Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Alan Vituli - Chief Executive Officer

Paul R. Flanders - Chief Financial Officer

Analysts

Reza Vahabzadeh – Lehman Brothers

Brian Hunt – Wachovia Capital Markets

Jeffrey Omohundro - Wachovia Capital Markets

Carla Casella – J.P. Morgan

Kenneth Byrne – Jefferies & Co.

Bryan Elliott - Raymond James

Art Rulach – CAI

Rishi Parekh – KBC Financial

Mitch Speiser – Buckingham Research

Greg Ruedy - Stephens Inc.

Carrols Restaurant Group, Inc. (TAST) Q3 2008 Earnings Call November 4, 2008 8:30 AM ET

Operator

Welcome to the Carrols Restaurant Group third quarter 2008 earnings conference call. (Operator Instructions) This conference is being recorded today, Tuesday, November 4, 2008. I will now turn the conference over to Paul Flanders, Chief Financial Officer.

Paul R. Flanders

Good morning and welcome to our third quarter 2008 conference call. By now everyone should have access to the announcement released this morning, which may also be found on our website at www.carrols.com under the Investor Relations section.

Before we begin the formal remarks I need to remind everyone that part of our discussion today may include forward-looking statements. These statements are not guarantees of future performance and therefore undue reliance should not be placed on them. We also refer you to our recent filings with the SEC for more detailed discussions of the risks that could impact our results.

On the call with me today is Alan Vituli, our Chairman and CEO. Alan will provide some commentary on the business. I will walk through our financial results for the quarter as well as update guidance and then we will open up the call for questions.

With that, I would like to turn the call over to Alan.

Alan Vituli

Good morning everyone. I will begin with what I believe is foremost in everyone’s mind before reviewing some highlights from the third quarter. First, let me be clear, we recognize and understand the general anxiety in the market place caused by financial leverage and are doing what is necessary to allay those concerns, specific to our situation.

The uncertain consumer economy combined with the strain on financial institutions related to their illiquidity has caused the company to make the reduction of our financial leverage a high priority. Accordingly, we have and will continue to focus our business plan to support this objective.

Our initiatives to lower debt will result in a substantial contraction in new restaurant development, a deferral of certain discretionary projects which would have required significant capital to undertake, and a reduction in the size and activity, and therefore the cost, of a number of support cost centers as a consequence of significantly scaling back our opening of new restaurants.

We have an experienced management team and a long history of successfully managing a leveraged balance sheet. We are confident that our actions to reduce debt will enable us to maintain an acceptable margin of safety with respect to the financial covenants in our loans. Paul will provide additional details and clarity on our plans in a moment.

Now, regarding the third quarter. It was certainly a challenging period given persistent weakness in consumer spending, the state of the economy in general and particularly in Florida, as well as the effect of Hurricane Ike on Taco Cabana’s results. Both of our Hispanic brands posted modestly negative comp store sales while Burger King continues to prove its mettle and posted formidable results.

The cost required to operate our business, particularly commodities and utility costs, remain high and have continued to put added pressure on our operating margins and earnings at each of our brands. As we indicated in the last call, we have been more aggressive in taking menu price increases and as a consequence we were able to hold gross margins steady on a sequential basis, compared to the second quarter.

Higher than anticipated increases in commodity costs prevented us from leveraging these price increases as much as we had hoped, although we did experience a sequential margin improvement at our Hispanic brands. All of our brands continue to be well positioned from a price/value standpoint and offer competitive options especially to the highly price-sensitive consumer.

We opened a total of four new restaurants during the quarter, including one Pollo Tropical in Broward County, which is in Florida, and three Taco Cabana units in Texas, one in San Antonio, one in Irving, and one in Houston. We also closed two Burger King restaurants and relocated a third.

As of September 30, 2008, our restaurant count totaled 559 units, which included 317 Burger King restaurants, 89 Pollo Tropical restaurants, and 153 Taco Cabana restaurants.

Burger King sales remained healthy with a 3.5% growth in comp store sales, marking our eleventh consecutive quarter of positive comp sales growth. The brand continued to perform well in the quarter as its bar-bell strategy of balancing value and full margin products continues to be effective. Promoted products included the Cheesy Bacon Tender Crisps and the Steakhouse Burger, complimented with a value oriented introduction of both a breakfast and lunch wrapper.

Our Pollo Tropical results were off both sequentially and compared to the third quarter of 2007. All but three of our 89 Pollo Tropical restaurants which the company operates are in south and central Florida. These regions have been hard hit by a large loss of jobs and therefore population count, and a contraction of disposable income and the housing crisis. In Orlando, where we have 11 comp restaurants, and a total of 15 restaurant units, comp sales fell 9.1% in the quarter, about the same as the second quarter of 2008.

While our south Florida markets have held up somewhat better, they did get weaker on a sequential basis in the third quarter. Comp sales for Dade and Broward Counties, our largest markets, were up about 0.6% to 0.7% positive. However, we did turn negative in Palm Beach County, where comps were down 3.4%.

During the third quarter we continued to promote our chicken and steak fajita line at Pollo Tropical. We also completed the roll out of our new clamshell grills as well as the conversion of our sandwich to a line of wraps. This product line includes a grilled chicken wrap, a chicken Caesar wrap, a roast pork wrap, and our new grilled Cuban wrap, which were featured in the quarter and supported with media.

