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Executives

Alan Vituli - Chief Executive Officer

Paul R. Flanders - Chief Financial Officer

Dan Accordino - President & Chief Operating Officer

Analysts

Reza Vahabzadeh - Barclays Capital

Brian Hunt - Wachovia

Jeff Omohundro - Wachovia

Ken Bann - Jeffries and Company

Joshua Long - Stephens Inc.

Brian Elliot - Raymond James

Carrols Restaurant Group Inc. (TAST) Q4 2008 Earnings Call March 2, 2009 5:00 PM ET

Operator

Good day ladies and gentlemen thank you for standing by. Welcome to the Carrols Restaurant fourth quarter and full year 2008 results conference call. As a reminder today’s call is being recorded. At time all participants are in a listen-only mode. Following the presentation we will conduct the question-and-answer session. Instructions will be provided at that time for you to queue-up for questions.

I’d now like to turn the call over to Mr. Paul Flanders for opening remarks. Please go ahead.

Paul Flanders

Good afternoon and welcome to our fourth quarter and full year 2008 conference call. By now everyone should have access to the announcement released this afternoon’s, which you may also find on our website at www.carrols.com under the Investor Relations section.

Before we begin the formal remarks, I need to remind everyone that 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 filings with the SEC for more detailed discussions of the risks that could impact our business and financial results.

On the call with me today is Alan Vituli, our Chairman and CEO, and Dan Accordino, President and Chief Operating Officer. Alan and Dan will provide some commentary on the business. I will walk through our financial results for the quarter, review our ‘09 guidance and then we’ll address any question that you might have.

I’d like now to turn the call over to Alan.

Alan Vituli

Thanks, Paul and good afternoon everyone. I’d like to begin by reviewing some highlights 2008 and our fourth quarter, specifically of 2008. For the full year total revenues increased 3.4% to $816.3 million, while comp sales grew 3.5% at Burger King, declined 1% at Pollo Tropical and were flat at Taco Cabana. Similar to 2007, Burger King held up the best of our three brands and continues to demonstrate its strength within the QSR segment.

We opened a total of 21 new restaurants in 2008 including seven Pollo Tropicals, ten Taco Cabanas and four Burger King Units and ended the year with 560 company owned restaurants. In the fourth quarter we opened two new Pollo Tropical restaurants in the Northeast, three Taco Cabana restaurants in Texas and two Burger King Restaurants, one of which was a relocation of an existing unit.

We closed four Burger King Restaurants, two related to locations and we also closed two Taco Cabana restaurants during 2008. In the face of the difficult consumer environment our fourth quarter results were reasonably solid at Burger King, where our comp sales were up 1.2% in the fourth quarter and Taco Cabana where comp sales increased 0.5%.

We did experience some further weakening in sales trends at Pollo Tropical, however with same-store sales down 3.6% in the fourth quarter. We were able though to increase profitability in earnings in the fourth quarter as our heightened focused on costs along with some moderation in commodity prices and lower interest rates enabled us to increase fourth quarter 2008 earnings per share excluding non-recurring items to $0.22 from $016 cents in the prior year.

Net income and diluted earnings per share for the full year were $12.8 million and $0.59 respectively, both down from 2007. In the fourth quarter we made substantial progress lowering our debt levels. We are very cognizant of the fact that the capital markets remained skiddish that highly levered company like ours are being more carefully scrutinized by shareholders.

We have and will continue doing what is necessary to allay their concerns. We have placed a high priority on maximizing free cash flow, so as to further reduce our financial leverage in 2009 and will do so in several ways.

First, we’ve reduced G&A expenditures as we scaled back our openings of new restaurants, look for about $3 million in total G&A savings in 2009. This savings maybe eaten into a little bit if our earnings improved and executive bonuses are -- second we’re containing operating costs at all three brands. Commodity prices rose in the fourth quarter.

We were encouraged by a moderating cost environment and foresee lower commodity inflation in 2009, compared to what we experienced in 2008. We also improved labor margins despite higher wage rates in many of our markets, as we took steps to reduce overtime hours and improve labor productivity.

We have significantly scaled back new unit development in an outlook of between five and seven total openings this year, plus two or three of Burger King relocations compared to the addition of 21 new units across the company in 2008. We will limit capital expenditures to about 60% of what we spent in 2008. That’s roughly about $30 million to $35 million as reflected in today’s press release.

We believe that acceptable financial leverage is being redefined by lenders and investors and we try to consider this as we developed our operating plans. Given persistent weakness in consumer spending and the state of the economy in general our industry is in [Inaudible] some difficult times. We are operating as if the economy is not like to the turnaround any time soon.

