CKE Restaurants F2Q10 (Qtr End 8/10/09) Earnings Call Transcript

CKE Restaurants (CKR)

F2Q10 Earnings Call

September 17, 2009 9:00 am ET

Executives

Lori Barker - Investor Relations

Andrew F. Puzder - Chief Executive Officer, Director

Theodore Abajian - Chief Financial Officer, Executive Vice President

E. Michael Murphy - President, Chief Legal Officer, Secretary

Analysts

Tony Brenner - Roth Capital Partners

Keith Seigner - Credit Suisse

Mark Smith - Fel & Company

Greg Rudy - Stephens Incorporated

Michael Wolerman - Sidoti & Company

Christopher O’Cull - Suntrust Robinson Humphrey

Presentation

Operator

Good day, ladies and gentlemen and welcome to the CKE Restaurants second quarter of fiscal 2010 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Miss Lori Barker, Investor Relations consulting for CKE Restaurants. Please proceed, Madam.

Lori Barker

Thank you, Janyda. As you know, we issued our press release yesterday announcing our financial results for our fiscal 2010 second quarter ended August 10, 2009, as well as our period eight same-store sales press release. These releases are available on our website, www.ckr.com. CKE has also filed its Form 10-Q with the SEC. This call will reflect items discussed within these press releases and Form 10-Q. CKE management will make reference to them several times.

To assist investors, we also prepared a slide presentation which can be found on our website. Click on Investors and then go to presentations. We will be referring to the presentation during the call.

Speaking on today’s call are Andy Puzder, Chief Executive Officer; and Ted Abajian, Executive Vice President and Chief Financial Officer. Also available are Mike Murphy, President and John Dunyon, our Executive Vice President of Supply Chain Management. Andy will begin today’s presentation with a few comments regarding our second quarter and then Ted will review some of the financials in more detail. Andy will conclude with comments on the strategic direction of the company. Following the prepared remarks, we will open it up to Q&A.

Turning to slide 2 in the presentation, I would like to remind you of our disclosure regarding forward-looking statements contained in our Form 10-Q and in our news release. Our disclosure regarding forward-looking statements can be found within our Form 2 10-Q under item 2, MD&A. Matters discussed during this conference call today may include forward-looking statements relating to future plans and developments, financial goals and operating performance, and are based on management’s current beliefs and assumptions. Such statements are subject to risk and uncertainty and actual results may differ materially from those projected in the forward-looking statements.

I would now like to turn the call over to Andy Puzder.

Andrew F. Puzder

Thanks, Lori. Good morning, everybody. Today I am excited to share with you that we have continued to maintain remarkably steady profitability and cash flow during the economic downturn despite challenging same-store sales results. In the second quarter, we held company operated restaurant level margins flat to prior year at 19.3%, despite a 100 basis point increase in depreciation expense due primarily to our remodeling program. We also grew our adjusted EBITDA by nearly 5% despite a decline in same-store sales. As such, we were able to significantly reduce our debt while continuing with our remodeling program and construction of new units.

While I am pleased with our ability to generate what I consider to be great profit margins and cash flow in a difficult sales environment, our management team remains very focused on improving our same-store sales performance. I will elaborate on our strategies for growing same-store sales after Ted covers our second quarter results in more detail.

Turning to slide 5 in the presentation, as I mentioned, we held consolidated restaurant level margins for our company-operated stores steady at 19.3%, despite a 4.6% decrease in same-store sales and a 100 basis point increase in depreciation expense, mostly due to our ongoing remodeling program. Lower commodity costs offset the increase in depreciation expense and the deleveraging impact of the same-store sales decrease. In addition, our operators did a great job managing labor costs, which ended up 10 basis points below the prior year. At 19.3%, our restaurant level margins remain among the highest in the hamburger focused QSR sector.

On slide 6, you can see our diluted earnings per share was $0.22, which is down $0.01 from the same quarter of the prior year. Facility action charges were $1.1 million higher this year than last year and although we had a favorable mark-to-market adjustment for our interest rate swap agreements, both this year and last year, this year’s favorable adjustment was $800,000 less than in the same quarter of the prior year. These two items negatively impacted the comparison of net income to the prior year and were partially offset by a decrease in interest expense related to lower interest rates and reductions in our debt.

On slide seven, you can see our five-year trend for adjusted EBITDA. For the second quarter of this year, adjusted EBITDA increased almost $2 million, or roughly 5%, to $43 million. Ted will provide more detail on how we grew adjusted EBITDA during his portion of the presentation.

One last comment on the second quarter before I move on to period eight same-store sales -- during the second quarter, we reduced our bank debt by $15.2 million, resulting in total bank debt at the end of the quarter of $289.8 million. Year-to-date, we have paid down our bank debt $25 million while funding approximately $50 million of capital expenditures.

We announced our same-store sales results for period eight yesterday. While the troubled economy and the extremely competitive landscape continued to put pressure on same-store sales during the period, we were particularly pleased to see an improvement in our same-store sales results during the latter half of period eight at Carl’s Jr. when we launched the Big Carl campaign. I’ll discuss more about the Big Carl in our focus on changing consumers’ misperceptions of our competitive pricing and value proposition after Ted shares the financial details.