These portable products are well suited for the on-the-go customer and provide an alternative to our platter-focused menu. We are selling 50 to 60 wraps per day per store compared to about 15 to 20 sandwiches previously so these products are doing well.

We have also increased our radio advertising campaigns at Pollo with more frequent spots promoting both the value and the healthful qualities that are inherent in our menu, as well as focusing the consumer on our home meal replacement business.

In the fourth quarter we are promoting our popular Tropical Trio offerings as well as focused messaging and POP on our $3.79 quarter-chicken meal, along with e-mail coupons for our $9.99 family meal.

Lastly, we are in the midst of expanding Pollo Tropical internationally through franchising to add to our current base of 25 franchise locations, of which 23 are in Puerto Rico. Our expansion strategy is to evolve the brand in a number of smaller markets in the Caribbean and Central America. This year we have started developing agreements for the Bahamas and Trinidad. We are also focused on adding developments in Jamaica, Panama, and Honduras, and identified a number of larger markets where the brand would do well.

As to Taco Cabana, comp restaurant sales were slightly negative at 0.9%. Hurricane Ike caused us to lose about 150 total restaurant operating days at our Houston-area restaurants, mostly as a consequence of power outages. We incurred very minor physical damage to our restaurants with the exception of one location on Galveston Island, which remains closed, but is fully covered by insurance. The hurricane negatively impacted overall comp sales by about 1% for the quarter and excluding the effect, comp unit sales did show some slight improvement sequentially from the second quarter.

While overall conditions are better in Texas than in Florida, economic pressure is present in Texas as well. Taco Cabana has held up reasonably well despite an onslaught of competitive activity, including growth in a number of new restaurants, aggressive QSR pricing, and the lingering effects from other concepts where day part expansion has encroached on our 24-hour operating model.

While same store sales have been relatively flat for Taco Cabana, new restaurants have opened strong in most markets. Paul will update you on sales trends by market, but in general we continue stronger performance in Dallas and Houston, while continuing to experience some top-line pressure in Austin and San Antonio.

In today’s environment, concepts need to stay fresh, innovative, and offer consumers exciting flavors and profiles, generous portion sizes, quality service, attractive ambiance, and of course, convenience. We are operating our business with that mind set and are confident that we can retain our relative market position despite higher prices, as we are not alone in confronting inflationary pressures.

Over time we believe the economy will recover and our concepts will be positioned to capitalize on long-standing demographic trends that transcend the current economic climate and will shape our country over the next few decades.

That said, we have been doing this for some time and believe that our diversified business model, which provides stability and limits risk, combined with target promotions, new products and strong execution, sustain our business.

As to our financial structure, we understand and are committed to a reallocation of a significant portion of our free cash flow from growth to debt reduction. Paul and I will get into that a little later on as we take questions to that issue.

Let me turn the call over to Paul who will review our financial results and update you on guidance.

Paul R. Flanders

Total revenues for the third quarter increased 2.7% to $209.1 million. Revenue growth was mostly driven by a strong performance from our Burger King restaurants as well as the addition of 23 new restaurants in our Hispanic brands since the beginning of the third quarter last year.

Revenues for our Hispanic brand restaurants increased 3.6% in the quarter and totaled $107.5 million. Our Pollo Tropical revenues increased 1.9% to $43.4 million, reflecting the opening of 10 new restaurants since the beginning of the third quarter last year, including one new unit opened during the third quarter of 2008. Comparable restaurant sales in the third quarter decreased 1.9% at Pollo against the positive 2.3% comparison from the prior year.

Taco Cabana revenues increased 4.7% to $64.1 million in the quarter, due primarily to the opening of 13 new Taco restaurants since the beginning of third quarter last year. Comparable restaurant sales were down 0.9% for the quarter against the positive 1.2% comparison from last year.

As Al mentioned, we estimate that we lost about 150 total restaurant operating days due to the storm in the 40-unit Houston market where in addition to temporary store closures we also experienced curfews that affected evening and late night sales. Houston same store sales were down 1.7% with the hurricane affecting our comps in that market by about 4%.

Dallas, a 33-unit market, continued to perform well with comps up 2.5% but we continue to see competitive affects in our 40-unit San Antonia market where comp sales were down 1.9% and in our 20-unit Austin market where comps were down 2.5%.

Although same store sales have been flat on an overall basis for the brand, new restaurant openings have strong in most markets. The exception has been in the valley where we have units that were opened in Brownsville and Weslaco that are running below expectations. However, we are assessing and working to improve the situation.

Our Burger King restaurants had another strong quarter as overall sales increased 1.8% to $101.5 million despite the net closing of nine restaurants since the beginning of the third quarter last year. Comparable sales increased a solid 3.5% against a tough 7.8% comparison from the third quarter last year, while our average unit volume increased 4.5%.

Our cumulative price increase for Burger King was 4.9% and held pretty well with our average check increasing 4.7% during the quarter.

With a modest 2.7% increase in overall revenues, the impact of inflationary pressures were heightened by our operating leverage, resulting in net income of $3.7 million, or $0.17 per share, compared to net income of $4.9 million, or $0.23 per share, in the third quarter of last year. The prior year did include a $0.05 impairment charge for the Pollo Tropical restaurant in Brooklyn that was closed.

Pre-tax margins declined 49 basis points, the direct result of higher cost of sales, which increased, which increased 162 basis points, and higher utility costs, which were up 56 basis points.

