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Carrols Restaurant Group, Inc. (NASDAQ:TAST)

Q2 2013 Earnings Call

August 6, 2013 08:30 am ET

Executives

Dan Accordino – President & Chief Executive Officer

Paul Flanders – Chief Financial Officer

Analysts

Bryan Hunt – Wells Fargo Securities

James Fronda – Sidoti & Co.

Bryan Elliott – Raymond James & Associates

[Andre Gardella – Bar Capital]

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Carrols Restaurant Group Q2 2013 Earnings Conference Call on the 6th of August, 2013. (Operator instructions.) I will now hand the conference over to Paul Flanders, Carrols’ Chief Financial Officer. Please go ahead, sir.

Paul Flanders

Good morning. 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 strategy, 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 to be useful in evaluating our performance. A presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with generally accepted accounting principles. A reconciliation of comparable GAAP measures is included in our earnings release.

I will 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 Q2 results, provide an update regarding recent Burger King initiatives as well as discuss the traction we continue to make at integrating the restaurants that we acquired from Burger King Corporation last year. Paul will wrap up our formal discussion by covering our financial results in greater detail and update our full-year outlook.

Q2 comparable restaurant sales increased 1.4% at our legacy restaurants, marking the eighth consecutive quarter of comparable sales gains. We view this as a solid accomplishment in the face of lapping an 8.8% increase in Q2 last year and in light of a somewhat tight competitive environment. You will recall the Burger King brand embarked on a broad venue expansion and other initiatives beginning in April, 2012, aimed at broadening our customer demographics and widening the overall appeal of the brand.

We continue to build on the success of those initiatives. Our two-year sales trend in Q2 was the highest that we’ve seen in several years. Burger King remains focused on taking a balanced marketing approach, highlighting premium items on a limited-time basis while balancing the use of value promotions to drive traffic. As a result our comparable sales gains in Q2 were driven by a balance of both increased customer traffic and an increase in average check.

Promotions during Q2 included a $0.50 small ice cream cone, a 2 for $5 mix-and-match offer for the Whopper, Original Chicken Sandwich and fish sandwich, and a $1.29 Whopper Jr. Featured premium items included a Chipotle Whopper, a Chipotle Chicken Sandwich, a turkey burger and a Bacon-Cheddar Stuffed Burger among others. The specialty coffee menu blended by Seattle’s Best was also expanded to include lattes and a variety of flavored iced or hot coffees.

Late in June Burger King brought back many of the Summer BBQ menu items that were launched last year including the Memphis Pulled Pork BBQ Sandwich and Carolina BBQ Whopper, frozen lemonades and sweet potato fries while adding new items including a rib sandwich, the Carolina Tendercrisp Sandwich, and a BBQ Chicken Salad. There have also been a number of premium desserts recently added to the menu for a limited time including an Oreo Shake and a chunky cookie made with Oreo pieces.

As you can see, product innovation continues to be very robust and the marketing is consistent with the brand’s balanced marketing approach. Having said that, it does appear that there has more recently been a modest pullback in consumer spending and in late June and July we have experienced more traction on the value-oriented promotions. Our July comparable restaurant sales were down modestly at about 1%; however, it should be noted that this was also against a strong 8.7% increase last July.

In terms of our overall Q2 performance, both legacy and acquired units expanded their restaurant-level operating profits and margins compared to last year. Restaurant-level EBITDA, which is adjusted EBITDA before G&A expense, was 15% of sales at our legacy restaurants and grew 56 basis points from Q2 2012. This improvement reflects what has been a more benign commodity environment along with our effective leveraging of higher sales.

Turning to our acquired restaurants we lapped the anniversary of the acquisition on May 30, making the year-over-year comparisons a little difficult since both restaurants were only included for about a month in Q2 last year. Still I think it is clear that the incremental improvements we are making are evident in our restaurant-level EBITDA margins, both compared to 2012 and on a sequential basis.