Consequently, we’ll focus on effectively managing through these challenging circumstances. Still we believe our brands continue to be well positioned and offer outstanding and competitive value especially to the highly price sensitive consumer and we seem to be holding up relatively well, all things being considered.

With that, I’d like to turn the presentation over to Dan to discuss each of the brands in greater detail.

Dan Accordino

Thanks, Alan. First I’d like to discuss Pollo Tropical. Policy with a substantial portion of its restaurants in Florida is our greatest challenge right now. The Florida economy is worse off than most state. With the slumping construction thousands of workers have left the state and envision to the general pressure on consumer spending, their absence is negatively affecting our sales.

Pollo Tropical experienced its worse comparable sales results for 2008 during the fourth quarter and while we expect these trends to continue near term, we are encourage that we haven’t seen them get any worse in the first quarter.

We have recently resumed television advertising in South and Central Florida after being off the air for several years. Our ads reflect brand building focusing on food, quality, value and health and this effort is being combined with continued radio campaigns in all of our markets. We are also distributing direct mail booklets and increasing visibility with billboards and select markets, particularly on the West Coast and in Central Florida.

While our development of company owned Pollo Tropical restaurants will appear modest this year, we are moving forward with establishing greater presence in the Northeast and expanding outside of the Continental United States through franchising. Currently we have 25 franchise locations, 20 of which are in Puerto Rico and two more in Ecuador.

In 2008 we signed new development agreements for the Bahamas and Trinidad and just recently added a new development agreement for Honduras. Our expansion strategy continues to focus on evolving the brand initially in certain small markets in the Caribbean and Central America, while we also work to identify development partners in a number of larger markets.

Present challenges, notwithstanding we are confident that in the long run Pollo Tropical will be a very strong brands with exciting growth. With regards to Taco Cabana same store sales were flat for the year, but did increase in the fourth quarter. While Paul will update you on trends by market, sales have been fine in Dallas and Houston while we have experienced considerable competitive pressures in Austin and San Antonio.

Also our new restaurants have generally opened strong. Traditional QSR are advertising price points of 2.99 and below, while casual-dining is offering $4 to $5 lunch prices and under $10 dinners. We believe that Taco Cabana is differentiated with its quality food and fresh ingredients. Nonetheless the competitive factors that we are faced with today are significant.

Our strategy this year includes promoting historically successful products such as enchiladas, Shrimp Tampico and chicken fajitas at as competitive price points. In order to highlight our value and obtain fair share of market given the competitive environment, we are currently testing reengineered and new product offerings at prices to start at $2.99 complemented with appropriate up sell strategies to compete with conventional QSR.

As Alan indicated, Burger King continues to perform well in the quarter as it’s bar bell strategy of balancing value and full margin products continues to be effective along with its highly recognized and successful advertising, promoted products in the fourth quarter included the Cheesy Bacon Tender Crisps and the Steakhouse Burger complement with value oriented addition of breakfast and lunch wrappers.

Looking ahead, we believe our Burger King results will continue to benefit from the BK pipeline and near term from the Angry Whoppers in BK shops. The Angry Whoppers was rolled out in January, while the BK shop was just rolled out in February.

Overall, we believe that quality offering such as these along with Burger Kings strong value proposition will continue to resonate well with consumers in the current economic environments.

I’ll now turn the call back to Alan.

Alan Vituli

Considering the state of the consumer economy, especially in Florida and the fears competition in our segment of the restaurant business, we don’t think that our overall results in 2008 were too bad. Concurrently, we acknowledge that our lack of visibility regarding of how long and how deep this recession will be has left us cautious in formulating our business plan for 2009.

As stated, we cut back on capital spending in new unit growth, not because we lack confidence in the potential of our brands, but because it became apparent on our shareholders were uncomfortable with our leveraged capital structure. We’ve lowered debt levels and improved our financial ratios. Our forecast for 2009, and beyond suggest that we will remain well within the provisions of the financial covenants in our senior credit facility.

Other than some relatively modest scheduled repayments of our term loans, our debts do not mature until 2012 and 2013 at which point we should hope for a return to normalcy in the capital markets. In the meantime, we have concluded that until we have more confidence in consumer behavior, we’ll continue to lower debt levels, improve financial ratios and slowdown growth while focusing on maximizing near term profitability through cost reduction.

As Dan said, our Burger King restaurants were doing just fine. Burger King Corporation’s management team is committed, capable and focused on both expanding market share for the brand and improving restaurant level profitability. Our Taco Cabana brand, while challenged by aggressive competitive marketing and the addition of significant increases in the number of new competitive restaurants in the Texas market has held its own.

Our Pollo Tropical brand has been jolted most as a result of the severe reversal of the Florida economy. With most of its restaurants in South and Central Florida has experienced declines in sales and unit profitability. In addition, a number of our newer restaurants on the West Coast of Florida as well as Orlando have not met our financial expectations.