Cost of sales as a percentage of restaurant sales was 30.5% in the quarter, compared to 28.8% last year, but only increased about 5 basis points sequentially from the second quarter, as Alan alluded to.

On a positive note, restaurant labor dropped 65 basis points from the leverage of our price increases combined with other steps to reduce hours and improve labor productivity.

We continue to experience higher commodity costs during the quarter, particularly at Burger King, where beef costs increased almost 25% from last year and almost 12% from the second quarter. Although commodities at both Hispanic brands were higher than last year and somewhat higher than we anticipated, we were able to positively leverage the price increases as cost of sales at both brands decreased sequentially from the second quarter.

The Burger King cost of sales increased 243 basis points from last year with a 24.7% increase in ground beef accounting for about 120 basis points of the increase. With the transition to trans fat free oils, shortening costs almost doubled, representing another 61 basis points while higher wheat costs have caused bun prices to increase about 27%, or 37 basis points.

At Pollo, cost of sales rose 146 basis points from last year, brought about mostly by the increase in our chicken contract and by increased costs for dinner rolls and yucca. However, sequentially, Pollo’s cost of sales decreased 74 basis points from the second quarter.

Taco Cabana’s cost of sales increased 39 basis points from last year with higher cheese and tortilla prices still being the most significant drivers year-over-year. Sequentially cost of sales decreased about 17 basis points from the second quarter for Taco.

We talked about it on our last call, we have become somewhat more aggressive in pricing given our cost increases. For the third quarter Pollo’s effective pricing was 7.4%, including a 4.6% increase in July.

At Taco effective pricing ran about 4% in the third quarter, reflecting 2.1% taken in late may and 1.9% in mid-August.

Finally, at Burger King pricing was 4.9% in the quarter, including a 2% increase taken in August.

We anticipate that cost of sales should decrease sequentially in the fourth quarter by 20 basis points to 30 basis points from the price increases taken already along with additional increases implemented with both Hispanic brands mid- to late-October.

In addition, we have begun to see a pull back on a number of commodities which we hope will slow the rate of cost increases somewhat as we look forward. As an example, beef costs at Burger King, which averaged $1.72 per pound in the third quarter, have come off their highs and are now in the $1.55 range. Although this is still quite a bit higher than last year, we are at least encouraged by the direction of the change.

In terms of other relevant costs, restaurant wages and related expenses were down 65 basis points, as I said. Other restaurant operating expenses were 15.5% of sales and increased 51 basis points due mostly to increased utility costs, which increased 15.9%, or approximately $1.4 million.

General and administrative expenses were slightly higher, or 11 basis points above last year. As Alan indicated, we plan to reduce certain G&A costs moving forward due to the near-term slowdown of expansion.

Lastly, interest expense decreased about $0.8 million to $6.9 million, reflecting lower effective interest rates on borrowings under a senior facility compared to last year.

Let’s turn to earnings guidance now. As indicated in our press release, we are adjusting our guidance for 2008, given more recent trends, to $0.50 to $0.53 per share, which translates into $0.11 to $0.14 per share for the fourth quarter.

We are estimating an overall revenue increase of approximately 3.4% to 3.6% for 2008 with comparable unit sales of positive 2.5% to 3% at Burger King, flat at Taco Cabana, and negative 3% to 4% for Pollo Tropical.

In terms of new unit openings we have three new Pollo Tropical units in the Northeast that should open in the fourth quarter, along with three or four Taco Cabana restaurants and two Burger Kings, one of which is a relocations.

Finally, let’s review our debt and capital structure for a moment. At the end of the third quarter our total debt balances were $361.5 million and increased about $5.0 from the end of the second quarter. This was expected given the timing of the semi-annual July interest payment on our 9% subordinated notes.

The increase in debt, combined with some erosion in EBITDA, did cause our leverage to tick up somewhat for the quarter though. However, we anticipate that both debt and leverage will come back down in the fourth quarter due to the timing of our cash flows.

In general, our credit facilities are in place and are on terms that are favorable relative to today’s markets. We have low amortization requirements and no near-term need to refinance or otherwise access the capital markets, which is very important given the state of those markets. Our $178.0 million of 9% sub debt is not due until 2013 and has no required amortization.

Our senior credit facility, put in place in March 2007, is not due until late 2012, and the term A part of that loan, which totaled $118.5 million at the end of September, requires only modest amortization in the near term.

Repayment of the term loans is running about $1.5 million a quarter now, increasing to about $3.0 million in mid-2009.

Also at the end of September, we had $17.2 million drawn from our $65.0 million revolver.

As Al mentioned, we are actively taking steps to increase free cash flow, reduce debt and lower our financial leverage. We have reduced 2008 capex from our original plans of spending upwards of $80.0 million to our current estimate, which is in the mid-$60.0 million range.

Through the third quarter capex spending totaled $49.0 million. In 2009 we plan to further eliminate our discretionary capital spending and anticipate total capex of $20.0 million to $30.0 million with new unit growth significantly reduced from 2008.

We have also continued to complete sale/lease-back transactions, using proceeds to pay down debt. Through the third quarter we have completed $6.8 million in sale/lease-backs. So far in the fourth quarter we have closed an additional $4.0 million with approximately $12.0 million being marketed and expected to close over the next six months or so.

I want to touch on one component of our debt balances, that being the $46.0 million of lease financing obligations on the balance sheet. These represent sale/lease-backs completed several years ago that did not qualify as operating leases under the accounting rules.