You can see on slide 8 that consolidated company-operated same-store sales were down 2.3% in period eight of this year, which compares to a positive four-tenths of a percent in the year-ago period. Our company-operated trailing 13 period blended average unit volume was $1.227 million. As you can see on slides nine and 10, while still negative our same-store sales have generally improved over the past four periods at both brands. We are determined to bring both brands back to positive sales territory but to do so without demeaning our brand image or consumer perceptions with respect to the taste and quality of our products.

In summary, while our team could never be happy with the decline in same-store sales, I am very pleased that we were able to hold company-operated restaurant level margins flat to prior year, grow adjusted EBITDA by $1.9 million, and pay down our bank debt by more than $15 million in this economic environment. Our primary focus is now on growing same-store sales while continuing to protect our profit margins and brand positioning. I’ll explain some of what we are doing after Ted takes you through the financials. Ted.

Theodore Abajian

Thank you, Andy. Good morning, everyone. As Andy indicated earlier, we are particularly pleased with two accomplishments this quarter. We achieved a consolidated restaurant level margin of 19.3%, flat to prior year and we increased adjusted EBITDA by $1.9 million, or 4.7% during the quarter. Given the challenging sales environment which impacted both of these metrics and a 100-basis point increase in depreciation expense that impacted restaurant level margins, we are very proud of these accomplishments.

Both Carl’s Jr. and Hardee’s held restaurant level margins consistent with the prior year during the quarter. On slide 12, you can see that Carl’s Jr. restaurant level margin was flat to prior year at 20.7% despite a same-store sales decrease of 6.1% for the quarter. Depreciation expense increased 80 basis points, primarily as a result of our ongoing remodeling program and rent expense increased about 40 basis points as a result of CPI adjustments and the deleveraging impact of the same-store sales decline.

Aggressive management of labor costs and a favorable adjustment to our workers’ compensation reserves caused labor costs to be flat to the prior year.

Increases in depreciation, rent, and other occupancy expenses were offset by a 160 basis point decrease in food and packaging costs, resulting primarily from favorable pricing for beef, cheese, oil and produce products, as well as reduced fuel prices, which aided our distribution costs.

On slide 13, we can see that Hardee’s restaurant level margin also remained consistent with last year at 17.6% for the second quarter of fiscal 2010. Similar to Carl’s Jr., Hardee’s absorbed a 120 basis point increase in depreciation expense primarily resulting from our remodeling program.

We were able to offset this and other occupancy expense increases with a 130 basis point reduction in food and packaging costs, primarily due to lower commodity costs for beef, cheese, flour and oil products.

Finally, our operators at Hardee’s did a great job controlling labor costs, resulting in a 30 basis point reduction in labor costs for the quarter. Turning to slide 14, you can see how we increased adjusted EBITDA by $1.9 million or 4.7% during the second quarter. Within the changes in store count section of the slide, the addition of 29 new stores since the beginning of the second quarter last year caused adjusted EBITDA to increase by $1.5 million.

Refranchising activities in the prior year accounted for a $400,000 decrease in adjusted EBITDA while all other franchise operations increased adjusted EBITDA by about $200,000.

Moving to the changes in operating results section of the slide, you can see that the $2.1 million decrease in adjusted EBITDA resulting from our 4.6% decrease in same-store sales was completely offset by the 90 basis point or $2.2 million decrease in restaurant operating expenses. In addition, reductions in G&A and all other costs increased adjusted EBITDA by $500,000.

So if you boil all of this down to the most significant factors that drove the increase in adjusted EBITDA, you would be left with new units and overhead cost savings driving the increase while restaurant operating cost reductions offset the impact of the same-store sales decline.

Overall, we are very pleased we were able to grow adjusted EBITDA by nearly 5% this quarter.

Looking a little closer at G&A expense on slide 15, you can see that we reduced G&A expense by $1.4 million during the second quarter. For the remainder of the year, I would expect our quarterly run-rate for G&A expenses to be approximately $0.5 million higher than the run-rate in the second quarter. This increase is primarily due to salary and wage increases that occur in the second half of the year and other spending fluctuations that occur in the second half of the year.

Moving now to the balance sheet, on slide 16 you can see that we have continued to pay down debt and reduce our leverage as we remodel restaurants and build new restaurants. In addition, we have continued to return capital to shareholders in the form of dividends and modest share repurchases. As of the end of the second quarter, we reduced our bank debt and other long-term debt by $25 million since year-end and our leverage ratio is now 2.14, well below our bank covenant of 2.75.

Total bank and other long-term debt was $290 million at the end of the quarter, including $40 million drawn on our revolving line of credit. We had $125 million of availability under the revolving line of credit as of the end of the quarter.

Slide 17 addresses our capital plan for fiscal years 2010 and 2011. We are on track to spend between $100 million and $110 million for fiscal 2010 and approximately $90 million for fiscal year 2011. We expect to end this year with approximately 80% of our company-operated Carl’s Jr. restaurants and 66% of our Hardee’s restaurants remodeled. Next year we will essentially complete the Carl’s Jr. remodels, ending the year with 90% remodeled, which is about as high as a percentage as you can reasonably expect to achieve. Hardee’s should be 80% remodeled by the end of fiscal 2011, with completion scheduled for fiscal 2012 and again, all of these percentages are for company-operated restaurants.

Assuming new unit development remains constant, fiscal 2012 capital expenditures should drop to approximately $80 million, reflecting the completion of the Carl’s Jr. remodels in fiscal 2011. Of course, we can adjust our spending level each year as our results and the needs of the business dictate. We remain committed to executing our capital plan without increasing our debt.

On slide 18, you will find a brief recap of our restaurant portfolio and the changes that have occurred since the end of the second quarter last year and during the second quarter of fiscal 2010, we have had a net addition of seven restaurants since the end of last quarter and a net addition of 40 restaurants since the end of the second quarter of last year.

Before I turn the call back to Andy, I want to comment on our expectations for the remainder of the year. Same-store sales will continue to be a challenge in the second half of the year and as Andy has stated, the number one focus of management. Andy will address a portion of our approach to improving same-store sales, so I will focus my comments on the cost side of the equation.

Year-to-date, we have held restaurant level margins flat to the prior year at 19.7% of company-operated restaurants revenue. Keeping it simple, there have been three primary factors that impacted our restaurant level margins in the first half of the year -- same-store sales results, favorable commodity prices, and increased depreciation costs associated primarily with our remodeling program. For the second half of the year, I would add the July federal minimum wage increase to the mix as a fourth factor.

With respect to food and packaging costs, it appears as though commodity prices bottomed out toward the end of our second quarter. In the first half of the year, our food and packaging costs were 100 basis points favorable to the prior year. Slide 19 shows the PPI in food cost inflation through August.

Overall, we expect commodity costs to remain favorable in the second half of the year, perhaps generating a comparable favorable variance to the prior year. As we get deeper into the year, we will have remodeled a larger percentage of our store base, so I would expect the year-over-year increase in depreciation expense to be similar to or perhaps higher than the 100 basis point increase that we experienced --

[Technical Difficulties]

The federal hourly minimum wage rate increased by $0.70 to $7.25 at the end of July. This primarily impacts Hardee’s, as most of our Carl’s Jr. units are located in states that have state minimum wage increases that are already higher than the federal rate. Given the difficult same-store sales environment, we have not taken additional price increases to directly offset this wage increase and it is difficult to determine when we will be able to do so.

Without price increases, the federal minimum wage increase adds about 30 basis points to our consolidated labor costs for the second half of the year.

So to wrap up, we expect commodity prices to remain favorable to the prior year in the second half of the year, although perhaps not to the same degree as in the first half of the year. Depreciation costs should remain approximately 100 basis points above prior year and we will be absorbing additional labor costs associated with the federal minimum wage increase.

Taking all these factors into consideration, once can pretty quickly conclude that holding restaurant level margins flat to prior year in the second half of the year will be a challenging goal and may well require an improvement in our same-store sales trend. Our focus here cannot be overstated.

Finally I want to mention that we recorded approximately $1.5 million in franchise revenue in the third quarter of last year related to refranchising activity and the collection of previously unrecognized amounts from financially troubled franchisees. We do not expect these payments to recur in the third quarter of fiscal 2010.

I will now turn the call back to Andy who will discuss in more detail what we are doing to address same-store sales.

Andrew F. Puzder

Thanks, Ted. Let’s turn to slide 21 now and take a look at the products we introduced in second quarter. This is a picture of the Carl’s Jr. Teriyaki Burger, also known as the bikini burger. Many of you probably remember the provocative ads with Aldrena Patridge. I am pleased to say the Teriyaki Burger was so popular that it has now become a permanent menu item. Carl’s Jr. also rolled out the two for $4 Western Bacon Cheeseburger during the quarter, supported by an ad featuring top chef’s [Padma Lacshimi].

At Hardee’s, we featured the French dip thick burger and our promotional campaign featured traveling French maids as we continued to focus on our core demographic of young hungry guys. We also introduced Hardee’s biscuit holes, which are deep fried balls of our famous made-from-scratch biscuit dough rolled in cinnamon sugar and served with a cup of icing for dipping.

On slide 22, you can see that for both brands, we partnered with Monster Beverage Company, a division of Hansen Natural Corporation. This brand of energy drink is particularly popular with our young hungry guys.

So what’s next to drive same-store sales? Well, for years consumers have properly given us credit for having superior quality burgers. There is a consumer misperception that all of our burgers also cost more than our competitors’ burgers. We believe this has hurt our sales and we intend to correct that misperception. Our current campaign is intended to address this concern and is in support of a product called the Big Carl.

On slide 23, you can see that the Big Carl is directly compared to McDonald’s Big Mac and the supporting campaign is designed to educate consumers about our relative value proposition. Namely, bigger, better, yet less expensive.

For those of you who live outside of a Carl’s Jr. market, you can see the ads at Carlsjr.com and at our Carl’s Jr. YouTube channel. By the way, I did this yesterday -- the YouTube channel is definitely the better way to see the ads. You can get a bigger picture of the ads without any other distractions.

Our Big Carl has twice the meat and twice the cheese of a Big Mac, but sells for just $2.49 or less in most restaurants. The Big Mac ranges in price but averages more than $3. If you do the math, for seven ounces of beef in the Big Carl at $2.49, it costs the consumer $0.36 an ounce of beef. This compares to the Big Mac, with 3.2 ounces of meat, or at $3.00, about $0.94 per ounce. Even if McDonald’s reduced the Big Mac’s price to $1.50 or two for $3.00, it would still cost the consumer $0.47 per ounce of meat as compared to $0.36 per ounce on the Big Carl. We believe this comparison is a compelling demonstration of the value we offer to consumers. Earlier this week, we introduced a product at Hardee’s called the Big Hardee with a similar ad campaign which you can view again at hardees.com or at our Hardee’s YouTube channel.

We just started running another perception changing ad which is focused on a comparison of McDonald’s Angus Burger to Carl’s Jr. $6 burger, as well as Hardee’s Thick Burger. In the past, other competitors such as Burger King have also tried to copy our premium burger’s success, each time they have failed. Put simply, their burgers don’t taste as good and don’t provide the same value. Our $6 burgers are 100% Black Angus charbroiled and about 25% larger than the McAngus burger, but they cost about the same.

In other words, our $6 burgers are once again bigger, better, and a better value to the consumer. Our new ads emphasize this comparison and for those of you who don’t live in a Carl’s Jr. or a Hardee’s market, you can view these ads at Carlsjr.com or hardees.com, or at the Hardee’s or Carl’s Jr. brand YouTube channels.

Again, we are focused on improving our value affordability perceptions but doing so in ways that are consistent with our positioning and our brand image. But coming out with a burger that is smaller than our $6 burger but sells for the same price, McDonald’s as the perceived value leader, opened the door for us to make favorable comparisons between our products. However, these ads are only the first step in our efforts to rebut the misperception among consumers that our burgers cost more than our competitors. We will continue our premium product strategy and use cutting edge commercials to promote our Big Juicy Burgers to young hungry guys but we will also focus on the value as well as the quality of our products.

Another priority for us is to expand our presence both domestically and internationally. Our long-term strategy in this regard is laid out on slide 24. You’ve likely heard me say in the past that for Carl’s Jr. we aim to lessen our exposure in California over time. As such, we are targeting a large percentage of our growth in Texas, a state that is deemed to be more business friendly.

I am pleased to report that we now have a total of 25 Carl’s Jr. restaurants in Texas, including six company-operated restaurants, and that we will be opening two more company-operated restaurants over the next several months. During second quarter, we also opened our first franchise restaurant in the Dallas area, and the results have been very positive.

Since our Carl’s Jr. restaurants are still predominantly located in California, we expect the brand to benefit significantly as the California economy recovers. However, meaningful geographical diversification in Texas should also improve our brands’ short and long-term prospects. Our franchisees continued to develop new restaurants with a total of 350 domestic Carl’s Jr. franchise development commitments.

For the Hardee’s brand, we plan to fill in some of our southern markets starting in the Carolinas. Doing so will aid us with our media buys as it will enable us to have more media purchasing power in certain regions. Our franchisees continue to develop new restaurants with a total of 136 domestic Hardee’s franchise development commitments.

On to slide 25, in the international markets we are very excited about opening our first restaurant in Shanghai, China. This marks the first of more than 100 Carl’s Jr. units planned in the municipalities of Beijing, Shanghai, and Tianjian, and the provinces of [inaudible], and [Juangzhou] over the next eight years, and we see potential for more than 1,000 restaurants in China over time.

In Shanghai, Star Food F&B Management Company Limited is our franchisee. We remain very active in our international franchise expansion effort and have plans to open our first restaurant in Pakistan in early November.

Currently we license 355 international restaurants between both the Carl’s Jr. and Hardee’s brands. We plan to double our international presence to more than 700 restaurants within the next five years.

And now I will wrap up with slide 26. We were pleased with our cost management and our ability to maintain a steady profit level during second quarter. With company-operated restaurant level margins remaining stable at 19.3%, and adjusted EBITDA up nearly 5%, we were able to continue driving down our debt while investing in our future with store remodeling and new units. Nonetheless, we were disappointed with our same-store sales growth in second quarter and we are very focused on improving our same-store sales results going forward. Our perception changing comparison ads for the Big Carl and Big Hardee as well as the $6 burger and Thick Burger are the first steps in our initiative to correct consumers misperceptions with respect to the value of our products while preserving consumer perceptions with respect to the quality of our products.

We will continue to utilize provocative advertising to enhance our brand awareness and educate the consumer about our value. Lastly, we are expanding domestically and internationally to accelerate our growth over the longer term. I am perhaps more excited than ever about our future and the potential of our brands. I’d now like to open up the call to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Tony Brenner with Roth Capital Partners.

Tony Brenner - Roth Capital Partners

We’re at a juncture where year-ago same-store sales comparisons begin to be much easier than they have been, consumer confidence is turning up and is actually higher now than it was a year ago. We are allegedly at the beginning of an economic recovery. I understand why you are being cautious with respect to same-store sales but given those factors, would you be losing ground if in fact your sales don’t become positive fairly soon?

Andrew F. Puzder

Well, if you mean losing ground in comparison to our competitors, obviously it would depend on what happened with their same-store sales too. We are looking forward to easier same-store sales rollovers. We are now through the stimulus check period and remember last year in May and June, people got stimulus checks so that really throughout the summer really had a great impact. Last year we all thought we were geniuses and this year it’s -- sales were down. We’re through that and as you can see from even just last period, both brands are doing better and we would hope that they would improve and we certainly have plans to improve them. The Big Carl has been a real successful product for us. We have the Big Hardee just started this week but we have high hopes for that. We’ve got -- we’re doing a test of, as we’ve discussed before, although we don’t -- I don’t have any new details so I didn’t get into it in the presentation, we’re testing the made-from-scratch biscuit rollout at Carl’s and we are making some moves digitally that we think will add sales. So we’re doing everything we can to assure the same-store sales increase and that we rollover the next few months very strong but there was a lot of -- is anticipated when you talked about the economy in your question and I’ll say that if your anticipations are correct, there should be very good results. If your anticipations are incorrect, then unemployment continues to accelerate in California, for example, that could negatively impact Carl’s but I hope you’re right -- I hope things are turning around and we are going to see some real improvement in the economy.

Tony Brenner - Roth Capital Partners

Just one quick follow-up -- you implied that in the second half of period eight, Carl’s sales were meaningfully better as you rolled out the Big Carl promotion. Can you provide a little color or spin on that degree of improvement?

Andrew F. Puzder

Well, I didn’t mean to intimate it -- I meant to state it. I think they were better in the second half of the period, although I am reluctant to get into -- reluctant to get into week-by-week sales information, particularly in this instance because the last two weeks of period eight were much better at Carl’s. I mean, the first two weeks were impacted significantly by people’s extra spending dollars going into back-to-school items, which I think negatively impacted everybody in the industry.

The last two weeks were materially better but it was a little difficult to come up with a meaningful comparison to the prior year because the Labor Day didn’t match up, so we were -- it was -- the numbers were better when you averaged everything together but confusing to look at day-to-day.

So I guess I can't give you anymore clarity, is my answer. I guess I made it more confusing but the second half was better.

Tony Brenner - Roth Capital Partners

Thank you very much.

Operator

Your next question comes from the line of Keith Seigner with Credit Suisse.

Keith Seigner - Credit Suisse

Good morning. I have a couple of different questions, one I just wanted to ask to Ted first -- you know, you gave us some great detail in terms of where the balances are in the term loan and the revolver. You’ve got $200 million of swap to fixed on the term loan. At 2.14, you are already underneath your maximum leverage covenant ratios for fiscal 2012. I’m just wondering if you could give us some color behind maybe where you would like to see the debt level go. And then with free cash flow accelerating, debt reduction probably waning to some extent as we get into next year, how does the capital allocation mature? How should we think about that?

Theodore Abajian

Well, you know, I mean, we’re certainly comfortable with our debt level where it is today. I mean, Andy and I are both somewhat debt averse but understand the merits of having debt on the balance sheet. I think, you know, as we continue to move through the year, work through our capital plan, you know, and get the bulk of capital spending behind us, I think as we look to the future and have greater clarity, let’s just say, on these anticipated future improvements to the economy, I think we can begin to reevaluate deployment of capital, whether it’s other normal course investments you might think to make, whether it’s expanding on our new unit development plans, whether it’s revisiting share repurchases -- all of those customary things but for the time being, we still feel that managing our debt is an important priority but given how much we’ve paid down so far this year, we’re thankful that it is not our highest priority by any means.

Keith Seigner - Credit Suisse

That’s very helpful, thank you. The second question relates to -- Andy, the numbers you gave us for the costs per ounce of beef for the Big Carl and Big Hardee are -- they are practically astounding. I mean, is this a very low gross margin profit, or product, I mean? I mean, how should we think about that? Is this still a good product to have in the mix or do you really need traffic pick-up?

Andrew F. Puzder

This product hasn’t negatively impacted our food costs whatsoever.

Keith Seigner - Credit Suisse

All right, that’s very encouraging actually to hear. And then one more question for now and then maybe I’ll get back in the queue --

Andrew F. Puzder

What would be encouraging if we were selling those Big Macs at $3 -- I mean, that’s -- I mean, good lord, how much money do they make on those things?

Keith Seigner - Credit Suisse

Obviously quite a bit. But last question, general LTOs around a $6 burger and a thick burger, we haven’t heard as much discussion in the last period or two about possible new ones and the Teriyaki Burger has been there for a little while and I know there’s great buzz around the Big Carl -- any color you can provide us around potential new, or the pace of LTOs around the premium burgers?

Andrew F. Puzder

You know, the problem is we get copied so much that I’m always reluctant to say what we are coming out with because I will find it in our competitor’s shelves before we have a chance to roll it but we are coming out with more thick -- well, the thick burger we always come out. We just had the French Dip thick burger at Hardee’s was our most recent burger product there. We just came out with the Big Hardee -- the Big Hardee and the Big Carl have been, those products have been around for a couple of years. It just -- we were kind of holding back until our very well-run and competent competitor opened the door for us to make some comparisons.

But we’ve got -- there are more thick burger and $6 burger products coming out. That’s the heart of both brands.

Keith Seigner - Credit Suisse

Okay. That’s all very helpful. Thank you very much.

Andrew F. Puzder

And we may have a chicken product coming out. You know, we try and do a chicken product here. [I’m not going to tell] you the next product is going to be $6 burger at Carl’s or a thick burger at Hardee’s but that will generally be the thrust in our product development.

Keith Seigner - Credit Suisse

Thank you.

Operator

Your next question comes from the line of Mark Smith with [Fel] & Company.

Mark Smith - Fel & Company

First off, Ted, a question for you -- can you just walk us through the distribution center revenue and kind of what we saw happen? We saw a pretty big decrease this quarter year over year.

Theodore Abajian

Well, that’s pretty straightforward. Our same-store sales at the company stores were down about 6%. The franchise stores, which drive the distribution revenue, were also down about 6%, 6.5% during the period so what you see is a direct overall reduction in distribution revenue resulting from that.

Now, if you are looking at -- on a consolidated basis, that also includes our equipment sales to franchisees and those volumes can change from year to year depending on how many remodels or how much equipment franchisees are purchasing but that’s a direct result mostly of our food sales to franchisees at Carl’s Jr.

Mark Smith - Fel & Company

Okay, so the big difference between a decline in distribution center compared to the same-store sales decline is -- that’s mostly going to be equipment?

Theodore Abajian

I’m sorry, could you repeat that, Mark? I couldn’t quite hear it.

Mark Smith - Fel & Company

Just any difference in your year-over-year decline in distribution center revenue compared to your same-store sales decline at franchise restaurants, that difference is mostly going to be equipment?

Theodore Abajian

Mostly, and you can within our queue, you can look at the Carl’s Jr. and Hardee’s detailed P&L pages that will break out specifically for you how much of the distribution revenue change is attributable to Carl’s, which is 100% food related and how much is on the Hardee’s P&L shows all of which would be equipment related. And if you have follow-up, I’d be happy to spend some time with you walking you through those numbers in the 10-Q.

Mark Smith - Fel & Company

Perfect. Second, just looking at G&A, can you just give us a quick rehash, a quick repeat of your comments on the second half on what you are looking for in G&A? And then if you can comment on any potential for savings and kind of tightening the belt in G&A that you have seen or that are potentials here for the second half?

Theodore Abajian

First of all, that’s a -- the focus on savings and cost-cutting, cost avoidance in G&A is a neverending process, something we talk about every month when our management team meets. But at some point as you begin growing the restaurants, you do have to make some investments. That said, the guidance I gave was if you use the Q2 run-rate, I am expecting G&A to be about $0.5 million a quarter higher for the second half of the year than it was using the Q2 run-rate. I mean, that’s an approximation. That’s the best estimate we have at this point. I mean, we’re extremely focused on controlling those costs but we are also mindful that as we come out of this current economic environment, we want to be well-positioned to be able to grow our company and take advantage of opportunities that perhaps other companies may not be able to take advantage of and that’s very important to us long-term.

Mark Smith - Fel & Company

Okay, and then the last question -- Andy, you talked a little bit about seeing some positive trends at Carl’s Jr. here recently. Can you break down kind of excluding California, I know that’s a big piece of Carl’s business, are you seeing better or worse or similar trends kind of excluding California?

Andrew F. Puzder

It depends on what state you are in. Oregon has a higher minimum wage and a similar regulatory structure as California and also has a similar socialist type government at the state level, so the business there is actually can be as bad or worse than California. And I think their unemployment rate is higher.

Arizona has a lot of issues with immigration and decline in the tourist trade, so Arizona has gotten hit kind of hard, so it really depends where we are. Washington is doing fine, Texas is doing fine. It’s -- Texas is doing real well. So it really just -- it’s really a state-by-state issue and illegal immigrants leaving one state for another state will hurt the restaurant business in the state they leave, not because we can't employ them but where do you think those guys eat? They are all farm laborers and construction workers and you’ve got severe unemployment in certain western states which will impact you, and then you’ve got a decline in tourist traffic. I would expect -- Las Vegas is a, for example, is a franchise market but Las Vegas, if the hotel business is down, you can assume that the restaurant business isn’t going to be thriving either. So again -- but then Texas, which is doing extremely well economically, restaurants are doing better.

So it’s really a state-by-state issue.

Mark Smith - Fel & Company

Perfect. Thank you.

Operator

Your next question comes from the line of Greg Rudy with Stephens Incorporated. Please proceed.

Greg Rudy - Stephens Incorporated

I appreciate the color on the Big Carl versus the Big Mac. Andy, you said the goal is to grow same-store sales by educating the guest on value. Advertising came down 28 basis points, or $700,000 year over year. How much spending is needed to educate the consumers? Or is your wider mix of marketing distribution enough?

Theodore Abajian

Greg, first of all on the advertising, that really was -- the 20 basis points was just a bit of an anomaly comparison to the prior year. We didn’t specifically reduce ad spending or anything like that. It generally runs a pretty consistent percent of sales so I wouldn’t read anything into that as an adjustment, and it’s a timing difference.

Andrew F. Puzder

Yeah, it was a timing issue -- it wasn’t really less spending.

Greg Rudy - Stephens Incorporated

And will you need to increase spending though even if we account for timing to educate the consumers?

Andrew F. Puzder

You know, we could in our discretion working with the franchisees increase spending to cover certain -- it hasn’t been -- well, we might be increasing it slightly on the Angus comparison ad but it is something we are willing to do if we think we need to do it but not to an amount that would be -- you wouldn’t be amazed by the amount if it happened.

Greg Rudy - Stephens Incorporated

Okay. Ted, it looks like the average check fell 3% at Hardee’s. Is there anything you can point to there? Is it day part mix? Is it strong trial of biscuit holes or are you lapping some price? Any color there would be helpful.

Theodore Abajian

I don’t think we really have anything dramatic to share with you there. I mean, I think that you’ve seen combo incidents -- across the industry, people are buying less fries and soft drinks along with their burger, so I think we are all seeing some impact on check from that and in talking to our suppliers, we’re seeing that through many of our competitors as well.

Andrew F. Puzder

And last year we had the prime rib thick burger at the same time people got stimulus checks, so we had a high priced premium product and people had cash in their pockets, so that may have impacted it as well.

Greg Rudy - Stephens Incorporated

Last one and then I’ll pass it along -- on I think slide 14, you disclosed a $1.5 million contribution to adjusted EBITDA from new company-owned stores. Is that based on 25 new restaurants?

Theodore Abajian

That’s based on the new stores that have opened since the end of second quarter last year, and so we literally just calculate how much the new stores contributed on a year-over-year variance basis. So I could -- I don’t have the exact number of new stores in front of me but I can get that for you.

Greg Rudy - Stephens Incorporated

Okay. Thanks so much.

Operator

Your next question comes from the line of Michael [Wolerman] with Sidoti & Company.

Michael Wolerman - Sidoti & Company

I just wanted to go back and touch on the food and packaging line here. I know that you guys said it looks like commodities have bottomed somewhat but what are you guys looking at moving forward? Are you expecting inflation, food cost inflation to come back here or are you looking for it to stabilize?

Andrew F. Puzder

Are you talking about year-end or are you talking about next year or what are you looking at?

Michael Wolerman - Sidoti & Company

Pretty much the back half of this year.

Andrew F. Puzder

We’re not expecting huge food inflation by the end of the year.

Michael Wolerman - Sidoti & Company

All right, and then just one other thing here -- on the payroll side, you guys have done a good job of controlling that labor, labor costs. With that new minimum wage hike coming in, is there anymore tightening of the belt so to speak there that you could kind of offset that? I know that you said you weren’t going to be able to take price but is there anymore room to kind of consolidate that leverage line?

Andrew F. Puzder

Our Hardee’s guys in particular over the last couple of years have -- our Carl’s guys have always been focused on this, our Hardee’s guys have really intensified their focus but you always can cut -- the question is at what point you start cutting service and we are unwilling to demean the service to the consumer so -- but we play it pretty close to the line. And as our -- as -- with unemployment so high, your turnover rate goes down. The people that you retain are better trained and better -- so there is always some movement you can make consistent with what the economy and the labor market are doing, so our guys are very focused on it and it’s possible we could get some more, we certainly don’t want to lose that three-tenths of a percent. That’s -- that basically is an estimate from Ted and his team. That certainly isn’t carved in stone anywhere. We’d love to see that continue to improve. And at Carl’s again, there’s no impact because as Ted noted that minimum wage in most of the Carl’s states, including California and Oregon, is already higher than the federal minimum wage so that $0.70 had no impact on labor at Carl’s.

At Hardee’s, they will continue to focus on trying to make sure that we don’t lose any leverage at the labor line but yeah, I think the number Ted gave you is our best estimate of what that impact could be.

Michael Wolerman - Sidoti & Company

All right, great. Thanks, guys.

Operator

Your next question comes from the line of Chris O’Cull with Suntrust.

Christopher O’Cull - Suntrust Robinson Humphrey

Andy, I think the company’s approach to improve its affordability perception is great but some of your competitors have been also increasing variety in their menu. Is there -- is greater menu variety an opportunity for Carl’s?

Andrew F. Puzder

I think we’ve got, particularly in red and green burrito restaurants, we’ve got a ton of variety and we are always -- we offer probably four new products a year at each brand. If it’s very popular, like I would fully expect the Big Carl to become a permanent menu item that -- we haven’t had that discussion yet but given the numbers that we are selling, I would think it would become a permanent menu item. The Teriyaki Burger became a permanent menu item recently. You know, value is good but value also stresses your system. The more value you put into a -- the more variety you put into a restaurant the more difficult that restaurant is to run, and the more difficult it is to make your products as they should be made. There’s a very meaningful statement in the restaurant industry that everything tastes great in the test kitchen. That doesn’t mean it’s going to taste good in the restaurant. And so as you -- Hardee’s is a perfect example of a brand that got so into variety and so into trying to give the consumer something new to think about all the time that it basically drove itself into utter incompetence in the mid-90s to the early 2000s until we came in and had to take about 40 items off the menu. So variety is a tactic that we use. We try and employ it to the minimum amount that we can get away with because we want to serve very high quality, very tasty, very good products and variety makes that extremely difficult to do. Another saying is that the 20-somethings in the kitchen just can’t make all that stuff and that is generally true.

Christopher O’Cull - Suntrust Robinson Humphrey

You know, I like the use of specific brands to create variety like the green and red burrito, and I like how it doesn’t dilute the Carl’s and Hardee’s position. I noticed that you are testing a Hardee’s menu board, or breakfast menu board, I guess, in a Carl’s unit, trying to leverage the Hardee’s appeal for breakfast. Can you give any comments or color commentary on what -- how that is performing?

Andrew F. Puzder

It was in one restaurant in Buena Park in Orange County by -- what’s that amusement park? Knoxbury Farm, and it’s in an area that we did not expect to be a particularly good area for biscuits and the test went extremely well. So we are rolling that test out on a broader basis now to try it in -- we know we can do it in one restaurant. We know they sold well in one restaurant. Now we would like to see how they do in a district and maybe a small market. If that works, I’ll tell you, if it works as well in the rest of the system as it did in that restaurant, you know, we’ve got about five years worth of products and five years worth of ads from Hardee’s that we can use at Carl’s for breakfast, so it could be a very encouraging development along with these perception changing ads and the perception changing products, so it’s -- we’re encouraged but I really -- it also could completely fail and not be meaningful beyond this one restaurant. That’s why I didn’t talk about it in the call. I really don’t have enough information to give you encouragement or discouragement yet. We have one restaurant in Orange County and it did well enough to expand the test. That’s kind of where we are right now.

Christopher O’Cull - Suntrust Robinson Humphrey

How large is breakfast at Carl’s as a percentage of the mix?

Andrew F. Puzder

About 15%.

Christopher O’Cull - Suntrust Robinson Humphrey

Okay, and that seems a little low compared to most of the competition, is that fair?

Andrew F. Puzder

Well, I mean, it’s low compared to McDonald’s and Hardee’s. I think McDonald’s and Hardee’s are the industry leaders but Wendy’s doesn’t have breakfast. I would guess Burger King isn’t meaningfully ahead of that -- they are probably behind that. I don’t even know what their breakfast products are.

I think Jack has had breakfast yet. They probably do pretty well at breakfast but I don’t know the breakdown of any of those brands. But when I took over, I’ll tell you, it was kind of funny, we were doing 9% of our business at breakfast at Carl’s. And 50% of that was burgers, like guys coming in on the way home at night after a night out getting Western Bacon Cheeseburgers at six o’clock in the morning. And now we’ve really turned that into more of a breakfast day part and increased the percentage. But you know, if we could get another 5%, 6% out of breakfast, that could be very meaningful for the brand and I don’t -- I’m not saying that biscuits will do that for us or that they won’t but if they could, it would be a big boost.

Christopher O’Cull - Suntrust Robinson Humphrey

And then last question, Ted, have you seen any improvements in the investment costs for remodeling the restaurants, given the weak economy?

Theodore Abajian

I think we are seeing some improvements there. We definitely have seen some improvements not because of the economy specifically in the cost of our exterior remodels, which are predominantly being employed at Hardee’s, where we can get permits to do the exterior remodels. That cost has come down rather significantly. So -- but we are seeing some benefit from just overall materials and contractors as well.

Christopher O’Cull - Suntrust Robinson Humphrey

Okay, great. Thanks, guys.

Operator

(Operator Instructions)

Theodore Abajian

While the queue is filling up, I’ll follow-up on two of the questions from earlier, one regarding the distribution center revenues -- I failed to mention that with falling commodity prices, that also reduces our distribution center revenues, as you would expect. We’re selling food at cost plus a mark-up for distribution fees, so that’s the reason you see a larger drop in distribution center revenues than the same-store sales from franchisees would otherwise suggest.

And the other question regarding the number of new units, yes, on slide 18 there has been an opening of 25 new units since the end of second quarter last year and that’s what is driving the EBITDA increase on the EBITDA bridge.

Operator

You have no questions at this time. I would now like to turn the call over to Lori Barker for closing remarks.

Lori Barker

Thank you. I would like to thank everyone for joining our conference call today. This will also be available on our webcast on our website, ckr.com. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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Comments

[Thomas Smicklas]

The lack of franchise cleanliness, inadequate updating, a fat-laden/no option menu fast food restaurant in Hardees bodes poorly for the future.

Building restaurants is one thing. Keeping the seasoned restaurants in decent shape with a competitive menu is quite another issue.

No confidence in this stock at this time.

2009 Dec 07 06:49 PM