In early 2008, we began focusing on expansion of our franchising of the Pollo Tropical brand outside the United States, as Dan said initially, in the Caribbean and Central America. In 2009 I believe, we’ll have Pollo Tropical’s franchise restaurants opened in the Bahamas, Trinidad and Honduras in addition to those currently operated in Puerto Rico and Ecuador.

2008 Pollo opened its first restaurant in Connecticut and its fourth restaurant in New Jersey. In 2009, it will open its first restaurant in Staten Island, New York as well as additional restaurants in Connecticut and probably New Jersey as well. We are very confident that despite the challenges in Florida the Pollo Tropical brand has great prospects.

Nonetheless we will continue to hold back on aggressive expansion of the brand in the current economic environment. While we do not profess to have a crystal ball, if history is any indication of the economic cycle and it is a cycle, we’ll recover. Our Hispanic brands will be more able to capitalize on the population and demographic trends that transcend the current climate and that will shape our country overt the next few decades.

With that said I’d like to turn it over to Paul who will review our financial results and discuss our 2009 guidance. Paul.

Paul Flanders

Total revenues for the fourth quarter increased 1.8% to $200.8 million, from $197.2 million last year. Revenues for our Hispanic brand restaurants increased 2.3% in the quarter and totaled $103.8 million compared to $100.6 million in the previous period.

Our Pollo Tropical revenues increased 0.7% to $42 million, from $41.7 million reflecting the opening of nine new restaurants since the beginning of the fourth quarter 2007 including two new units opened during the fourth quarter of 2008 in the Northeast.

Comparable restaurants sales in the fourth quarter decreased 3.6% against a positive 2.0 comparison from the prior year. South Florida counties of Miami, Dade, Broward and Palm Beach where we have 63 total units performed somewhat better than the areas around Orlando where we operate 15 restaurants. Miami Dade was flat; Broward County decline 2.8%, Palm Beach County was down 5.8%, while Orlando was down 10.9%.

Taco Cabana rest revenues increased 5% to $61.8 from $58.9 million due primarily to the opening of 11, new Taco restaurants since the beginning of the fourth quarter of prior year.

Comparable restaurant sales in the fourth quarter were up 0.5% against the positive 0.9% comparison from the fourth quarter of 2007. As Dan indicated Taco Cabanas comparable sales results were mixed among markets. Houston 41, unit market experience 6.3% increase in comparable sales, Dallas a 36 unit market which performing well all year was down slightly at 0.7% mostly because of a 3.9% comparison from the prior year.

We continued to see competitive pressure, though affecting us in our 20 union Austin market where comp sales were down 1.2% and in our 40 unit San Antonio market where comps were down 3.1%. For Taco Cabana new restaurant openings have generally been strong. The exception to this was our location in Brownsville and Weslaco Texas where given their weak results. We closed these locations in late December.

Our Burger King restaurants had a solid quarter considering the higher than normal snow fall in the Northeast this winter. Overall sales increased 0.4% to $97 million despite the net closings of ten restaurants since the beginning of the fourth quarter of 2007.

Comparable sales increased 1.2% against the 4.6% positive comparison from the fourth quarter of ‘07. Despite only a modest increase in overall revenues and the continued affect of inflationary pressures across much of the P&L we still were able to improve operating margins. Overall EBITDA actually improved $1.3 million in absolute dollars while EBITDA margin improved close to 50 basis points to 11.5%.

Net income for the fourth quarter of 2008 was pretty solid at $4.4 million or $0.20 per diluted share compared to net income for the fourth quarter of 2007 at $3.5 million or $0.16 per share. The fourth quarter of 2008 included non-recurring gains and losses in the aggregate reduced earnings by approximately $0.2 per diluted share which I’ll review in a little more detail.

During the fourth quarter we incurred impairment and related charges of $5.4 million or $0.15 per share after tax, this included a charge of $2.2 million related to the two Taco Cabana closings, consisting of impairment charges of $1.7 million plus accrued rent and related cost of another 500,000.

We also took impairment charges of $3.2 million associated with three Pollo Tropical restaurants in Florida, based on a review of those restaurants operating performance. Offsetting the impairment charges were two separate gains.

First we recorded a gain of approximately $0.5 million or $0.01 per share after tax related to insurance recovery for damages to our Taco Cabana restaurants in gallon and Texas caused by hurricane Ike. Second, our opening market repurchases of $13 million principal amount of our 9% senior subordinated notes resulting in a gain of approximately $4.2 million or $0.12 per diluted share after tax.