We have the unilateral ability to restructure certain provisions in a large percentage of these leases if we find it beneficial to do so. Accordingly, we inherently have the ability to significantly reduce our lease financing obligations, qualify the leases as operating leases, and remove these debt balances from the balance sheet.

I think that this is worthy of mention, given what we perceive as the market’s concern over our compliance with debt covenants. While we are comfortable that we have taken the necessary steps to ensure that we can maintain an acceptable margin of safety with respect to the financial covenants in our loans, our unilateral ability to restructure these leases does give us more flexibility to lower our leverage than what might otherwise be apparent.

Our focus right now is on doing our best to effectively control what we can control and make decisions that we believe are best for the company’s long-term success. Our multi-faceted response to today’s industry challenges address both top-line growth and cost containment and are further helped along by a diversified business model that is more relevant than ever.

And with that we would be happy to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Reza Vahabzadeh – Lehman Brothers.

Reza Vahabzadeh – Lehman Brothers

Just on that last point, Paul, when you say you can adjust the terms of the lease finance obligation, how can it be helpful to you and over what time frame can you possibly adjust the terms.

Alan Vituli

Paul, why don’t you first just explain that the covenants treat that as debt, as conventional debt and converting them to operating leases takes them totally out of the purview of the covenants.

Paul R. Flanders

That’s the basic issue. These leases have one or two terms that we could restructure, unilaterally, to remove the debt. And in most cases, or in some cases at least, those are purchase options.

I will give you an example. I was looking at one of these leases yesterday where we retained these purchase options, obviously, because I think we thought that at some point in time they could be of value perhaps in refinanced leases, and we have refinanced some of these leases but we have cases where the appraised value of the properties was significantly above what our minimum purchase option was, and the economics of this would imply that it would not be to our advantage and we have elected not to buy that property.

Now we have held on to the purchase option but as a practical matter there probably isn’t an economic value that we are going to be able to take advantage of because we probably are never going to buy that property. So we have the ability to just cancel the purchase option. And that solves the accounting problem.

Reza Vahabzadeh – Lehman Brothers

So it just helps your cushion against the covenants, essentially.

Alan Vituli

Correct.

Reza Vahabzadeh – Lehman Brothers

With the sale/lease-back transactions that you are contemplating, would you anticipate lower net debt at the end of the fourth quarter from where you are today?

Alan Vituli

Yes.

Reza Vahabzadeh – Lehman Brothers

And I forget how much you have on the revolver right now.

Paul R. Flanders

At the end of September we had $17.0 million drawn.

Reza Vahabzadeh – Lehman Brothers

And your cash position?

Paul R. Flanders

Nominal. About $2.5 million to $3.0 million.

Reza Vahabzadeh – Lehman Brothers

On the operation side, how would you characterize the competitive conditions and dynamics for Taco Cabana?

Alan Vituli

Texas is a big state and the market places tend to have certain autonomy to them. I think what we’re getting is new entrants into the market in both San Antonio and in Austin. And as a consequence, what you’re getting is more competitive pricing and basically more of a sharing of the market. We’ve got strategies to just raise consumer awareness and it is putting some pressure on our pricing strategy in terms of dealing with some of the promotions.

Dallas and Houston seem to be just fine. Same store sales have been up. In all five of our principal Texas markets we are experiencing effective longer hours by conventional fast feeders, including Burger King, but it’s really San Antonio and Austin that are leaving us with much more price promotion strategies.

Reza Vahabzadeh – Lehman Brothers

Obviously you have been battling higher food costs all year long and it seems like you closed the gap a little bit from your own pricing standpoint this third quarter. Would you anticipate catching up a little bit on the food cost side in the fourth quarter but still be basically behind slightly?

Paul R. Flanders

I think we see, on a sequential basis, cost of sales coming down somewhat in the fourth quarter. They’re still above last year. But we have seen commodities start to pull back. I think what our sense is that the rate of increase is going to slow in 2009 but having said that, we still see an increase, right now our view is 5% to 7%.

Reza Vahabzadeh – Lehman Brothers

And do you have visibility around that as far as locking up contracts?

Alan Vituli

We are in the process of negotiating a number of the larger contracts now. I think it would be inappropriate to comment on that at this point in time. But we do have the benefit of that visibility.

Operator

Your next question comes from Brian Hunt – Wachovia Capital Markets.

Brian Hunt – Wachovia Capital Markets

Alan, you mentioned in your comments cutting some G&A and support functions in 2009 to control costs. Could you talk about what dollar amount you anticipate saving, as well as what those functions may be.

Alan Vituli

It’s premature to deal with the specificity of who, especially given the state that the company is in. I certainly don’t want to cause panic in our ranks. We believe that we should be able to lower our G&A, our support cost functions, by about $2.5 million to $3.0 million.

Brian Hunt – Wachovia Capital Markets

Second, the most recent round of price increases you saw in Q3 maybe coincided with lower gasoline, could you talk about what you believe your customers’ willingness is to accept higher prices on your current menu products?

Alan Vituli

Clearly, we are three brands in three distinct situations. The Burger King brand is still essentially a lunch, sandwich brand. Burger King has been very clever in its marketing and very wise in its pricing strategies of using both a value menu and at the same time introducing and promoting full margin products. And so you’ve got a marketing strategy and a pricing strategy there that’s been working and should continue to be working and they can always engineer products to fill in either side of that bar bell.

