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Carrols Restaurant Group, Inc. (NASDAQ:TAST)

Q1 2013 Earnings Call

May 7, 2013 8:30 am ET

Executives

Paul Flanders – Chief Financial Officer

Dan Accordino – President and Chief Executive Officer

Analysts

Bryan Hunt – Wells Fargo Securities

Operator

Good day ladies and gentlemen, and thank you for standing by. Welcome to Carrols Restaurant Group, Inc. First Quarter 2013 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions)

This conference is being recorded today, May 7, 2013. I would now like to turn the conference over to Paul Flanders. Please go ahead, sir.

Paul Flanders

Good morning, everyone. By now you should have access to our earnings announcement released earlier this morning, which can also be found on our website at www.carrols.com under the Investor Relations section.

Before we begin our remarks, I would like to remind everyone that our discussion will include forward-looking statements, which may include comments regarding our strategies, intentions or plans.

These statements are not guarantees of future performance and therefore undue reliance should not be placed on them. We also refer you to our filings with the SEC for more details, especially the risks that could impact our business and our results.

Please note that during today’s call, we will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and a reconciliation to comparable GAAP measures is available in our earnings release.

I’ll now turn the call over to the President and CEO of Carrols Restaurant Group, Dan Accordino.

Dan Accordino

Thanks Paul and good morning everyone. I will begin today with a discussion of our first-quarter results, update you on our progress for the restaurants that we acquired last May from Burger King Corporation, and provide an update on Burger King’s ongoing brand initiatives. Paul will then cover our financial results in more detail and discuss our full-year outlook.

For the first quarter comparable restaurant sales for our legacy restaurants increased 1%, marking the seventh consecutive quarter of positive growth. You may recall that based upon sales trends earlier in the year, we had expected the first quarter to be down modestly because of pressures on consumer spending and heightened competitive activity. However, as Burger King rebalanced its value messaging in late February, sales trends quickly improved in March, and our comparable restaurant sales increased 5% for the month of March, ending up 1% for the quarter.

We were generally pleased with these results given the challenging 5.9% comparison from the prior year period and the more seasonable weather in 2013. This momentum continued in April, and although we faced our toughest comparison in April with a 9.8% comparable sales increase last year, we were extremely pleased with the 0.4% comparable sales increase for the month.

Burger King continues to take a balanced marketing approach, highlighting premium items that drove the average check, while balancing the use of value promotions to drive traffic. Premium items featured in the first quarter included white meat chicken nuggets, and Avocado Swiss Whopper, Cheesy Tots and a couple of dessert products. Late in the quarter the brand introduced its new premium limited time offer products, including the Chipotle Whopper, Turkey burger, Bacon Cheddar Stuffed Burger, and a pina colada smoothie.

We also launched our new Smooth Roast Coffee blended by Seattle's Best, and expanded our specific coffee menu to include two menu items, including lattes and a variety of flavored ice or hot coffee. As you can see product innovation continues to be robust and we are successively broadening customer appeal at the Burger King brand, while continuing to drive average check higher.

On the value side, promotions included a Buy One Get One Free Chicken Sandwich offer, a $1.29 Whopper Jr. promotion, and a 2 for $5 offer for Avocado Whopper, the original chicken sandwich with a premium Alaskan Fish sandwich. We also had a short introductory promotion of our new Latte for a $1. As I said the rebalancing of the value messaging mid-quarter, including offerings that addressed multiples at value price points was effective in driving sales and traffic and improving sales trends in both March and April.

Turning back to our first quarter performance, restaurant level operating profits, which excludes G&A expense, improved in our legacy restaurant, with restaurant level operating margins increasing to 11.8%, or by more than 70 basis points compared with the first quarter of 2012. This improvement reflected the effect of a higher average check from Burger King’s marketing initiatives, along with favorable sales mix changes and slightly lower commodity costs.

With respect to the 277 restaurants in last year’s acquisition, we continued to gain traction from our ongoing integration efforts and further improved the financial performance of these restaurants in the first quarter. As we said in the last call, we expect our efforts to improve restaurant operations and [control disciplines] will continue to gain momentum and be more evident in the P&L as we progress through 2013.

