.

[Paul Flanders:]

Well, we are still obviously evaluating some of the alternatives on that really, I think today we could directionally say where we are heading. But I think your read through was probably generally correct that we are looking to increase total available capital, whether that be in the form of drawn or undrawn, depending on what vehicle we may utilize. But our intention would be to try to increase the committed capital to continue to buy stores and as we said, to continue remodeling.

[Operator:]

And we will take our next question from Brian Vaccaro with Raymond James.

[Brian Vaccaro:]

Just had a couple of quick ones. First, Paul, can you remind us, on the ground beef side of things, can you remind us what your average ground beef cost was in the first and second quarter of '14?

[Paul Flanders:]

Last year -- yes, I get it -- we averaged about 2.20 a pound in the first half of last year. And that was pretty steady between the first and second quarters. The increase really that we had in the year came about in August.

[Brian Vaccaro:]

Okay. So 2.20, fairly stable. Okay. That’s helpful. Wanted to also a question about the recently acquired stores in 2014. Can you give us a sense of the margin opportunity? Is it similar to what we saw in the, obviously the magnitude is not similar, but in terms of the components of margin opportunity. Is it primarily in what we should we expect to see some pretty significant food cost improvement at these units? And can you talk about some of the other investment that may or may not be similar to prior in terms of the labor cost etcetera?

[Paul Flanders:]

I would say, as we typically see, our cost of sales run much lower than most others. And I would say that these acquisitions are similar to that. And the opportunity probably isn't as great as it was with the stores we acquired in 2012, because I think generally the units we acquired, the particular operators were pretty good operators and the P&L disciplines were reasonably good. However, having said that, right now we have already made improvements in these restaurants. At the end of the year we are running about 150 basis points difference which is really the opportunity we are focused on at this point in those stores. Which is something you see is not as large but that is still a couple of million dollar opportunity to improve margins. Generally speaking, the margins overall look similar to the units we acquired in 2012 primarily because the volumes are lower than our legacy restaurants. That will in part improve over time as we close some of the lower value or underperforming restaurants.

[Brian Vaccaro:]

Okay. All right. That’s helpful color. One other quick one. On the G&A front, you mentioned that, I think you said that the incentive comp accruals were down $1 million in the fourth quarter. How should we think about the full reload, '15 versus '14? Was incentive comp down in the first three quarters as well in '14?

[Paul Flanders:]

No. I mean our hope is that this year we will -- the operating and the financial performance will be better than last year and as a consequence we will get bonuses. I mean 2014 includes no bonus expense, essentially other than at the restaurant level, district level. But having said that, based on the guidance we have given, you could probably assume that would include incremental $3 million of bonus expense year-over-year.

[Operator:]

And we will take our next question from Billy Sherrill with Stephens Inc.

[Billy Sherrill:]

Congrats again on another good quarter. Real quick, could you update us on the remodel metrics? I know we have kind of talked about them already but I think last time we spoke, you mentioned that that the flow through on the remodels, that accelerated as a larger percentage of the system was getting the updated image. Just wondering what that sustainable sales lift looks like and the [increase] [ph] on it now.

[Paul Flanders:]

It really goes to the question that I answered for Brian. But we are seeing about, call it 10% sales increase which on a flow through basis, if you assume 40%-45% flow through, we continue to see about 15% return on the capital investment.

[Billy Sherrill:]

Great. Thanks. And then one more quick one. I realize that the pending finances we have discussed are going to kind of take [pace] [ph] of the remodels then the pace of acquisitions going forward. But is there any reason to believe that you wouldn’t be able to take -- with the cash you have on hand, that you wouldn’t be able to take advantage of potentially profitable acquisitions between now and that refi if those were opportunities were to pop up. I know that we kind of have, even you all have limited visibility in the pace with your flow but just trying to figure how to think about that.

[Daniel Accordino:]

There will be some deals between now and the time that we do the refi, yes.

[Operator:]

And we will take our next question from Jon Evans with JWEST LLC.

[Jon Evans:]

Can you just maybe expand on that question a little bit more before on the acquisition environment? And what I was hoping to understand is, can you characterize the environment? I mean if you get that refi done and you are able to expand the balance sheet like we all hope, are there bigger deals that are out there? Can you just talk about the environment?

[Daniel Accordino:]

The environment certainly is fungible. Moves as the year goes on. But I would tell you that right now, based upon what we know of existing deal flow, there will be significant number of opportunities for Carrols in 2015.

[Jon Evans:]

Okay. Great. And then the other question that I have for you is just to understand the guidance that you had in the press release, you are talking about the 2 to 4 in comp. That’s on a 52-week period. You have 53 weeks. Is the EBITDA guidance on a 53-week or a 52-week?

[Paul Flanders:]

Everything else is on a 53-week basis.

[Jon Evans:]

Okay. And then also on beef costs. So can you just help us understand, you talked about they had moderated a little bit sequentially since the beginning of the year. Are you hedged much as you go into this year? And I guess can you just give us a sense of how much beef is up year-over-year so far in the first quarter?

[Paul Flanders:]

We don’t purchase on our own behalf. There is a cooperative that purchases for the system and does not hedge any significant portion that I am aware of. In terms of the trend of the cost, as I said, we were running about 2.20 a pound in the first half of last year. That jumped up pretty dramatically in the back half were we averaged probably 2.65, between the third and fourth quarter. And it has moderated early in the year which sometimes it does just on a seasonal basis. And we think for the quarter we should probably be in the 2.45 a pound range. So still above last year. Maybe 20%. But it's come down a little bit. I think this week's price is 2.32 a pound. So it's just to give you a sense it moves around a bit.

[Jon Evans:]

Yes. And then the other question I have for you, so when you talk about the guidance that you have, what kind you have embedded for beef cost or how much are you anticipating that will be up year-over-year kind of in the guide that you gave?

[Paul Flanders:]

The assumption on beef is that it will be up about 6% or 7%. Most of that increase is in the first half of the year and for the full year, we think we should be averaging maybe 2.60 a pound. That’s our embedded assumption.

[Operator:]

[Operator Instructions] And we will take our next question from [Stephan Miktuc with Act Asset Management] [ph].

[Unidentified Analyst:]

Two questions. I guess first, you said your same store sales are tracking plus 9 at this point in the quarter. I would think that give us some pretty good visibility for March. I am just curious how you got the 2 to 4 same store for the year on a 52-week basis and how much conservatism is built into that?

[Paul Flanders:]

We always hope we do better than we say but I mean a lot of what's causing that difference is the fact that the first half of last year, we were negative 2.5%-3% in the first of the year. Largely due to weather, particularly early in the year. So a lot of these increases we are seeing are simply because we are lapping easy comparisons. We also think fundamentally the business is improving, the consumer's spending is improving. But we certainly are not assuming we are going to trend at 9% through the balance of the year.

[Unidentified Analyst:]

No, no. I am just -- last year you did negative 2.5% in Q1 and then negative 2% in Q2. So you got pretty easy comparisons for the entire first half and then back half a little tougher. So you are certainly assuming that it seems to imply that the back half is -- you would think you are going to get back, you are going to be down at 1% or 2% or something like that. Is that kind of what you have built into your number?

[Paul Flanders:]

We tried to be conservative in the back half definitely. I mean what's embedded in the 2% to 4% is sort of a equal balance between price and traffic. So we are assuming 1.5% increase in traffic or so and similar increase in price.

[Unidentified Analyst:]

Right, right. Of the 9 year-to-date, is it still kind of 1.5 to 1.6 of price and the rest is traffic?

[Paul Flanders:]

No. It's both. We had about a little under a percent of price coming in. So a lot of this is being driven by traffic.

[Unidentified Analyst:]

Okay. And then....

[Daniel Accordino:]

Yes. Most of it in the first quarter is traffic but it's primarily weather driven.

[Unidentified Analyst:]

Right. I got you. But, I mean it's weather but you also -- it would seem like the employment environment is better than it was a year ago. I don’t know your market specifically, and then certainly gasoline prices there are better which has got to help your core customer.

[Paul Flanders:]

We agree. We just don’t know how to measure them.

[Unidentified Analyst:]

Right. Okay. And then I think you mentioned $10 million hit from beef cost in 2014. That was just the total beef cost in the P&L, '14 versus '13?

[Paul Flanders:]

No. That was the effect of the year-over-year increase. The effect of the year-over-year 22% increase in beef cost.

[Unidentified Analyst:]

Right. I guess what I was wondering is, if you look at now on the current store base, how much beef you consumer and you are at, and we just say $2.45 or something in price, but what do you consider to be -- where was beef, call it maybe two year ago, before prices really accelerated so much. And on your consumption trends, if and when it ever gets to "normal", how much delta is that?

[Paul Flanders:]

In 2013 we averaged about $2 a pound. I think the thinking is that, I mean obviously the beef costs have been at an elevated levels in 2014. I think from what we read , it would be expected that they are going to stay at those elevated levels for some time and perhaps we start seeing some moderation in cost by 2016.

[Unidentified Analyst:]

Right. I guess what I am asking is, is on the current level, the number of stores you have, if you get back to $2, it's got to be more than the $10 million of EBITDA that you get back. Isn't it? Because you have got more stores now?

[Paul Flanders:]

Absolutely.

[Daniel Accordino:]

Yes. Yes. We are using 25-26 million pounds of beef a year and that’s the way to think about it.

[Operator:]

And gentlemen it appears we have no further questions at this time. I would like to turn the conference back over to management for any additional or closing remark.

[Paul Flanders:]

We have no additional comments other than to thank you for your time today and we look forward to talking to you and updating you next quarter.

[Operator:]

And ladies and gentlemen this does conclude today's conference and we do thank you for your participation.