In terms of Taco Cabana, we clearly have plenty of flexibility in the menu. We’re now promoting an enchilada platter for $2.99, which is a little bit analogous to the bar bell pricing we have in Burger King, so we have plenty of flexibility to sort of put things at one end of the bar bell for the very price sensitive consumer and at the same time leave the consumer who is more interested in some of the premium offerings to go in that directions.

Pollo Tropical is the greatest challenge we have right now because the economy in Florida is worse than either of what the other two brands are contending with. So price sensitivity is very high for us. But we do offer products for $3.49, a quarter chicken, rice, and beans. We do have flexibility in lowering certain prices to target certain customers. We do offer, built on a platter of rice and beans, certain proteins that get added and have an attractive price.

The substance of what I’m saying is that the broad menu gives us flexibility to both increase prices at one end and continue to hold on to the price-sensitive consumer at the other. Florida is in this sort of chaotic state where hundreds of thousands of what were construction workers, both documented and undocumented, have essentially left the state. And that’s what’s causing the challenge to our numbers.

We are confident in the long run Pollo Tropical will be a very, very strong brand but right now our strategies have to be just to attract customers with a low price point at one end and premium products at the other.

Brian Hunt – Wachovia Capital Markets

And looking at Burger King and its strengths, it has had several great quarters. You all have mentioned using that portfolio maybe as an opportunity to de-lever and it appears there are several buyers out there. How much energy do you have around managing that portfolio lower through sales?

Alan Vituli

When you say energy and managing that portfolio, we have been in the Burger King business since 1976. It is a business that we run smoothly and we are a franchisee. So in terms of energy absorption, in terms of management absorption, Burger King is a very good partner in helping us manage at least the marketing parts of that business.

Brian Hunt – Wachovia Capital Markets

I really meant managing the size of the portfolio lower and using it as an asset and potentially liquidating, because you have mentioned that in previous calls.

Alan Vituli

The zeal to sell Burger Kings for us is high in terms of reducing our financial leverage. But our situation is a pretty luxurious situation in that we can manage our financial leverage without selling Burger King. And so the only thing that has really stopped us has nothing to do with anything that is internal, it has to do with getting our price for our Burger Kings.

There are plenty of predatory buyers in the market and as a consequence of us having a high affinity for the asset and it not absorbing huge energy, if you will, in the company, our feelings are that if someone offers the right price, and we certainly have talked to brokers, we’ve talked to plenty of buyers, we would sell. And that price is a reasonable, correct price, but we are not prepared to quickly sell them.

Brian Hunt – Wachovia Capital Markets

In looking at securing your raw materials for next year, we have heard significant discussions from suppliers of wanting to reduce the time frame in which they extend contracts from a year to six months, or even a quarter. Are you seeing that push back from your suppliers?

Alan Vituli

Yes.

Brian Hunt – Wachovia Capital Markets

And how are you going about working in those negotiations?

Alan Vituli

It’s early on for us. And the zeal to enter into a long-term contract in a market that seems to have the dynamics to either move down or up leave both the vendor and the user in a little bit of state of let’s take a conservative approach. So while we are still the early phases of negotiations. The fact that they’re holding us up to six months, I’m not sure is necessarily inconsistent with what our own objectives are.

Operator

Your next question comes from Jeffrey Omohundro - Wachovia Capital Markets.

Jeffrey Omohundro - Wachovia Capital Markets

On the G&A savings that is anticipated, that $2.5 million to $3.0 million savings, in what sort of time frame do you expect to achieve that and do you anticipate some sort of restructuring charge associated with it or would it be through more of an attrition process?

Alan Vituli

I think that if you look at the company’s run rate six months from now you would see that run rate would probably have the $2.5 million to $3.0 million out of it. If the economy didn’t change in direction. And we don’t see any significant charges. There may if we follow the course and reduce headcounts, we may some charges just for terminations but nothing significant. Paul, do you agree with that?

Paul R. Flanders

I do.

Jeffrey Omohundro - Wachovia Capital Markets

And on the Florida situation, I’m just wondering about the effectiveness of the fajitas promo in this kind of challenging macro environment. If you’re contemplating moving the message more toward value, certainly a message we’re seeing really across industry with increasing media support, just thinking about how you might be planning on positioning Pollo Tropical going forward.

Alan Vituli

It’s a good question and one that we struggle with. To the extent that we’re in the lunch business, clearly our competitive set is quick service as well as casual diners who are essentially lowering their prices so that they’re pretty close to some to quick-service parts of their menu. So I think we have got to have the strategy that has significant sensitivity to the competitive set for lunch, and that being quick-service.

And the dinner segment, we certainly must be a value proposition. But our entry points can be higher. And so the notion of price points for dinner is a little less than the relevance of the value proposition, without it being guided entirely by a $0.99 entry point.

So for example, the ability to feed a family of four for under $10.00 is a tremendous value proposition in the dinner day part. And it is clear that our message is going to be going in that direction. It has been going in that direction but I think we are going to have to drive that message harder simply because the economy appears to be getting worse here.

Operator

Your next question comes from Carla Casella – J.P. Morgan.

Carla Casella – J.P. Morgan

One clarification on the lease obligation. If you were to switch that into an operating lease, does that add rent expenses? Is it already classified as rent expenses or is it interest right now?

Paul R. Flanders

The payment now is mostly all in interest.

Carla Casella – J.P. Morgan

So that would move into leases?

Paul R. Flanders

It would move from interest to rent.