Now getting back to the operating portion of our P&L. Cost of sales was 29.8% of restaurant sales which was about 48 basis points higher than the fourth quarter of ‘07. Although commodities were higher than the prior year, our overall cost of sales was about 35 basis points better than we had anticipated.

Year-over-year Pollo cost of sales were up 142 basis points and Burger King increased 77 basis points while Taco Cabana actually improved 67 basis points versus the fourth quarter of 2007. Cost of sales also declined 68 basis points sequentially from the third quarter, including a decrease of 87 basis points at Burger King, 10 at Pollo and 43 basis points Taco Cabana. These costs at Burger King while still up about 14% over 2008 declined 13% to the levels that we experienced in the third quarter.

As we said on our last call, we were somewhat more aggressive in pricing in 2008 given the significant increase in commodities. For the fourth quarter Pollo effective pricing was about 9% including the most recent 1.8% increase taken in October.

The Taco, effective pricing ran about 5.7% in the fourth quarter reflecting a 2.4% increase in October. At Burger King pricing was 4.3% in the quarter, include a 2% increase taken in August. We do not expect to be taking as much pricing in 2009 given the more favorable commodity environment and in light of current economic conditions.

As we lap our 2008 price increases, we have effective pricing in the first quarter of about 4.5% at Burger King and 6.5% at both Hispanic brands. Before any additional increases in 2009 effective pricing for the full year is about 2.5% for Burger King and between 3.5% to 4% for our Hispanic brands.

We have most of our key commodity contracts for 2009 in place for our Hispanic brands at this point and currently estimate commodity inflation to be about 4% to 4.5% at Pollo Tropical, flat to less than 1% Taco Cabana and although we have less visibility with respect to Burger King believe that cost will be up 4% to 4.5%.

Restaurant labor fell 81 basis points in the quarter to 28.5% of restaurant sales from the leverage of our price increases, lower medical costs combined with other steps to reduce hours and improve labor productivity. Restaurant operating expenses were 14.9% of sales, 33 basis points above last year with utilities accounting for more than half of the increase.

General and administrative expenses were 6.5% of total revenue and 0.8 million or 52 basis points lower than last year mostly due to lower accruals for incentive bonuses in 2008. Lastly interest expense decreased about $1.2 million to $6.6 million reflecting lower effective interest rates on borrowings in our senior facility given the significant decline in short-term borrowing rates and to some degree from lower debt levels compared to last year.

Let’s now review our debt and capital structure for a moment. At the end of 2008 our total debts stood at $316.2 million which reflected a $45.3 million reduction from the third quarter of ‘08 and $37.8 million reduction for all of 2008.

You may recall that we announced the completion of sale lease backs or six restaurants properties during the period with net proceeds of about $8 million used to reduce debt. We also opportunistically repurchased $13 million of our 9% senior subordinated notes in the open market for an aggregate purchase price of $8.5 million or about a 34% discount to par.

Finally we amended or modified certain provisions and leases for 23 restaurants properties which have been included in our balance sheet as lease financing obligations. The changes permitted these to qualify as operating leases and resulted in a further reduction of $31.6 million in our debt balance.

Our senior credit facility required our total debt to EBITDA coverage to be under 4.5 times at December 31, 2008 and is calculated for purposes of compliance we were at 3.77 times at the end of the fourth quarter.

In terms of senior debt we are required to be under 2.25 times EBITDA and we were at 1.8 times. As you can see we were well within compliance and had a considerable margin of safety. As we noted in the past, our credit facility is on terms and are favorably relative to today’s markets and we have no, low near term amortization requirements. We have no need to refinance or otherwise access the capital markets any time soon, which is very important given the state of those markets.

Our 9% sub-debt is not due until 2013 and has no required amortization. Our senior credit facility put in place two years ago is not due until late 2012 and requires only modest amortization in the near term. As Alan mentioned, increasing free cash flow, reducing debt and lowering our financial leverage are high priorities this year.

To that end we’ve reduced discretionary capital spending and anticipate total CapEx for 2009 to be $25 million to $30 million below 2008. We also plan to complete sale lease back transactions using proceeds to pay down debt. Last year we completed a total of $14.6 million sale lease backs and anticipate closing another $15 million in 2009.

Finally, I’d like to discuss our earnings guidance for 2009. I want to first point out that fiscal 2009 is a 53 week period whereas fiscal 2008 had 52 weeks. We estimate the effect of this extra week to benefit net income in the fourth quarter of 2009 by approximately $0.07 per diluted share. We are projecting a total revenue increase of approximately 3% to 4%, including a comparable sales increase on a comparable 52 week basis of 1% to 2% for our Burger King restaurant, flat to negative 1% for Taco Cabana and a decrease of 3% to 4% for Pollo Tropical.