Average weekly sales for the acquired restaurants increased 0.7% from Q2 2012. However, this increase was net of an approximate 2.0% reduction in sales from our elimination of 24-hour operating hours in a large number of the acquired restaurants during Q3 last year.

We continue to work hard to improve operating results in these restaurants and we are in fact realizing very solid sales gains in a number of markets; however, the overall sales performance of the group is being muted by a few markets where it is simply taking longer to rebuild the brand image and regain customers. For example, the 113 acquired restaurants in our North Carolina markets as a group posted a solid sales increase of over 3.0% for the quarter. On the other hand sales at our 42 restaurants in Virginia declined 4.7% for the quarter as we continue to work to restore the Burger King image in those markets.

In terms of profitability the acquired restaurants continue to improve and contributed $5.3 million to restaurant-level EBITDA in Q2 2013. Operating margin, which was 6.8% for the quarter increased 189 basis points from Q2 2012, and even though margins expanded at our legacy restaurants we still reduced the margin gap by 112 basis points at the acquired restaurants sequentially from Q1 2013.

Cost of sales at the acquired restaurants was 143 basis points higher than the legacy restaurants in Q2, and sequentially this difference narrowed about 200 basis points for the quarter. We believe this difference will continue to narrow. On the other hand, the gap in labor costs widened about 100 basis points sequentially for Q2 to 221 basis points. However, this was primarily caused by unusually high workers comp claims at the acquired restaurants in Q2 which we do not believe should be recurring.

We also closed four of the acquired restaurants during the quarter, resulting in a reserve of $1.6 million to cover estimated future rental and other lease costs. These closed units averaged less than $500,000 in sales and had negative cash flow of approximately $740,000 for the past twelve months. These closings, which were planned, will obviously improve our P&L results going forward.

In the first half of 2013 we completed the remodeling of 71 restaurants to the 2020 design image, and now intend to remodel a total of 100 to 110 restaurants for the full year. For all remodels completed over the past year we are experiencing an average sales lift of more than 10%.

So all in all we felt like it was a pretty solid quarter. Although the competitive environment has heated up a bit during the year we continue to increase sales against some difficult comparisons. Operationally we effectively leveraged the increase in sales and expanded margins at our legacy restaurants while continuing to improve both operational and P&L metrics at the acquired restaurants. Lastly we believe that Burger King’s balanced marketing strategy will continue to be effective at driving our business as we move forward.

With that I’ll now turn the call over to Paul to continue our financial review.

Paul Flanders

Thanks, Dan. On a consolidated basis restaurant sales in Q2 2013 increased 42.1% to $173.5 million of which $78.2 million was from the acquired restaurants. Total sales last year were $122.1 million including $27.5 million from the acquired restaurants. Comparable restaurant sales in our legacy restaurants increased 1.4% consisting of a 1.0% increase in average check with no pricing and a 0.4% increase in customer traffic. This compared to a strong 8.8% increase last year following Burger King’s initial launch of its new marketing and product initiatives.

Average weekly sales for the acquired restaurants were $21,950, 12.7% lower than our legacy restaurants but increased 0.7% from Q2 last year. As Dan said, this increase in average sales was net of about a 2.0% reduction from the elimination of 24-hour operations in a large number of the acquired restaurants.

Adjusted EBITDA was $10.4 million in Q2 compared to $8.6 million in the prior year, and adjusted EBITDA margin was 6.0% in the quarter compared to 7.1% last year. The improvement in adjusted EBITDA reflects positive contributions from both legacy and acquired restaurants; however, margins declined on an overall basis from the inclusion of the acquired restaurants for a full quarter this year.

Restaurant-level EBITDA margins were 15.0% at our legacy restaurants and increased 56 basis points compared to Q2 last year. Cost of sales improved 126 basis points reflecting modest changes in commodity costs as well as favorable sales mix changes and a higher average check. Restaurant labor costs were also favorably leveraged 22 basis points in the quarter. These margin improvements were however offset somewhat by an increase in our local advertising expenditures.