Carla Casella – J.P. Morgan

And do you have an approximation of the amount?

Paul R. Flanders

It would depend on how much of these leases we restructure. I think as a general rule, the interest component is about 10% of the obligation balance.

Carla Casella – J.P. Morgan

The key covenant, is that still 5.5x total leverage covenant?

Paul R. Flanders

No. We have a senior leverage covenant which is at 2.5x and we have a total leverage covenant that requires a maximum of 4.75x. And we are well below both of those.

Carla Casella – J.P. Morgan

And you mentioned the chicken contract change. Did you say what the average life of it is now?

Alan Vituli

Well, we had a 15% increase on chicken. Let’s start there. We are renegotiating it as we go forward.

Carla Casella – J.P. Morgan

How many suppliers on chicken?

Alan Vituli

Two suppliers.

Operator

Your next question comes from Kenneth Byrne – Jefferies & Co.

Kenneth Byrne – Jefferies & Co.

I was wondering, in Florida and Texas, since you’re cutting back on your new growth plans, do you see any of those competitors that you’re going against cutting back on their growth plans and/or do you see other restaurant chains that also might be having some financial problems closing up any restaurants in those markets?

Alan Vituli

Carrols is a very disciplined organization. Let me make one point clear. Cutting back our growth plan, please insert the word strategically cutting back. We continue to look at good opportunities in Florida, we continue to look with zeal for opportunities in the Houston and Dallas markets, and we will, indeed, be continuing our expansion plan for Pollo Tropical in the Northeast.

The fact that you are seeing other restaurants continue to open has a little more to do with the absence of discipline on the part of some restaurateurs. Clearly the absence of financing for a lot of restaurant companies should basically cause some diminution in new store openings, but in Austin and Houston we are not really seeing that. And we have seen some competitive entry in Florida. But my sense is that if the economy stayed here, going forward, though I can’t point to any specific examples, we will see a reduction in the number of restaurants.

Kenneth Byrne – Jefferies & Co.

And your strategy in the Northeast with Pollo Tropical, you will have six or seven restaurants in the Northeast, does this not provide you with enough competitive clout in the Northeast or will you change your strategy about that expansion down the road if you can’t get enough competitive restaurants open in that area?

Alan Vituli

We have three restaurants currently open. By the end of the year we will have six restaurants open. Our strategy is really one of putting flags in a number of places in the Northeast and then sort of testing the resitivity and growth potential of whether we put four more in that market or two more in that market.

So the restaurants that will be opening is one in Staten Island, New York, we’re opening one in New Jersey on Route 46 and we’re opening a third restaurant in the Hartford, Connecticut, area.

That would give us six, but no clout at all, if clout means marketing. It will give us infrastructure, it will give us some savings in terms of cost of getting our product delivered to the store. But the strategy is to plant flags in specific geographic areas and then continue the growth in those areas, albeit at a more moderate rate.

Kenneth Byrne – Jefferies & Co.

Would you ever contemplate going towards more of a franchise model in Pollo Tropical and Taco Cabana and selling off units to franchisees or have franchisees grow the business, saving you the capital expenditures?

Alan Vituli

There is no question that that possibility exists. But we first need to expand our footprint in terms of how those brands work. And then franchising smaller markets down the road is certainly not off the table.

Kenneth Byrne – Jefferies & Co.

In terms of changing some of your capitalized lease obligations to operating leases, how quickly could that occur and I presume you have talked with your accountants, that they would sign off on them being treated as operating leases if you did change the terms.

Paul R. Flanders

Yes, we have had that discussion with the accountants. And given the nature of the terms we’re talking about, we could do it very quickly. I mean, if it’s a matter of giving up a purchase option, it’s a matter of sending a notice to the landlord that says we give up our purchase option.

Kenneth Byrne – Jefferies & Co.

What size are we talking about here? Could we reduce that obligation by $20.0 million to $25.0 million fairly quickly?

Paul R. Flanders

Again, it depends on how we might chose to take advantage of our ability to do this, but there’s $46.0 million of these lease obligations and I will tell you that we have the ability to do this unilaterally with a substantial portion of that balance.

Operator

Your next question comes from Bryan Elliott - Raymond James.

Bryan Elliott - Raymond James

The sale/lease-back activity, I think you said you are marketing and expect to close about $12.0 million in the next six months. Refresh my memory on how much is behind that $12.0 million?

Alan Vituli

Behind the $12.0 million we probably still own, I’m going to guess, 30 properties, perhaps.

Bryan Elliott - Raymond James

Beyond that $12.0 million or today?

Alan Vituli

On top of the $12.0 million we own another probably 30 properties. Although we would not necessarily consider doing sale/lease-backs on all of those.

Bryan Elliott - Raymond James

And you mentioned the Galveston store was fully covered by insurance. Just wondered what the accounting for that is? Is that in other income?

Paul R. Flanders

There has been no accounting effect of that.

Bryan Elliott - Raymond James

Because it was after Q3.

Paul R. Flanders

It was in Q3.

Bryan Elliott - Raymond James

You wait for the settlement, essentially. Are you incurring any ongoing costs for that restaurant.

Paul R. Flanders

There weren’t any substantial costs in the third quarter because of the timing of the hurricane. To the extent that there are costs in the fourth quarter, what we will do is we will be accruing the insurance proceeds for business interruption insurance to offset that.

Operator

Your next question comes from Art Rulach – CAI.