In an effort to maintain our financial flexibility and pay down debt, we have limited our new restaurant openings to between five and seven locations for our Hispanic brands. We are currently projecting two or three new Pollo Tropical restaurants and three or four Taco Cabana restaurants. In addition, we plan to relocate two or three Burger King restaurants to new locations. We also anticipate closing two Taco Cabanas, one Pollo Tropical and three or four Burger King.

Total CapEx is estimated to be $30 million to $35 million in 2009, which is somewhat higher than our initial estimates of ‘09. The increased expenditures and the result of certain remodeling expenditures deferred from 2008 and timing delays from 2008 for a couple of new restaurants that opened in the first quarter of 2009.

At this point, it also appears that a fair amount of the 2009 new unit CapEx will be in the back half of the year and we should have some flexibility to further reduce in circumstances we aren’t doing so. We’ve taken action to reduce G&A expense by approximately $3 million. After planned increases and incentive bonuses G&A in the aggregate should at least be flat compared to ‘09 and down 20 to 30 basis points as a percentage of sales.

Our annual effective tax rate is currently estimated at 37.5% and lastly diluted earnings per share projected to be between $0.75 and $0.80 and as I said a moment ago, the 53 week of the fiscal period is estimated to positively impact earnings per share by about $0.07 in 2009. While we don’t like to give quarterly guidance, I would like to comment on what we see in the first quarter in order to help set expectations. Particularly, given the current estimates on the street, which we believe are a little low.

As we alluded, Pollo Tropical continued to be soft and so far in the first quarter comps are running 3.5% to 4% negative, which is generally how we see the quarter is shaping up. Taco Cabana sales have also been softer, thus far and partly due to timing of length and related shift in our promotional calendar. While we anticipate making up some ground in March, it looks like Taco Cabana will be two to 2% to 2.5% negative for the quarter. On the other hand, Burger King has been extremely strong with our comparable unit sales up about 5%.

As I indicated, we’ve seen a moderation in commodities, so margins have stabilized. Given our focus on operating costs, we are also seeing leverage on a number on a number of items across the P&L, which is holding operating margins in line with the first quarter of 2008 and lastly the reductions in our debt balances, along with the significant drop in short term interest rates are also positively contributing to our earnings in 2009. Given these factors, we expect to see an earnings increase in the first quarter.

In conclusion, when we look at the big picture, we’re comfortable with our positioning in the current environment. We are addressing our challenges on both the top and bottom lines at all three of our concepts. We have diversification across brands, across regions and across various cost items like commodities, which helps limit our overall exposure while providing greater stability to our business.

We understand that 2009 will be a challenging year and we are taking the steps to improve our business and financial condition in order to emerge from this downturn stronger than when we entered it.

With that, we we’d now like to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Reza Vahabzadeh - Barclays Capital.

Reza Vahabzadeh – Barclays Capital

Just some housekeeping items Paul; the $0.07 share that you are attributing to the 53 week, any idea what the operating income implication of that is?

Paul Flanders

I must say about $3.5 million.

Reza Vahabzadeh – Barclays Capital

As far as the debt balances as of the end of the fourth quarter, can you bring us up to date on what’s outstanding in which facility and which piece of debt?

Paul Flanders

Year end?

Reza Vahabzadeh – Barclays Capital

Yes.

Paul Flanders

There was about $18 million borrowed under the revolver. As you know we bought back about $15 million of the sub debt during 2008. So, we had about $165 million of a sub debt, but the lease obligations that were remaining on the books were about $14.9 million and then the term loans were at $117 million.

Reza Vahabzadeh – Barclays Capital

Was there any cash on hand?

Paul Flanders

Cash balance was $3.5 million to $4 million.

Reza Vahabzadeh – Barclays Capital

Okay. Just turning to operations Alan and Dan, the labor costs management has been obviously very helpful to the numbers and helped you manage the P&L. Is that sustainable or are there any concerns that service levels maybe impacted or any commentary on that?

Dan Accordinon

No, we think it’s sustainable. Part of that is just the leverage of the menu price increases Reza, but no, the operating measurements that we use for all three brands, we use a consistent metric across all three brands in terms of how we measure consumer satisfaction and those numbers are continuing to rise during the 2008 and into 2009. So we think that those labor costs are sustainable.

Reza Vahabzadeh – Barclays Capital

As far as the taco franchise is concerned, the difference in terms of the southern Texas markets versus the other ones, is it just a coincidence of QSR being more promotional in those markets?

Dan Accordino

That I think there’s a couple of things Reza. The is San Antonio and Austin certainly we have seen more competitive pressure than on the other markets, but Dallas has been a good performing market for us now for quite a period of time and Houston just as an overall market seems to be, it actually got an inflow of customers, an inflow of population.

So it’s certainly the best performing market that we have and is continuing to be in 2009, even with competition in Houston, the population increase is out pacing the number of new seats.

Reza Vahabzadeh – Barclays Capital

But any concerns that whatever is taking place in San Antonio and Austin, the competitive intensity spread out to the other major markets?

Alan Vituli

No, Dallas is already very, very competitive, but he’s also got a population influx there and there and there’s no competitors that we have in San Antonio in Austin that we don’t have in Dallas and Houston.

Paul Flanders

In addition we basically are focusing on engineering specific products and price points in the San Antonio and Austin markets that will essentially enable us to combat competition.

Reza Vahabzadeh – Barclays Capital

What’s the risk of having to promote, going forward to deal with QSR promotions especially in your Hispanic consents?

Paul Flanders

We don’t think there’s any risk in terms of -- we are not doing a lot of what you would call the traditional QSR marketing, where you have a coupon a week and a permanent value menu and that sort of thing. Our advertising really is talking about existing opportunities, products that we have at the brands and discussions those from a value and quality perspective.

Reza Vahabzadeh – Barclays Capital

And then lastly Paul, what’s your rent expense running at annualized.

Paul Flanders

The rent expense at fourth quarter is about $12 million.

Alan Vituli

I need to point out, the fact that we took off these leases off the balance sheet those are now going to be treated as operating leases, so there’s been some shift in the rental payment if you will around the P&L; whereas that payment was treated as interest and principal, prospectively that will be treated as a rent.

The net effect prospectively is about between $2.5 million and $3 million of rent, just as a consequence of taking those leases off balance sheet. On the other side of that the interest goes down between $3 million and $3.5 million, depreciation goes down, so it’s actually accretive to earnings of about $1.1 million or $1.2 million.

Operator

Our next question will come from Brian Hunt - Wachovia.

Brian Hunt – Wachovia

I was wondering if you could talk about the specific day part for Pollo Tropical and where your successes are and where do you see the biggest competition in the San Antonio as well as Austin market, from a day part perspective.

Alan Vituli

I believe you are asking about Taco Cabana.

Brian Hunt – Wachovia

Yes Taco, excuse me.

Alan Vituli

The primary area of competitive infusion has been the overnight. Taco is a 24 hour operation and has been a 24 hour operation since its founding 30 years ago. In the past several years as you well know, many other competitors are expanding their hours and now we compete against those folks on an overnight basis. So that’s been the primary area where we’ve seen sales erosion.

Breakfast also has been under some pressure. Breakfast in San Antonio in particular is a high percent of sales and we’ve lost some market share there as well.

Brian Hunt – Wachovia

Okay. Then switching gears and looking at Pollo Tropical and the challenges it’s had, especially I guess in western Florida and around Orlando, given the economics of new store openings, are you seeing any new stores that are either or any stores at all that are operating at a negative contribution margin? Are you going to have to close some stores because of same-store sales weakening up in those areas?

Alan Vituli

We’d announced that we would close one restaurant, one restaurant that we just opened recently. I mean with that said we’ve written down some of our new openings in Orlando and the west coast, but I don’t see us closing any more.

Brian Hunt – Wachovia

Okay and can you talk about this question that comes up on every conference call, the relative performance of your Northeast stores compared to your expectations?

Alan Vituli

The Northeast stores are doing reasonably well. Operating costs are a little higher. Our recent restaurant openings in both Hartford, Connecticut and in the northern New Jersey markets have been pretty good. They don’t match the volumes we are custom to in South Florida, but quite frankly we did always anticipate that the brand was a relative unknown and that as we established a presence the volumes would build overtime. So we now have essentially three free standing restaurants and they are doing reasonably well.

Brian Hunt – Wachovia

And then last question, I was wondering if you could talk about your poultry supply in 2009 given the industry changes we’ve seen. It sounds like all the suppliers have gone to if you want a fixed price contract 90 days, is that reflected in your cost expectations for the year for Pollo Tropical or just could talk about your contracts for poultry supply given that’s your largest cost, in that concept?

Alan Vituli

We have two poultry processors that we entered into contract at the beginning of 2008 and in 2009 the contract called for the same contracts with a corn escalator, so those contracts are in place for all of 2009 at a fixed cost that’s already been pre-negotiated.

Operator

Your next question comes from Jeff Omohundro - Wachovia.

Jeff Omohundro - Wachovia

Just a question on Burger King, I’m just wondering what your read might be on some of these products that are geared towards the new broiler, specifically the Steakhouse XT and fire grilled ribs?

Dan Accordino

Jeff, you know as much about it as I do. Yes, I’ve tasted them, they taste good. I think the ribs are going to be a little bit of a challenge, because the price point at least initially looks, as it was originally proposed, looks like it could be a little bit on the higher side.

I think the new broiler is exciting in terms of the flexibility it’s going to provide. There is a significant portfolio of new products that I think could really reposition the Burger King brand from a dinner day part, but in terms of the specific performance until these things get tested with the consumer, your guess is as good as mine.

Operator

Your next question comes from Carla Casella - JP Morgan.

Analyst

Hi, this is Millie phoning for Carla Casella. Could you us some indication of what you’ve seen in input costs and your outlook for 2009? You mentioned fixed contracts for Chicken, what about other proteins? Is that also, are those also fixed contracts or and what your outlook is on them?

Dan Accordino

Well, Paul gave you a sense of where we thought each brand would be for the year, but specifically in terms of the Hispanic brands, Pollo and Taco are primary costs are contracted for the entire year, yes; the beef and the wheat and the cheese for Taco Cabana, and the chicken and the yucca and the plantains and rice for Pollo Tropical.

Burger King as you know, we don’t do any buying and consequently RSI, who is the buying cooperative has a contracted for some of those costs for 2009 with the biggest variable, which they do not contract is the ground beef.

Operator

Your next question comes from Ken Bann - Jeffries and Company.

Ken Bann - Jeffries and Company

Could you talk a little about utility expenses and what you hope that you can see that come down this year or expenses for natural gas and as have you hedged any of that?

Paul Flanders

Yes, as I said, we saw utilities still increasing in the fourth quarter. Obviously, the markets have come down pretty dramatically. We do hedge as much as we can, where we can, where it’s deregulated. So, as we come off those contracts, we do in fact think that the overall season is favorable in our utilities.

Ken Bann - Jeffries and Company

Can you give us any idea about a basis point decline or is something like that you might…?

Paul Flanders

I think the way, I’m thinking about right now, I think total utility expense; it should be about flat year-over-year and that’s obviously with some increased number of units.

Ken Bann - Jeffries and Company

Okay and then also you talk about continuing to reduce debt. What kind of goal might you have in mine for generating free cash flow that pay down debt in 2009?

Paul Flanders

We are really looking at 2009 and beyond. My feelings are that we’ve targeted, we’ve got an EBITDA-to-debt ratio or debt ratio to EBITDA of under three to one, over the next couple of years. We certainly don’t want to come into 2012 with the ratio that is not below that and so it’s a pretty orderly process of modest debt reductions and conservative assumptions on the EBITDA growth. We see ourselves paying down a few million dollars in 2009.

Ken Bann - Jeffries and Company

Are there any further switches of capitalized leases and operating leases included in that or is that just your pay down of the term loan?

Paul Flanders

We may have a few leases to convert, but there’s only $15 million left on the balance sheet at this point. So that number is not going to change a whole lot. It’s really a function of the consequence of our free cash flow generation that we anticipate in ’09; it’s a consequence of reducing CapEx to do some more sale/leasebacks and we hope to reduce debt $25 million, $30 million in ‘09.

Operator

Your next question comes from Greg Ruedy - Stephens Inc.

Joshua Long - Stephens Inc.

This is Joshua Long for Greg. I just wanted to touch base about your Northeast Pollo Tropical units. Given that you have incremental or traditional units up in that area. What’s your read on the receptivity of the brand?

Alan Vituli

We are very positive. Most of the real estate professionals, who are assigned to finding new locations, really are assigned to looking in the Northeast. Our feeling with respect to the long term prospects for Pollo in the Northeast and by Northeast we mean someplace near Washington to someplace near Boston over the next number of years should see us with significant growth.

The only reason we are not pursuing it with a passion today is we’ve just set up deleveraging as a very high property. There’s just too much uncertainty. In addition we see real estate prices coming our way. So, the short answer is we are very positive and optimistic about the Northeast and we believe we’ll get very good unit economics, although we’re still building infrastructure there.

Joshua Long - Stephens Inc.

Previously we’ve talked about a potential three to four more units over the intermediate term, does that number still a standard or does that comedown given your change in perspective towards delevering and just waiting for real estate prices to normalize or comedown even further?

Paul Flanders

We expect that number in 2009 to be three or four new Pollo Tropical units.

Joshua Long - Stephens Inc.

Okay and then more just toward the general system of Pollo Tropical. You have a bit of price in there, I think you mentioned 9%, are you seeing much pushback from the consumer in any of those markets given the test situation a lot of them are in.

Paul Flanders

Well, certainly the revenues are down, but as Dan said clearly we’re always taking the consumers temperature and as a practical matter, our value scores are very, very high and the consumer reaction to the brand is very, very high. So, we’re not really getting any pushback. With that said, for us comp sales are still down, but we don’t really think it has anything to do with the pricing.