As in prior quarters we’ve provided supplemental data on restaurant-level operating expenses in today’s earnings release to enable you to analyze the differences in operating margins between the legacy and acquired restaurants. Restaurant-level EBITDA margin of the acquired restaurants improved 189 basis points compared to Q2 last year and improved sequentially by 438 basis points from Q1.

Also, the difference in restaurant-level EBITDA margin when compared to our legacy restaurants narrowed by another 112 basis points sequentially from Q1 this year. While we still have opportunities to make improvements it is evident that we are making progress as we continue to improve the operating results and margins at the acquired restaurants.

General and administrative expenses were $9.5 million for Q2 2013 and were $1.4 million higher than Q2 last year, reflecting increases for regional and district infrastructure and for training costs supporting the acquired restaurants. G&A as a percentage of sales was approximately 113 basis points lower than in Q2 last year. I note, however, that Q2 last year included approximately $836,000 in expenses related to the acquisitions and $673,000 of legal fees related to our litigation with the EEOC that was settled earlier this year.

Depreciation and amortization expense increased from $6.1 million in Q2 2012 to $8.4 million this year due primarily to the addition of the acquired restaurants and our remodeling initiatives over the past year. Interest expense increased from $2.6 million in Q2 last year to $4.7 million due to the increase in outstanding debt from our May, 2012, financing used to fund the acquisitions and to raise capital to fund our restaurant remodeling plan.

Net loss from continuing operations was $3.5 million or $0.15 per diluted share compared to a net loss from continuing operations of $779,000 or $0.03 per diluted share in the prior-year period. As noted in this morning’s press release, our net loss from continuing operations included a charge of $2.2 million, or $0.06 per diluted share after tax, for impairment and other lease charges.

As Dan said, $1.6 million of this charge was for a reserve for future lease costs at the four acquired restaurants that we closed during the quarter. However, the closing of these restaurants added about $740,000 to our EBITDA which is the amount of negative cash flow from these restaurants over the past twelve months.

Our effective tax rate in Q2 reflected a tax benefit of 32.5% which is lower than the overall rate expected for the year. The Q2 tax provision included a reduction of $355,000 to our 2012 WOTC credits after finalizing these credits when preparing our 2012 tax return.

At the end of the quarter our cash balances were $33.1 million including $20.0 million of restricted cash held as collateral for our revolving credit facility. Total outstanding debt was $161.0 million at quarter-end, essentially unchanged from last quarter. Capital expenditures for Q2 2013 totaled $13.8 million including $11.2 million for restaurant remodeling. Total capital expenditures for the six months were $27.3 million. Thirty-two remodels were completed in the quarter and 71 restaurants have been remodeled during the first half of the year.

Finally we provided the following updated guidance for 2013: given our trends and current expectations we have modestly lowered our sales guidance for 2013. We now expect comparable restaurant sales of 1.5% to 3.5% in our legacy restaurants and total restaurant sales of $660 million to $670 million for the year. Commodity costs are now expected to increase only 1% to 2% for the year.

We still expect general and administrative expenses of approximately $35 million to $36 million which excludes stock compensation costs. We closed six restaurants in the first half of 2013 and expect to close a total of eight to ten restaurants for the full year. Our annual effective income tax rate is expected to be between 42% and 45% including the carryover benefit of the 2012 WOTC credits that were mostly recognized in Q1.

And lastly, capital expenditures are expected to be approximately $45 million to $50 million including $35 million to $40 million for remodeling a total of 100 to 110 restaurants. Our steamed remodeling expenditures include $6.5 million for the relocation of two restaurants to new sites and for costs to scrape and rebuild four restaurants. Excluding the scrapes and relocations the remodels are generally still expected to average around $300,000.

That concludes our prepared remarks and with that we’ll now open the line for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions.) We have a first question which comes from Bryan Hunt from Wells Fargo Securities. Please state your question.

Bryan Hunt – Wells Fargo Securities

Daniel and Paul, good morning. You saw your performance gap narrow again in Q2 but at a slightly different pace than it has between the legacy stores and the acquired stores during the last three quarters. Could you talk about one, in more detail what happened with the workers comp claims and maybe give us some more magnitude there; and then two, maybe give your expectations on how you expect that performance gap to narrow throughout the rest of the year?

Dan Accordino

Sure, Bryan, I’ll answer the second question first. We expect it to be at around a 200 basis point delta to the legacy stores in terms of cost of sales by mid-year and at 150 basis points by the end of 2013. And we expect that that’s what we will achieve. That’s actually about 50 basis points better than what we had expected when we began the year so we’re actually a bit ahead of where we expected to be in terms of the cost of sales management which is food and paper variances.

The labor issue which was indicated was primarily driven by a workers comp issue, and these were simply two claims that occurred in these restaurants that were very high-cost claims. So we don’t expect again that that’s going to be a recurring phenomenon. We had two claims that were well over $100,000.

Bryan Hunt – Wells Fargo Securities

Okay, great. And then Paul, you’ve talked before about monthly sales performance. Is there any way you can give us the sequential sales trend throughout the quarter? And you’ve obviously given us some light on what’s going on in July, but also I guess, Daniel, you talked about it seems like consumer was trending down to more of a value-oriented mix. I was wondering if you could just expand on those comments.

Paul Flanders

Yeah, in terms of sequential sales, as we said on last quarter’s call April was about 0.4%. That got much better in May – we were up about 4.2% in May. And then as Dan said we’ve seen some consumer pullback and a little more escalation of the value messaging in June and July, and June was actually about 0.9% negative. And as he said, July is about 1.0% negative but those are up against pretty big sales increases as we said over the last year. I think July we comped up 8.7% last year so I think all in all the two-year trend is still looking pretty solid.

Bryan Hunt – Wells Fargo Securities

Alright. And then my last question is what are your expectations for liquidity by the time you get to the end of this year and where do you see that trough-ing out as you move through the throes of the remodeling process?

Paul Flanders

I mean our focus has clearly been trying to balance how quickly we’re running with the remodeling program and in relation to how quickly the cash flows from these acquired restaurants are improving. And those two go hand-in-hand. Our guidance originally for CAPEX if you recall was fairly wide at I think 90 to 130 remodels this year, and it was purposefully guided wide because we knew we were going to need to flex that depending on how we progressed.

We’ve cut the remodeling down a little bit which is reflective of the fact that we’ve lowered the sales guidance a little bit but our intention would be to end the year with cash balances that are in the $20 million to $25 million range.

Dan Accordino

We’re calibrating the pace of the remodels, Bryan, based upon where we think the sales are going to be. And we moderate that and recalibrate it every couple of months.

Bryan Hunt – Wells Fargo Securities

And is there any way you can delineate the sales performance between Virginia and North Carolina as well as were there any other major regional differences?

Dan Accordino

That was a major regional difference. The Carolinas, I think there are probably two issues – the average unit volumes in Virginia and the same-store sales in Virginia with all the franchise groups, the Burger King groups, seemed to be a little softer than what we’re seeing elsewhere in the system. We’ve got two markets in Virginia. Norfolk is probably somewhat volatile based upon what’s going on with the military there – that’s a big part of our sales component. And Richmond is the other market. Markets (inaudible) weren’t negative than Richmond.

And in North Carolina I think the brand was in better shape when we bought these restaurants but we already had a significant presence in many of these Carolina markets. We’ve also done significantly more remodels in the Carolinas – in Virginia we haven’t even started the remodeling project yet and we’ve only got two stores that have been recently done. So I would expect that we’re going to start to see some more brand traction in Virginia once we move these remodels along as well.

Bryan Hunt – Wells Fargo Securities

Alright, great. Thanks for your time.

Dan Accordino

Thanks.

Operator

(Operator instructions.) Our next question comes from James Fronda from Sidoti & Co. Please state your question.

James Fronda – Sidoti & Co.

Hi guys, good morning. Can you give us some insight into 2014 and I guess how many remodels you expect to do?

Paul Flanders

We’re going to provide that guidance later in the year. As we just said we’re still recalibrating these as we move forward and I think it would be more appropriate to provide a little more clarity later on in the year.

James Fronda – Sidoti & Co.

Okay. And I guess with commodities the way they are, are there any anticipated price increases going forward?

Dan Accordino

Yeah, in the legacy restaurant. We’ve already had some pricing in the acquired restaurants simply by adjusting some of the prices in these restaurants. When we bought these restaurants there were 278 different pricing tiers that we had for pricing so we’ve recalibrated that and condensed some. And so consequently the acquired restaurants have already had about a 0.6% to 0.7% price increase and I would expect by the end of the year that that might be at around 1.0%. The legacy stores I think there will be somewhere between 0.5% to 1.0% by the end of the year.

James Fronda – Sidoti & Co.

Okay, alright. Thanks guys.

Operator

Our next question comes from Bryan Elliott from Raymond James. Please state your question.

Bryan Elliott – Raymond James & Associates

Good morning, gentlemen. I just wondered if through some of Burger King’s consumer research that they do or any other source you might have, any sense of what might be creating this consumer behavior change that we seem to be seeing across much of the US restaurant landscape in the last couple months?

Dan Accordino

I would guess, Bryan, and you’re absolutely right – you’re seeing this across all segments, certainly the QSR segment. I think that the economy at least in terms of our customers is perhaps not as strong as what is being reflected in the stock market and in other areas. I mean our customers are still very value-oriented and we’re going to have to be responsive to that for the balance of this year. Burger King is recalibrating its marketing tactics and we will certainly be very value-focused over the next little bit. We’ll have a balance of premium products as well but I think that everybody’s going to have a stronger value orientation because that’s clearly what the customers are telling us.

Bryan Elliott – Raymond James & Associates

And a different question while I have you: part of the brand repositioning obviously is tied to the modernization and remodeling effort. Any sense of where the tipping point on consumer perception is that hey, this is a different Burger King than it was three to five years ago? What percentage of stores in a market or… Is there a tipping point or is it random market-by-market and even store-by-store.

Dan Accordino

Yeah, we really haven’t done an entire market yet so it’s difficult to determine if remodeling an entire market has a different response than if we only did part of the market. On average we’re seeing a good response to these restaurants that is north of 10% in terms of an incremental sales lift, so our intent would be to complete markets as quickly as we can. And we’re further along in the North Carolina market than we are anyplace else. Indianapolis we’re pretty far along in terms of getting that market remodeled. We’ll have Philadelphia done by the end of this year and then we’re going to attack Virginia.

Bryan Elliott – Raymond James & Associates

Very good, thank you.

Operator

Our next question comes from [Andre Gardella from Bar Capital]. Please state your question.

[Andre Gardella – Bar Capital]

Good morning, gentlemen. My question is regarding the weather. Can you comment please on the July weather and if it’s been beneficial compared to last year? Thank you.

Dan Accordino

I don’t think that the weather has any significant bearing on our same-store sales at all.

[Andre Gardella – Bar Capital]

Not at all. You’re saying it’s something similar to what happened last year.

Dan Accordino

No, when you’re geographically as diverse as we are you had certain storms and certain heat waves but overall I think it’s not terribly different from a year ago.

[Andre Gardella – Bar Capital]

Okay, thanks.

Operator

(Operator instructions.) There appears to be no further questions at this moment. Please go ahead with any points you wish to raise.

Paul Flanders

We don’t really have anything to add to this. We think all in all it was a pretty good quarter. We appreciate your attendance today and we will talk to you after Q3. Thank you.

Operator

This concludes today’s conference. Thank you for participating. You may now disconnect.

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