Art Rulach – CAI

Can you just quantify the total amount of commodity impact in 2008 versus 2007?

Alan Vituli

That’s a tough question. The degree to which 2008 commodity costs were higher than 2007, in the aggregate?

Paul R. Flanders

Let me try it this way. If you exclude the effect of our price increases, and only look at the increase in commodities year-over-year, I have something here that doesn’t have everything but has probably 80% of our commodities, just to give you a sense, in the case of Burger King we are probably up 250 basis points. About the same in all three brands, it’s about 250 basis points.

Art Rulach – CAI

And looking at the CRB index just in the last three months it’s down 50%, back to sort of 2002 and 2003 levels, and I know in the fourth quarter your prices are locked in and perhaps even for the first quarter of 2009, but can you look at those prices and prospectively give a sense from a dollar amount of what impact we may see in terms of a tail wind versus a head wind in Q3 and Q4 of 2009?

Alan Vituli

You’re still running off of 2008, some of them being covered under contracts. It’s clearly too early and too unsettled. We’re just developing our 2009 profit plan. As you have heard from the earlier question, most suppliers are not looking to go long, man are attempting to shorten the duration of their contracts. And Paul, unless you have a better answer, I just can’t at this point get to a response where we have our arms around what kind of savings is in the bank from lower commodity prices.

Paul R. Flanders

These markets have been very volatile. I think what has been very encouraging to us is that we are seeing pull back in a number of the commodities. I have said what we are doing is we are building our plans around our current view that commodities are going to increase 5% to 7%. Now if they get better than that, that’s a great thing. But we are not building our plans around that. Which I think is just the prudent thing to do in this environment.

Alan Vituli

Ground beef prices are bouncing all over the place and defy predictability for us, while chicken prices in the spot market are down. The prognosis for chicken prices is not nearly as positive as what the current spot is on them. So it is in a state of complete flux for us.

Art Rulach – CAI

I guess you’re saying right now the level of volatility is so high you don’t feel comfortable assuming you’re going to have future cost savings in the bank, despite the fact that for example, most of the primary feed costs are down over 50%?

Alan Vituli

At this moment. But egg sets are down, egg sets being a very good indicator of future chicken prices. And ethanol, the U.S. government’s policy of increasing the amount of ethanol as an additive in gasoline, has not backed off. And that was an important catalyst for the increase in corn prices, and other agricultural commodities. And we don’t really see a change in terms of the government policy. If anything, it’s increasing the amount of ethanol going forward. So it’s just too dynamic.

Paul R. Flanders

We will have a much better feel very shortly and when we issue guidance for 2009 we will have a very good sense of where we are, at least on the Hispanic brands where we have control over the contracts.

Art Rulach – CAI

So it just sounds like at this point you’re uncomfortable sort of prognosticating on that. Like the fact that corn, for example, is down 50% in the last four months. Is that fair?

Alan Vituli

Yes, that’s fair.

Operator

Your next question comes from Rishi Parekh – KBC Financial.

Rishi Parekh – KBC Financial

Could you tell us when your loan covenants step down, or do they step down.

Paul R. Flanders

They have already stepped down somewhat. They stepped down at the end of December to 4.5 total leverage and 2.5 senior leverage. And they stay there until the end of next year.

Rishi Parekh – KBC Financial

Are you allowed to repurchase bonds under your credit line?

Paul R. Flanders

Yes.

Rishi Parekh – KBC Financial

But you haven’t done any recently?

Paul R. Flanders

We purchased a couple of million in the second quarter.

Rishi Parekh – KBC Financial

Would you comment on your general appetite?

Alan Vituli

We’re not going to comment on whether or not we are going to do it but certainly the price has been very attractive.

Rishi Parekh – KBC Financial

A few questions ago you volunteered a random comment about the economy appears to be getting worse. I’m wondering if you could elaborate a little bit on the key metrics you watch? Is it more employment? I mean, gas prices are getting better. And I guess I’m trying to get a sense, there has always been sort of a though process that maybe there is some sort of a floor in mill replacement abatement. I’m wondering if there is some sort of leveling off in terms of traffic.

Alan Vituli

My comment ran to the Florida market. And I think what we are doing basically is being done by a fair number of companies, and that is significant cost reduction initiatives, which generally mean lay-offs. My sense of the Florida market is that the problem will more likely get worse before it gets better, in terms of employment. And it’s employment that we are focused on, the jobs in the Florida market. More globally it’s difficult but we do recognize lots of companies are laying people off.

And that’s beginning now, so it’s move from liquidity issues and housing issues to job issues, employment issues, and you’re starting to see that in the stats.

Operator

Your next question comes from Mitch Speiser – Buckingham Research.

Mitch Speiser – Buckingham Research

Just a few questions regarding Burger King. First, just to circle back on the cost information you gave, you said beef costs are around $1.55, down from the third quarter. Any sense, do you expect that over the next couple of quarters to continue to decelerate or is this whole herd liquidation and trade-down cycle perhaps going to take beef costs higher?

Paul R. Flanders

There historically seems to have been some seasonality in that they tend to come down this time of year anyway. I think the forecast that we’ve seen earlier in the year from the purchasing co-op for the system implied that the beef costs would be much lower than where they are today, and obviously they’ve been somewhat higher. And that has been a consequence of trade down, as you say, in that consumers are cutting back in terms of their discretionary spending and tend to be cutting back on higher quality cuts of meat, which has created some pricing pressure on ground beef.