Joshua Long - Stephens Inc.

Okay. Are you seeing a fair amount of that flowing through or are people trading around the menu to some of the other items?

Paul Flanders

Florida is the economy that’s worst hit than most other states in the country. So you’ve got lots of behavior patterns trading down, not eating as frequently. The price is stuck, but we’re getting some shift. Certainly our marketing is built around value, so I think the 9% probably in the fourth quarter, if you compare that to what the average check went up the check was probably up 4%, 5%. We are getting some mix shifts as a consequence.

Joshua Long - Stephens Inc.

Last question, what initiatives surround your increasing labor productivity? We’ve seen that line to see some benefit as of late. What kind of initiatives do you have in places that are really supporting that?

Alan Vituli

Most of it is just leveraging the price increase. When you have a 9% embedded price increase, you can lever that pretty significant in terms of reducing your labor costs. In terms actual productivity enhancements within the restaurants, we’ve put in some technological tools at both Pollo and Taco that we’ve had at Burger King, in terms of how we are more effectively schedule. We’ve got automatic labor schedulers and reviews which the brands did not have until the midpoint of 2008, which has been a bit helpful for them.

Operator

Your next question comes from Brian Elliot - Raymond James.

Brian Elliot - Raymond James

A couple of questions; first just following up on that discussion, so we have 9% pricing at Pollo and we’re getting 5% and some flow through is helping labor margins; is the overall margin decline there then a function of food or overhead and infrastructure in the Northeast? Flush that out a little bit, please?

Paul Flanders

Its food cost, which were up pretty dramatic until ‘08 for Pollo. Be careful, we are getting hung up on 9% pricing. It just happened to be the way that we lapped in the fourth quarter. For the full year we’re probably closer to 6% or 6.5% for Pollo, which is still a pretty good increase, but we’re seeing some deleveraging across the P&L as a consequence of where the comp sales are.

Our labor, given the unit volumes that Pollo does, tends to be somewhat fixed at those levels. So, we’re seeing some deleveraging on labor in relation to the sales decrease and beyond that it’s just really…

Brian Elliot - Raymond James

So labor was not of that Pollo, it was up for the whole company, but it wasn’t up at the Pollo brands or down I mean I’m sorry.

Paul Flanders

It was up at Pollo. It’s been up a little bit. The fourth quarter is up a little bit at Pollo.

Brian Elliot - Raymond James

Okay any advertising shifts of note in Q4 for any of the brands?

Alan Vituli

Not, in the fourth quarter?

Brian Elliot - Raymond James

Okay. I wanted to do also talk about the franchising in the Caribbean that you mentioned and whether there is any themes that accrue or collect at that timing that layout the revenue streams from those new agreements and maybe thoughts on timing of actual store openings?

Alan Vituli

The expanded franchise agreement for new franchisee is $45,000 per unit, of which some portion of it is paid immediately, based upon the size of the market and the 5% royalty rate. In terms of the accounting for that, how much of it may have flowed through? Both and we did take in some dollars from the new Trinidad franchisee and I think the Bahamas franchisee.

Paul Flanders

We’ve collected some money’s, but remember none of these franchisees have yet opened restaurants. So, a lot of the recognition of that will be deferred until we start seeing some openings. So I wouldn’t say that there’s been a big benefit, certainly in the fourth quarter.

Alan Vituli

Brian, to expand the question even though you had not asked it; our plan is really to develop the infrastructure to support a significant franchise business outside the United States. There’s very good receptivity to the brand from what we see and from our travels and we’re just sort of opening the small markets in order to better position the brand and develop the infrastructure ultimately, to go after the larger markets. From a strategy standpoint our plan is to be a significant franchisor in some big markets.

Brian Elliot - Raymond James

Within the guidance, Paul that you gave is there a measurable contribution more than a penny or two or maybe as much as a penny from revenue that will accrue and would you expect several stores to open in ‘09?

Paul Flanders

No, there is not any significant. When we say we anticipate we’ll see some restaurants open in some of these newer markets, probably later in the year and we will probably recognize a little bit but I would not say the income stream is really significant in the guidance.

Bryan Elliott - Raymond James

So the guidance is still basically domestic improvement?

Paul Flanders

That’s correct.

Operator

It appears we have no further questions in the queue at this time. I’ll turn it back over to our host for any additional or closing remarks.

Alan Vituli

No closing remarks. We appreciate your attention today and we look forward to speaking with you again next quarter.

Operator

Again, ladies and gentlemen, this does conclude today’s conference call. Thank you for joining us and have a great day.

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Source: Carrols Restaurant Group Inc. Q4 2008 Earnings Call Transcript
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