Although our restaurant level operating margins were negatively impacted by the acquired restaurants, when compared to the first quarter of last year, we were pleased to demonstrate meaningful headway and narrowing the performance gap between the acquired legacy restaurants on several fronts. On the top line, the gap in average weekly sales narrowed considerably in the quarter. The average sales of the acquired restaurants were 12.1% lower than the legacy restaurants in the first quarter, as we narrowed the gap on a sequential basis from 15.9% in the fourth quarter of 2012. The sales gap progressively improved throughout the quarter and by March it was actually down to about 10.5%.

The gap in overall restaurant level operating margins also improved in the fourth quarter as the difference between the legacy and the acquired restaurants narrowed about 500 basis points in total for the quarter. While some of this was due to certain integration costs included last year, we clearly saw improvement across almost all expense items.

Cost of sales at the acquired restaurants were 343 basis points above the legacy restaurants in the first quarter, but sequentially this difference narrowed in the fourth quarter of 2012. It is clear that we’re improving cost of sales at a more rapid rate than what we indicated in the last call.

However, higher vendor rebates at the legacy restaurants in the first quarter masked some of the operating progress that we made at the acquired units. The cost of sales difference, excluding vendor rebates, was reduced to 260 basis points compared to the legacy restaurants in the first quarter, and narrowed 162 basis points sequentially. We also lowered the gap with the legacy restaurants across most other P&L line items compared to the fourth quarter.

The difference in labor costs was 110 basis points lower, the difference on rent expense was 53 basis points lower, and the difference in other operating expense was 272 basis points lower. While these improvements were certainly noteworthy, there remains a considerable opportunity to further improve both sales and restaurant level margins at the acquired restaurants.

We have improved operations as evidenced by all operational metrics, and based upon measured customer feedback. However, there are a few markets where we expect it will simply take more time to get former customers to come back to the brand as we continue demonstrating improved and consistent operations.

We have made considerable progress in staffing and training, and while our management vacancy rate is now at a manageable level, we do expect some additional turnover as we continue to intensely focus on improving our operation (inaudible) at the acquired restaurants.

As we indicated in the last call, we are also replacing the point of sale software in all of the acquired restaurants in order to enhance control, and to provide us with the transactional level data to enable us to better detect and manage cash and inventory losses at these restaurants. We are well into this and expect this system will also be complete by mid-May.

Lastly, in the first quarter we completed the remodeling of 39 restaurants to the 20/20 design image, and plan to finish between 90 and 120 remodels in total this year. So to conclude, our legacy restaurants had a solid first-quarter considering the consumer pressures that we experienced early in the year. From a brand standpoint, Burger King’s product innovation and balanced marketing approach continues to drive our business in the right direction as both sales and profitability have improved. And finally our acquired restaurants are gaining meaningful traction, and we expect to see continued margin improvement as we move through the year.

With that I will turn the call over to Paul to continue our financial review.

Paul Flanders

Thanks Dan. On a consolidated basis, restaurant sales grew 82.7% to $156.1 million, which included $70.4 million sales from the acquired restaurants compared to total sales last year of $85.5 million.

Comparable restaurant sales at our legacy restaurants increased 1% against the 5.9% increase in the first quarter last year due to an increase in average check of 4.4%, including the effective price increase of 0.8%. The increase in average check reflects the positive impact to the Burger King marketing and product initiatives over the past year, including an effective balancing of both premium and value promotions.

Average weekly sales for the acquired restaurants was $19,746, about 12% lower than our legacy restaurants at $22,475. As Dan highlighted, the gap between the two narrowed meaningfully during the quarter. While the acquired restaurants were not included in our results for the first quarter of last year, average sales of those units increased 2.8% for the quarter on a year-over-year basis.

Adjusted EBITDA, a non-GAAP measure, was $3.3 million in the first quarter, compared to $3.8 million in the prior year and Adjusted EBITDA Margin was 2.1% compared to 4.5% in the prior year. The decline in Adjusted EBITDA primarily reflected our increased G&A cost to support the acquired restaurants. I will point out that our G&A costs are essentially fixed costs and that our sales are lowest during the winter months, specifically during the first quarter. We would expect to see positive year-over-year EBITDA comparisons in the upcoming quarters as sales increase on a seasonal basis.

Restaurant level operating margins, which exclude G&A expense, were 11.8% in our legacy restaurants and increased more than 70 basis points compared to the first quarter last year. Cost of sales improved 97 basis points reflecting favorable sales mix changes, the higher average customer check, and slightly lower commodity cost. Restaurant labor costs were also favorably leveraged by 71 basis points in the quarter.

These margin improvements were offset somewhat by an increase in our investment spending on local advertising. We have provided supplemental data on restaurant level operating expenses in today’s earnings release, which will enable you to analyze the differences in operating margins between the legacy and acquired restaurants.

Restaurant level operating margin at the acquired restaurants improved sequentially by 376 basis points in the fourth quarter, while the difference compared to our legacy restaurants narrowed by about 500 basis points. Dan has already provided color on this, so I will just say that we are pleased with the progress that we demonstrated and we expect to continue to improve the acquired restaurant operating margins moving forward.

General and administrative expenses were $9.1 million for the first quarter of 2013, and increased $2.9 million from the first quarter last year, due mostly from the addition of district and regional supervision and training costs supporting the acquired restaurants. G&A as a percentage of sales was however favorably leveraged by approximately 144 basis points for the quarter. I will point out that we incurred $85,000 of final legal costs related to the EEOC litigation in the first quarter this year. Last year G&A included $95,000 for the EEOC legal costs alone, $411,000 of expenses related to the acquisition.

Depreciation and amortization expense increased from $4.7 million in the first quarter of 2012 to $8.1 million this year due primarily to the addition of the acquired restaurants and our remodeling initiatives over the past year.

The interest expense increased from $915,000 in the first quarter last year to $4.7 million due to the increase in outstanding debt from our May 2012 financing used to fund the acquisition and to raise capital for funding our restaurant remodeling plan.

The net loss from continuing operations was $5.2 million, or $0.23 per diluted share, compared to a net loss from continuing operations of $2.9 million, or $0.13 per share in the prior year period. I will also point out that our effective tax rate in the first quarter reflected a tax benefit of 50.5%, which is somewhat higher than our overall rate expected for the year. The tax rate in the first quarter of 2013 reflected a benefit of $1 million related to the 2012 WOTC credit, which were all reported in the first quarter due to the legislative delays in extending those credits.

At the end of the first quarter, our cash balances were $46.7 million, including $20 million of restricted cash held as collateral for our revolving credit facility. Total outstanding debt was $161.2 million at quarter end, essentially unchanged from the end of 2012.

Capital expenditures for the first quarter of 2013 totaled $13.5 million, including $10.9 million for restaurant remodeling. 39 remodels were completed in the quarter.

Finally, we provided the following update as guidance for 2013. We expect sales for the year to still be between $670 million and $700 million, including comparable sales increases for the legacy restaurants of 2% to 4%. Commodity costs are now expected to increase 2% to 3% for the year. General and administrative expenses are expected to be approximately $34 million to $36 million, including the full year effect of [field] and other G&A increases for the acquisition.

We plan to close 16 restaurants this year. One of these was closed in the first quarter. The annual effective income tax rate is now expected to be between 45% to 47%, including the carryover benefit of the 2012 WOTC credits recognized in the first quarter. And lastly, capital expenditures are expected to be approximately $40 million to $50 million for the full year, including $30 million to $40 million for remodeling a total of 90 to 120 restaurants.

And with that, we’ll now open up the lines for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Bryan Hunt from Wells Fargo Securities. Please go ahead.

Bryan Hunt – Wells Fargo Securities

Thank you, and good morning.

Dan Accordino

Hi Bryan.

Bryan Hunt – Wells Fargo Securities

You have remodeled about 120 restaurants so far since the third quarter of last year. I was wondering if you could just talk about in general the performance of those restaurants, and how the remodeling process has evolved.

Dan Accordino

The overall sales lift Bryan has been between 8% to 10%, which is the incremental sales lift, which is what we have expected. And the speed and the efficiency at which we have done these have been everything that we had hoped for from the time that we have committed all of the restaurants that for the balance of 2013 and some for 2014, so the plans we have done and we already have (inaudible) permit, and the costs are coming in slightly below what we had estimated at $300,000.

Bryan Hunt – Wells Fargo Securities

Now, if I’m not mistaking you, first to attack probably the restaurants that needed the most attention early in the process, and so the remodel numbers were in the – if I recall correctly, closer to 350 range per store, and now you are looking at closer to 300. Is that the proper metrics?

Dan Accordino

Yes, we have modeled 300, and we did a mix between restaurants in 2012 that we could do for 120,000 to 130,000 because they weren’t that bad a shape. At some the cost is over $400,000 but on a go forward basis, we are running $280,000 and $310,000 for these.

Bryan Hunt – Wells Fargo Securities

Great, and then on your same store sales turnaround, are there any, if you look at the day parts and the geographies, are you seeing any one dramatically difference in performance between the day parts and/or the geographies within your system?

Dan Accordino

The day parts we are not seeing a very significant difference between day parts. I would submit that dinner sales were a tad weaker in the first quarter, probably because it is more weather-related. From a geographic standpoint, for the same reasons, the Carolinas did better in the first quarter by virtue of the fact that they didn’t have such favorable weather in 2012 (inaudible).

Bryan Hunt – Wells Fargo Securities

Okay, and then my last two questions, if I look at you commodity inflation forecast coming down and you raised closures number going – your closures number going up, can you just talk about the differences between your forecast a couple of months ago and where it sits today?

Dan Accordino

Yes, we have seen these costs go down quarter-over-quarter, in the first quarter about 2%. While those – they are up a little bit from where we were in the fourth quarter, I think the outlook is – while it is going to go up a little bit, it should be pretty tame the rest of the year. We have also seen favorable pricing adjustments on chicken and our (inaudible) a little lower than we anticipated.

Bryan Hunt – Wells Fargo Securities

And in the closures?

Dan Accordino

I think we adjusted that – just slightly for two restaurants.

Bryan Hunt – Wells Fargo Securities

Okay. I appreciate your time. I will get back in the queue.

Operator

Thank you. And our next question comes, excuse me, pardon me – (Operator instructions). And our next question comes from the line of (inaudible). Please go ahead.

Unidentified Analyst

Good morning guys. I just had a question on the acquired units and you had mentioned that you saw some sequential sales improvement through the quarter. I think you said 10.5% gap to the legacy end margin. Was there a similar sequential improvement in profitability at those acquired units?

Dan Accordino

Yes, the flow-through announced that sales gap would even be greater by virtue of the fact that the cost of sale metric has also shrunk pretty dramatically.

Unidentified Analyst

Okay. So it is in both on the sales leverage you showed us all, but also the COGS were a little bit better as you moved through the quarter as well?

Dan Accordino

They were quite a bit better and then if you look at the balance of the P&L as we said in the statement we have actually made good improvements in most of all the other operating expenses.

Unidentified Analyst

Okay, great, great. And two, I didn’t pick up during the call, my line went a little static, but can you reiterate what you said about the April comp trend, and also what Capex was in the first quarter?

Paul Flanders

Yes, comps were actually positive about 0.4% in April, which we thought was pretty good considering that last year was our toughest comp at 9.8%. So we’re pretty pleased with that. In terms of Capex, total Capex was about $13.5 million in the quarter, and $10.9 million of that was for remodeling.

Unidentified Analyst

Okay. Thanks very much.

Operator

Thank you, and our next question comes from the line of Bryan Hunt, a follow up from Wells Fargo Securities. Please go ahead.

Bryan Hunt – Wells Fargo Securities

If I go back to your statements about when you think you can get the acquired stores from a sales perspective in line with legacy stores as well as from a margin perspective, has that guidance changed or that timeline changed in your opinion considering the progress you have made in the last quarter?

Dan Accordino

The sales data Bryan, I think [below 10%] in the second quarter. The COGS as I previously had said we were looking at a run rate by the end of 2013 we would be at a 200 basis point gap to the legacy stores. I think that we would be at least one quarter ahead of that potentially too.

Bryan Hunt – Wells Fargo Securities

Fantastic. Great progress. Thank you.

Operator

(Operator instructions) And I’m showing no questions in the queue. I like to turn it back to management for any closing remarks.

Paul Flanders

We don’t have any additional comments. We appreciate your time today and look forward to the next quarter and hopefully reporting some continued progress. Thanks for your attention today.

Operator

Ladies and gentlemen, that does conclude our conference for today. We appreciate your participation, and you may now disconnect.

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