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Einstein Noah Restaurant Group, Inc. (NASDAQ:BAGL)

Q1 2013 Earnings Conference Call

May 2, 2013 17:00 ET

Executives

Jeff O’Neill - President and Chief Executive Officer

Manny Hilario - Chief Financial Officer

Analysts

Nicole Miller Regan - Piper Jaffray

Alex Slagle - Jefferies

Mike Tamas - Oppenheimer & Company

Phan Le - Lazard

Operator

Good day, and welcome to the Einstein Noah Restaurant Group First Quarter 2013 Earnings Conference Call. Just a reminder, today’s call is being recorded. At this time, I would like to turn the call over to Manny Hilario, Chief Financial Officer. Please go ahead sir.

Manny Hilario - Chief Financial Officer

Thank you. Good afternoon everyone and thank you for your time today. Let’s begin by covering a few regulatory matters. During our formal remarks and in responses to your questions, certain items may be discussed which are not based on historical facts. Such items, including statements indicating our beliefs, trends, plans, expectations, assumptions, anticipation, guidance, projections, estimates, or the like should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are subject to risks which could cause our actual results to differ materially. For more details, please refer to our earnings release issued today and to the risk factors in our recent SEC filings.

And now, let me turn the call over to Jeff O’Neill. Jeff?

Jeff O’Neill - President and Chief Executive Officer

Thanks, Manny. We appreciate you all joining us today. Let me begin our discussion by briefly reviewing our results and discussing our planned initiatives for 2013. For the first time in two years, we reported a decrease in system, comparable store sales of minus 0.6%. This softness in comp sales was driven largely by the macroeconomic trends as well as the calendar shift in the Easter and Passover holidays in the first quarter. This trend also coincided with a rollout and upfront investment in our new transaction driving strategy during the quarter which impacted our flow-through to the bottom line.

The new Everyday Value strategy is building off the successful test we initiated in 2012 that focused on driving transactions to Everyday Value Combos along with extended hours and new operations initiatives centered on ensuring an exceptional guest experience. The rollout did show a 1 point sequential improvement in company transactions in the first quarter. And looking ahead, we expect to build on the positive momentum we experienced coming out of March and we should continue it into April.

The new Everyday Value Combos also underscores our transition to a more value-oriented strategy and features items such as deli sandwich side and a drink for $5.99 at lunch or a classic fresh baked bagels shmear and a medium coffee for $3.99 at breakfast. The value combos are resonating with customers and are already beginning to move our traffic in the right direction as they did in our tough markets in 2012. And to complement our value products and create further opportunities for check growth, we have also introduced a series of what we called Big Eat sandwiches featuring such items as our paninis, Nova Lox and other popular gourmet sandwiches as a feature.

Specialty beverages grew over 8% in the first quarter and remain a priority for us as we look to build on the success of our coffee platform and capture more beverage occasions. New updates to our lineup include a frozen strawberry lemonade, a line extension to our popular strawberry banana smoothie, along with the launch of a vanilla hazelnut iced coffee. So, with the store level initiative now in place, in addition to the nationwide rollout of extended hours, we are in a good position to improve traffic trends with a focus on fresh baked, fresh brewed, and fresh prepared sandwiches. In addition, we are supporting these efforts to grassroots and mass-marketing initiatives such as directional billboards along with a TV cast that will run through the balance of the year.

Driving continued supply efficiencies is also key to our investment strategy going forward. This year we are focusing on packaging supply contracts and distribution center rationalization to say between $2.5 million and $5 million on top of what we have achieved in 2012 and 2011. Most importantly, as in the past, all of these cost improvement initiatives are focused on supply and back of house improvements, which do not touch the customer or quality of service.

Turning to development, we are on track with our 2013 plans which Manny will review shortly. This year will consist of company expansion and relocations within current markets, while franchise growth will focus primarily on infill of existing franchise territories and a build out in some key development areas. License growth will remain in traditional spaces such as hospitals, universities, and stadiums, but there will be a little more emphasis on airports where we have already experienced significant traction. The influx of experienced operators who seek to partner with us and deploy their capital to build Einstein Brothers’ bagels is indicative of the strength of this strength and will enable us to continue executing on our Asset Light strategy over time. In fact, our pipeline now consists of over 176 franchise restaurant commitments, of which 40 have already opened.

And with that, I’d like to turn the call back to Manny.

Manny Hilario - Chief Financial Officer

Thanks Jeff. I am going to briefly review our quarterly financial results and then we reiterate our outlook for 2013. Total revenues increased $1.2 million, or 1.2% to $106.1 million from $104.9 million. System-wide comparable restaurant sales decreased 0.6% and consisted of a 3.1% increase in average check that was offset by a 2.7% decrease in transactions.

Company-owned restaurant sales increased $779,000, or 0.8% to $94.2 million, compared to the year ago period. Comparable restaurant sales decreased 1%, and consisted of a 1.7% increase in average check, and was offset by a 2.7% decrease in transactions. Cost of goods held steady at 28.2% of restaurant sales because of our ongoing cost saving initiatives. However, labor costs were up 170 basis points at 30.4% of freshmen sales as we had labor inefficiencies related to the new stores, sales leveraging along with incremental benefit costs compared with the year ago period.

We would expect the impact of new stores on the P&L to subside as we proceed through the year and as they began to optimize our operations. Rent and related expenses increased 50 basis points to 11.5% of restaurant sales while other operating expenses increased 80 basis points to 10.8% of restaurant sales versus the previous year. Both of these variances were due to the leveraging of fixed and semi-variable costs.

Our investment and marketing initiatives was flat to 2012. Gross margin at company stores decreased 290 basis points to 16.5% of restaurant sales reflecting our investment in Everyday Value and performance from new stores. Manufacturing revenues from our Whittier facility increased by 13.1% or $1 million and were partially offset by a decrease of $0.5 million due to the closure of our commissaries by the end of the first quarter of 2012.

Gross margin as a percentage of manufacturing commissary revenues increased from 18.4% to 27.3% as we realized cost savings from both the commissary closures along with the efficiency initiatives. General and administrative expenses decreased to $10.2 million in the first quarter of 2013 from $11.1 million in the first quarter of 2012 due to lower variable incentive compensation expense.

Pre-opening expenses were $0.3 million compared to $64,000 in the prior year first quarter and was along with expenses for the locations planned for opening in the second quarter. In the prior quarter, we incurred $0.6 million in restructuring expenses related to the commissary closures for which there is no comparable charge in the first quarter of 2013. Adjusted EBITDA was $10.4 million in the first quarter of 2013 compared to $11.5 million in the first quarter of 2012 and reflects the impact of a $2.5 million investment in Everyday Value through discounting.

Interest expense was $1.7 million in the first quarter of 2013 compared to $0.8 million in the first quarter of 2012 reflecting a higher level of indebtedness related to the special dividend paid in December 2012. All else being equal, the increase overall in the interest expense impacted our after-tax diluted EPS this year by $0.04 per share. Net income in the first quarter of 2013 was $2.4 million or $0.14 per diluted share, which included $0.09 per diluted share for investments in Everyday Value. Net income in the first quarter of 2012 was $3.2 million or $0.19 per diluted share which included $0.02 per diluted share for restructuring expenses.

Total debt as of April 2 was $130.8 million and consisted of $98.8 million under the term loan A and $32 million under the revolver. Our cash balance at quarter end was $7.5 million. In terms of our outlook for 2013, we are reiterating all our prior expectations. Specifically, we look for 60 to 80 system wide openings including 15 to 20 company-owned restaurants, 15 to 20 franchise restaurants, and 30 to 40 license restaurants.

Capital expenditures are estimated at $20 million to $22 million. Cost of good inflation is projected to be between 2% and 3%, which we plan to offset through efficiency initiatives. Pre-opening expenses of $65,000 to $75,000 per new company-owned restaurant, interest expense of $6.5 million to $7 million, and an annual effective tax rate not to exceed 39%. However, we will continue to only pay minimal cash taxes for the next several years.

And now, I would like to turn the call back over to Jeff.

Jeff O’Neill - President and Chief Executive Officer

We view the first quarter as a period of both investment and transition where positioned the company to improve on traffic trends for the remainder of the year and beyond. As previous discussed, our $5.99 and $3.99 price points and value messaging have already started to resonate with consumers and we are complementing that value driving momentum with a balanced focus on featuring our premium sandwiches as well. Obviously, our goal is to translate the March and April momentum we have seen in sustainable traffic growth, higher cash flow, and increased profitability. In addition, we will continue to utilize our Asset Light franchise focused business model to create new units and value for our shareholders.

And with that, operator, I would like to open it up to any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question comes from Nicole Miller Regan with Piper Jaffray.

Nicole Miller Regan - Piper Jaffray

Thanks and good afternoon.

Jeff O’Neill

Hi Nicole. We are having trouble hearing you here so….

Nicole Miller Regan - Piper Jaffray

Okay. So, is that a little bit better?

Jeff O’Neill

Perfect. Thank you.

Nicole Miller Regan - Piper Jaffray

Okay, sorry about that. Good afternoon, thanks for letting me know. Just a couple of quick ones here could you talk about the test of the value menu versus the rollout and what I’m getting at is did you expect the trends that you saw in the first quarter, was that largely expected and how it worked in test?

Jeff O’Neill

Yeah. So, a couple of things, so overall we did expect we are seeing what we expected in the customer a traffic point of view. The thing to understand here is that we didn’t get it fully rolled out in Q1 and this a little bit of what I’m talking about at the transition. So, we got a little bit of the investment upfront. And when I talk about a transition quarter we’re really moving from what we would call sort of a high low direct mail coupon kind of a strategy to an everyday value strategy. And what happened in first quarter is we had a little bit of both going on as we transitioned into the full rollout. So, the full rollout occurred really at the beginning of April and what we did it, we kind of rolled it sort of where we call rolling thunder through January, February and March to get where we are today. So, that’s why you’re seeing a little bit more of a discounting in the first quarter. But certainly from a traffic point of view and everything we saw there I see we are right on track and we are pleased and I’ll add to that that in April our traffic was the highest it’s been since the first quarter of – sorry the last quarter of 2010. So, we’re pleased with what we’re seeing from a traffic point of view and it’s in line with our expectation.

Nicole Miller Regan - Piper Jaffray

Is that third quarter of 2010?

Jeff O’Neill

Fourth quarter of 2010.

Nicole Miller Regan - Piper Jaffray

Okay. And now it was the second thing I want to clarify is you said the positive March momentum continued into April. So, you’re not saying that comps are positive, but that traffic is positive?

Jeff O’Neill

Sequential improvement and so when we look at our test and we look at about a 3 to 5 point improvement from our test in traffic trends that’s what we saw through the test that certainly we’re pleased with that and that’s our expectation and everything we see is in line with that. I mean what we are really talking about here in the call is we’ve done a lot of great things in the organization, it’s now time to get our traffic moving, we are committed to doing that. This is the new strategy we tested it pretty much entirely all of last year in the markets before rolling it out to really ensure we knew what we had. And I feel very confident that we do and based on what we see, I really believe that what we have is sustainable traffic improvement program and strategy and that’s what we’re looking for.

Nicole Miller Regan - Piper Jaffray

Okay. And then just a last clarification, when you talk about the down 0.6% comp I think that was the company comp. Can you give us the price and mix in traffic maybe if you can, what I’m asking is where is the mix component that would help us understand the underlying trends better as well?

Manny Hilario

7 o’clock, this is Manny, point six was system wide.

Nicole Miller Regan - Piper Jaffray

Okay.

Manny Hilario

The company and was negative of one comp sales or 2.7...

Nicole Miller Regan - Piper Jaffray

Okay could you…

Manny Hilario

2.7 on trends and plus one on check.

Jeff O’Neill

One plus.

Manny Hilario

And on check.

Nicole Miller Regan - Piper Jaffray

And where is the mix shift in that transaction or that check?

Manny Hilario

It’s in the check.

Nicole Miller Regan - Piper Jaffray

Okay, alright. Thank you.

Jeff O’Neill

Okay, thanks Nicole.

Operator

We will move on to Alex Slagle with Jefferies.

Alex Slagle - Jefferies

Hi guys, thanks. Just following up on that is that what was the effective menu pricing I guess in the first quarter and what might it be in the second quarter just trying to kind of breakout the discounting piece and the mix?

Manny Hilario

So, the pricing piece in the first quarter was about 0.5 a point in price in Q1.

Alex Slagle - Jefferies

Okay and is that pretty much going to be the same in the second quarter?

Manny Hilario

Yeah, the pricing will be very modest throughout the year. We’re going to – we have some very small increase going in April, but pricing would be in that 1% range for the whole year.

Jeff O’Neill

And then we had some benefit of course from catering and the mix.

Manny Hilario

Right.

Jeff O’Neill

On top of that, so.

Alex Slagle - Jefferies

Right. Have you guys ever gone back and looked at the catering and sort of tried to figure out how much of potential incremental traffic sort of get taking out in that when you have the big – sort of big catering checks that are just counted as one transaction?

Jeff O’Neill

Yeah, it’s a great question and here is what I would say as I look at sort of all catering side of thing, catering is – it’s a good growth engine for us. We’ve seen real strong growth, I got high expectations for catering going forward. Clearly, when you look at one catering order at $100 – on average $110, $115 is an average order size for us. That’s one transaction, just like our bagel and cream cheese transaction is one transaction, I kind of look at this way through Alex. This is just – there is a big rolled out there to go and capture share on catering, so I am not as hang up on the impact on traffic although there is an impact on transactions when you look at it that way. I just really look at it from our perspective as I really believe that there is an opportunity for us to go out and double our catering business over the next few years. And that’s what I’ve got the team and our team is totally focused on doing. So, I am less worried about the potential transaction shift from one catering order as I’m excited about the opportunity from an overall growth point of view.

Alex Slagle - Jefferies

Okay, thanks. How was the catering growth sort of in the quarter and how are you looking at that coming out of the quarter?

Jeff O’Neill

So, over the last couple of years we’ve been kind of in the 18% to 20% range. First quarter we were plus 11%. But I still as I said we’ve got great plans in place and I still think that we can continue on the momentum and build on what we had over the last couple of years.

Alex Slagle - Jefferies

Great, and it will have some of the calendar impact as well?

Jeff O’Neill

Yeah.

Alex Slagle - Jefferies

Great, alright. Thank you.

Operator

And next will be Brian Bittner with Oppenheimer & Company.

Mike Tamas - Oppenheimer & Company

Great, thanks. This is actually Mike Tamas on Brian. I just wanted to follow-up on the earlier comment about traffic. If I am looking back if I have this right, it looks like 4Q ’10 traffic was around plus two is that accurate or is that kind of what you’re saying for April as well is the quick clarification and I do have a follow up question?

Jeff O’Neill

So, you’re asking so traffic in the fourth quarter was, yes so I guess we got to think of that – of it as company traffic was minus 3.7 in the fourth quarter and in the first quarter company traffic was minus 2.7. So, that’s the – so at the beginning of the impact that we’re seeing on that traffic change, remember as I mentioned earlier we didn’t have the full roll out of the program for the year, but coming out of the year or coming out of quarter I should say from a company point of view we continue to see strong momentum there.

Mike Tamas - Oppenheimer & Company

Okay, sorry for not enough being clear, I was talking about the April trend you said it’s best since the fourth quarter of I think 2010 I was just trying clarify that was what you said. And then at that was around plus 2 on the traffic side, if that’s an accurate number or if I need to kind of correct my notes? Thanks.

Jeff O’Neill

Thanks. No, I mean so the best traffic we’ve had on a quarterly basis for the company, so basically what we’re saying is we got traffic in around its tricky for us to start giving actual numbers on this thing coming into second quarter.

Manny Hilario

Let me try this, so fourth quarter for the company as a total we are down 3.7, quarter one we are down 2.7 and March was the better month in the first quarter and April sequentially improved overall March number.

Jeff O’Neill

That’s it.

Mike Tamas - Oppenheimer & Company

Okay, alright. Thank you.

Operator

(Operator Instructions) Next question come from Matthew DiFrisco with Lazard.

Phan Le - Lazard

Great, thank you. This is actually Phan sitting in for Matt. I was wondering if you guys will be able quantify the impact of the Easter and pass over shift I don’t know if you were able to break that or not?

Jeff O’Neill

Yeah. So the Easter pass over’s pretends.

Phan Le - Lazard

Okay, great. And then just wanted to dig in a little bit on the labor line in terms of the leverage, I think you guys had mentioned it’s –was it primarily due to new store openings. I don’t know if there was a contribution towards perhaps you saw traffic trend at the beginning of the quarter that made it more difficult to manage labor line or if it was primarily the new stores. I’m wondering have you seen this sort of de-leverage or these challenges in the past when you opened prior stores or did these specific stores have some sort of specific (indiscernible) that made them a little bit tougher?

Jeff O’Neill

Let me start with it by telling you there is really two areas that we de-leveraged from a labor point of view. We had the revenue drop, so when you think about the incremental discounts that we put in, that’s really where we saw de-leverage on the revenue line that had an impact – that had a considerable impact on our labor. And then also it’s more to think of it this way Phan is that we always have an initial kind of 90-day ramp up from a new store opening. We opened nine restaurants in December and so coming out of the year that was a big number for us at the year end and that’s kind of what – why we saw something a little bit different. It was the actual number of restaurants that we opened up, the fact that we open up in December and so that’s the impact that would be what I would call sort of the do different if you will this time relative to the normal openings. Manny I don’t know if you want to add anything?

Manny Hilario

Yeah, so we actually have a lot more color on the 10-Q related to this item, but if I just kind of high level think about it, there is about 20 or 30 basis points that was driven by higher benefit cost year-over-year and then the difference on the rest is evenly split between new store impact and the de-leveraging from the discount, that’s not when I look at the 170 basis points increase over year-over-year that’s how I think of it in terms of baskets.

Phan Le - Lazard

Yeah, great.

Jeff O’Neill

If you look at going forward, we’ve already seeing start to see the normalization of the new store so, we are seeing that in the numbers already and then we have a number of other initiatives as we look to labor that are going to get as back in line so, think a Q1 has the anomaly and that we’ve shown that we can managing that pretty well and our expectation is that we are going to see as we go forward.

Phan Le - Lazard

Got it and then one more question if I may, just in terms of the investment on the everyday strategy, I was wondering if you could just remind me what’s going into that, are you guys are having more workers or just some sort of investment outside of that and then how long do you think that investment is going to persist through the remainder of the year or are you guys already done with the book of it?

Jeff O’Neill

I’ll kick it off let Manny kind of follow-up on this, but when we talk about the investment in everyday value in the first quarter, I think of it has sort of a transition quarter that we moved from a program where we did a high low direct mail coupon in program and we are now moving to more of an everyday value in restaurant driving frequency with a 399 and 599 value. So, we had an increase in discounts in the first quarter of over $2 million from this what we call sort of a transition quarter if you will. So, it really was a discount piece that was an investment, it wasn’t how other kind of investment, labor investment or any of that. It was really a discount transition period in the investment that we put in discounts as we move kind of in between these two. So, as we get into the second quarter and we moved away from this program fully into our everyday value that’s – that will go away as we go forward. Manny if you want to?

Manny Hilario

I mean, the only other thing I would add to that so think of the $3.99 breakfast typically the bagel and cream cheese is $2.59 on the many of the drink is $1.95 so, at $3.99 we’re giving you about a 12% discount in the initial stages of featuring that price points at the stores. We pass back that discounts to the P&L, the 12% discount obviously because we are not doing mass media awareness on the promotion it takes times for the traffic to build up so that’s where the investment transition comes in.

Phan Le - Lazard

Got it, very clear, thanks guys.

Jeff O’Neill

Thanks.

Operator

And that conclude the question-and-answer session. I will now turn the conference back over to management for any additional or closing remarks.

Jeff O’Neill - President and Chief Executive Officer

Yes, Jeff O’Neill here. Just to wrap up, clearly I would have much preferred if our investment into our new transaction driving initiative had not coincided with the one of the worst quarters for the industry in over three years. But I would just leave it – leave us with this, it’s the right focus for the business and it doesn’t dampen my enthusiasm for the rollout of our Everyday Value strategy and the positive impact it’s going to have on the business going forward.

We all know that traffic driving is – was the one piece of the puzzle that I would say that we wanted to focus on and continue to build the business from. And we put a lot of work and effort. And we had not outside consultant helping us with this. We tested it all of last year. We are happy with the results. And we are ready to move forward on this. Our new transaction strategy, the continued focus on new units and franchise development, strong manufacturing efficiency, we didn’t touch on that, but if you take a look at our manufacturing really strong margin improvement in that area continues. Media tests which I’m excited about, if this all sets us up for our future growth and sustainable traffic growth, and I look forward to reporting in this as we go forward during the year. And with that, I’d like to close off the call and turn it back to the operator.

Operator

Thank you. And that does conclude today’s conference. We do thank you for your participation today.

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