Mitch Speiser – Buckingham Research

Does the herd liquidation cycle have any material impact in the foreseeable future?

Alan Vituli

I’m not sure I’m qualified to comment on that.

Mitch Speiser – Buckingham Research

And just on the overall cost outlook and you did touch on this, I just thought I would ask it in another way, you are indicating about a 5% cost increase for 2009. Maybe just to break it out by kind of first half 2009, second half 2009, is it safe to say that within that forecast, second half 2009 is maybe in the flattish to down year-over-year or is that getting too specific?

Paul R. Flanders

Well, I think to the extent that we’re a little hesitant to give it a very clear sense of what we think costs are going to do in 2009 in general, I think it would be somewhat difficult to further narrow that by quarter. I think in general that, at least in our Hispanic brands, the contracts that we are in the process of negotiating now will obviously set prices for at least of the first half of the year.

Alan Vituli

And then depending on what commodities do, perhaps if commodities continue to see pull back, then that could get better as we go along. But that’s hard to predict.

Mitch Speiser – Buckingham Research

Just on to the utilities, which you said were up 16%. A lot of companies have mentioned very high utilities in the calendar third quarter, is that an annual contract, quarterly, will that adjust or are we going to look at this higher year-over-year for the next couple of quarters?

Alan Vituli

We’re in a lot of different locations so we don’t have one or two contracts. We do certainly buy contracts. They lapse periodically for a fair portion of the system, separately. So we are always, in any given month, putting on new contracts and having contracts lapse. So there is a certain gradual nature to it. It’s not going to be any kind of a cliff phenomena.

Mitch Speiser – Buckingham Research

Maybe just for calendar fourth quarter, first quarter 2009, do you expect this level of year-over-year utility increases?

Paul R. Flanders

No. The large increases really began late last year. So we’re starting to lap the worst of this.

Mitch Speiser – Buckingham Research

I would like your thoughts, with McDonalds looking like they’re going to focus a little bit more on profitability with their dollar menu, do you expect to follow that lead in terms of focusing on profitability or maybe to try and exploit that opportunity?

Alan Vituli

McDonalds’ controversial issue is its double cheeseburger, with its high food costs and the franchisees who are adamant about having that pulled that off their dollar menu. We don’t have a double cheeseburger on our dollar menu. There is talk, you know, McDonalds is McDonalds and Burger King is Burger King. But certainly they are in the same industry and one can create opportunities or competitive pressures for the other.

If McDonalds pulls its double cheeseburger off it may relieve Burger King from some of the pressures on its dollar menu. But we don’t have the same sensitivity that was created by McDonalds with their compelling value double cheeseburger. The premium sandwich that we have is a Whopper Jr. which, while it has a high food cost, is not nearly as compelling an offer and the McDonalds double cheeseburger, with an enormously high good cost.

Mitch Speiser – Buckingham Research

On the Burger King company U.S. which was solid, can you give us a sense of the breakfast and late night comp and if you can’t comment directly maybe just as a factor, were those the faster growing day parts?

Alan Vituli

No, our sales have been strong really across the day. We’ve continued to see double-digit increase certainly in the late night business, which I think is a combination of the fact that the hours are longer as well as one of these new wrap sandwiches seems to be driving some sales in that day part. But other than that I would say it has been pretty solid across the day.

Operator

Your next question comes from Greg Ruedy - Stephens Inc.

Greg Ruedy - Stephens Inc.

Next year’s guidance on the capex line, $20.0 million to $30.0 million, could you break that up in terms of repair and maintenance versus new development?

Paul R. Flanders

Our maintenance capex runs $9.0 million to $10.0 million. We have, as you are aware, we are rolling out point of sale systems, we rolled out point of sale systems at Taco Cabana in 2008, we’ve got another couple of million for that next year. There’s an initiative from Burger King to roll out new broilers. We’ve got them in some small percentage of our restaurants, maybe 10% of our restaurants but we need to do that, probably in the back half of the year and that would require another $4.5 million roughly. And then of course, any remodeling that we need to do for Burger King.

So I think right out of the gate we’ve got about $20.0 million of sort of minimum capex, excluding any new store development. And I think from there it’s just a function of how many units we end up deciding to open next year. And that’s why we’ve got the range from $20.0 million to $30.0 million.

Greg Ruedy - Stephens Inc.

Do you know how many leases you have signed for potential units next year?

Alan Vituli

We have an expectation of about five new units next year.

Paul R. Flanders

But those are not signed at this point.

Greg Ruedy - Stephens Inc.

You mentioned a couple of new units at Taco Cabana in the valley have come in below expectation. Is there anything you can point to and could that inhibit your inability to grow in that market?

Alan Vituli

I think I said earlier that the focus for our growth in Taco Cabana in the near term will be used in the Dallas markets and an occasional fill in site in Austin and San Antonio. The valley is sort of off our list. We do have another market, New Mexico, the Albuquerque market in which we will be pursuing the opening of a restaurant soon.

So the bottom line is the valley, which tends to be more conventional Mexican in its food fare, rather than the traditional Tex-Mex, it will probably be an area that we won’t be developing in in the short term. But we’ve got plenty of growth opportunities at the current level of capital that’s been allocated in Houston and Dallas and Albuquerque.

Operator

There are no further questions.

Alan Vituli

We appreciate your attention and look forward to talking to you next quarter.

Operator

This concludes today’s conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Carrols Restaurant Group, Inc. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts