Bob Evans Farms Management Discusses Q1 2014 Results - Earnings Call Transcript

Aug.20.13 | About: Bob Evans (BOBE)

Bob Evans Farms (NASDAQ:BOBE)

Q1 2014 Earnings Call

August 20, 2013 10:00 am ET

Executives

Scott C. Taggart - Vice President of Investor Relations

Paul F. DeSantis - Chief Financial Officer, Principal Accounting Officer, Treasurer and Assistant Secretary

Steven A. Davis - Chairman and Chief Executive Officer

Analysts

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Will Slabaugh - Stephens Inc., Research Division

Michael W. Gallo - CL King & Associates, Inc., Research Division

Michael Halen - Sidoti & Company, LLC

Stephen Anderson - Miller Tabak + Co., LLC, Research Division

David Carlson - KeyBanc Capital Markets Inc., Research Division

Operator

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Bob Evans Farms 2014 First Quarter Earnings Release. [Operator Instructions] I would now like to turn the call over to Scott Taggart, Vice President, Investor Relations. Mr. Taggart, you may begin your conference.

Scott C. Taggart

Thank you, and good morning from Columbus, Ohio. This is Scott Taggart, Vice President of Investor Relations. I would like to welcome you to Bob Evans Farms' First Quarter Fiscal 2014 Conference Call. With me this morning are Steve Davis, our Chairman and Chief Executive Officer; Paul DeSantis, our Chief Financial Officer; and Ed Mitchell, our Vice President and Corporate Controller.

Our call today begins with a summary of our performance from Paul; and then Steve will go into further detail regarding developments within each of our segments. After that, we will open the call for questions.

Please note our comments today contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These forward-looking statements include projections regarding anticipated future results. A number of risks and uncertainties could cause our actual results to differ materially from these forward-looking statements.

Our recent filings with the Securities and Exchange Commission include a discussion of these risk factors. We caution investors not to place undue reliance on forward-looking statements, which speak only as of the date of this conference call, and we undertake no obligation to update these statements.

Also, we will reference non-GAAP financial measures. We have provided a reconciliation of the non-GAAP information to the most directly comparable GAAP financial measures in our earnings release, posted on the Investor Relations section of our corporate website at bobevans.com and filed with the Securities and Exchange Commission on Form 8-K.

And now here's Paul DeSantis with a review of the quarter's results and a look ahead of the remainder of fiscal 2014. Paul?

Paul F. DeSantis

Thanks, Scott. Good morning, everyone. We reported non-GAAP EPS for the first quarter of $0.58 a share. We're also reaffirming our full year EPS guidance of $2.60 to $2.67 per share prior to any effect of the share repurchase program we announced yesterday.

Today, I want to highlight some challenges we're facing in the second quarter and discuss our confidence in the strategic actions that will drive profitable growth in the third and fourth quarter.

As we continue to remodel Bob Evans Restaurants, we're getting better insight into the effects on the P&L and the timing of those effects. One of the items to bring to your attention is the effect of the calendarization of the remodel program for this fiscal year. As you know, we accelerated 2 years of remodel into this year. During the first and second fiscal quarters, we're planning on more remodels this year than last year. However, that tide begins to turn during the third quarter. And by the fourth quarter, we'll have significantly less remodels than last year. As a result, we expect to see the remodel sales-related lift begin to accelerate in the third quarter, through the fourth quarter when we'll roll over more closed days last year than this year.

Additionally, on an incremental basis, the refresh program cost us approximately $1.1 million in the quarter, primarily through the profit effect of closed restaurant days and preopening expenses, as well as SG&A expense to support the expanded startup program.

During the first quarter, Bob Evans Restaurants began the implementation of a new workforce management process that includes a new labor scheduling tool. We're making this transformational investment to help our people manage our largest cost item on the P&L. Although cost were less than $100,000 in the first quarter, we expect to invest approximately $900,000 to $1.2 million during the second quarter, primarily to train almost 2,000 managers.

Workforce management will allow us to better schedule our teams to ensure that the right people are in place at the right time for peak labor efficiency. We have 56 restaurants already converted and expect the chain to be done by the end of the second quarter of fiscal 2014. The full year effect of this program, once it's up and running, is expected to be $6 million to $7 million or 60 to 70 basis points of margin improvement for the restaurant business.

We will not see that full amount on the bottom line as we also anticipate continuing labor cost increases over time in areas like minimum wages and health care.

Net sales were once again up double digits for the foods business, but profitability was challenged. There were 3 contributors to the profit decline year-over-year: increased sow cost, the timing of trade spending and incremental SG&A cost, primarily associated with allocation increases from the Mimi's business and direct and indirect cost associated with supporting the ERP project.

The trade spending increase as a percentage of gross sales was primarily the result of the timing of spending. During fiscal year '14, we expect to spend more in the first quarter and less in the second quarter compared to the pace of spending last year. Overall, spending will be up for the first and second fiscal period, but primarily related to the increased volume.

Sow costs were more than $2 million unfavorable year-over-year as the July run-up in prices unfavorably impacted our P&L. Generally, trade spending moves inversely to sow costs. When sow costs increase, we decrease trade spending, like we're planning this year. When sow cost decrease, trade spending will increase, like we saw last year. Typically, we negotiate our trade spending well in advance of the sale, sometimes up to 120 days in advance depending on the season, holiday, promotion and customer. As a result, there tends to be a lag between sow cost movement and trade spending, particularly when sow costs are rising. This year, we expect the trade spending reductions to help offset the sow cost increases to occur primarily during the third quarter, as we are just now beginning to negotiate pricing for the holiday season.

Over the long term, we can make structural changes by closing facilities or investing in processes and equipment to drive efficiencies, and we've done both in the past. Of course, overall, our side dish business is growing at double digits, while the sausage business is growing less rapidly. As a result, we expect the sausage business to continue to decline as a percentage of overall sales.

In terms of a sow cost forecast for the rest of this year, we consult with 3 separate outside experts and our own internal supply chain. The forecast are calling for gradually declining prices for sows, getting back into the low- to mid-$60s range in the second half of the year. However, we expect sow cost for the second quarter to be in the $70 range compared to $43 last year. That will impact the second fiscal quarter P&L between $6.5 million and $7 million compared to last year, with offsets coming primarily in the third quarter as adjustments to trade spending are realized.

We planned for higher sow cost this year, but not this high, and are adjusting upward our annual guidance to be in the $65 to $70 range, reflecting the significant strain on the second quarter. For the third quarter then, we expect those high sow cost to decline to begin to realize the benefits of the Bidwell, Ohio and the Springfield, Ohio plant consolidations announced in May 2012 and to reduce trade spending.

Switching gears. One of the major sets of initiatives supporting our 8% to 12% long term EPS growth are our margin innovation projects. We're committed to improving margins by a net 300 to 350 basis points, and we're on track to deliver. I'd like to update you on a few of our key projects.

Earlier, I addressed the workforce management process in which we ultimately expect to generate $6 million to $7 million of annual savings to more than offset labor cost increases.

Another area we expect to generate savings is in regards to our closed restaurants. Over the past 7 years, we've closed a significant number of underperforming restaurants. We put those restaurants up for sale, and generally, we're able to sell the ones in better locations. During the quarter, we finished the cleanup, announced write-down and potential sale of the last 29 properties. 15 of the properties are restaurants, which have been closed and for sale for an average of 4 years, and the remaining 14 were vacant land. We've negotiated a price of approximately $3.5 million for the aggregate of these properties. Once the deal is closed, we would expect the annual carrying cost and depreciation savings of approximately $1 million as a result of the sale.

In regards to the cost overhang related to the Mimi's services agreement, we've taken steps to ensure we achieved our commitment of eliminating the majority of these costs. As you may recall, we've discussed $10 million of annual allocated overhead, of which we forecast eliminating an annualized $6 million.

We've taken action to realize those savings and are confident we've identified the $6 million of annual cost to be eliminated. We expect $2 million of the cost benefits to be realized in fiscal 2014, with the full $6 million realized in fiscal 2015.

In terms of the foods business, the Sulphur Springs and Kettle Creations expansions should be operational in October at the end of the second quarter. Although we expect to incur between $1 million to $2 million of start-up cost during the second quarter, once these plants are up and running, we're planning to save approximately $4 million to $5 million or more than 1 full margin point of improvement for the foods business during the second half of this year from consolidating the Bidwell, Ohio and Springfield, Ohio plants volume into the Sulphur Springs expansion.

The Kettle Creations expansion will be used primarily to support our side dish sales growth. We'll be in a better position to discuss margin enhancement initiatives resulting from the Kettle Creations expansion next year as we have some time to run the new third production line.

The Farm Fresh Refresh version 2.0 innovation project is in full swing as well. This project targets improvements in both speed of service and efficiency. We will begin to get some real-world experience later next month when our new restaurant in Finneytown, Ohio opens with a newly modified back of the house designed to improve speed of service and efficiency.

The ERP program has kicked off and is on schedule and on budget. We expect the ERP to be an enabler on a host of efficiency improvements and increased business insight.

In terms of capital allocation, I'd like to clearly articulate our policy. The primary use for our capital is to invest in appropriate ROIC growth opportunities. During the quarter, we invested more than $50 million in projects like our accelerated Farm Fresh Refresh remodel and our foods plant expansions. Also integral to our capital allocation strategy is our dividend. Yesterday, we've announced we increased our dividend for the eighth consecutive year to $0.31 per share on a quarterly basis, 12.7% increase.

We evaluated the results from the strategic transformation we made in fiscal 2013, the ongoing implementation of our growth strategy, margin innovation initiatives and strategic capital investments. Based on our confidence of continued success, we're raising our target leverage ratio. Going forward, we will target approximately 3 turns of leverage, as measured on an adjusted debt-to-EBITDAR basis, higher than we talked about in the past, but more consistent with other successful long-term growth-focused companies in our space. It's the right level of leverage for us to maintain financial flexibility for investments, including bolt-on acquisitions, while continuing our practice of returning cash to shareholders. We will be in this leverage range by the end of the fiscal year through a combination of our capital spending, increased dividend and a robust share repurchase program. We will endeavor to generally keep within this leverage range and will use ongoing share buybacks as an opportunity to continue to return excess cash to shareholders, as we've been doing for the last 8 years.

Our board has authorized an additional $150 million of share buybacks for a total of $175 million in fiscal '14. This buyback will be contingent on our ability to arrange appropriate financing and market conditions. We're planning on open market purchases over the remainder of the fiscal year.

In terms of more specific guidance for fiscal year '14, overall, we continue to expect 2014 non-GAAP EPS to range from $2.60 to $2.67 per diluted share, consistent with our 8% to 12% long term growth target and prior to any effect of our incremental share buyback plan. For Bob Evans Restaurants, we're continuing to expect fiscal 2014 same-store sales growth of approximately 1% to 2%, driven by our value layers and our restaurant remodel initiatives.

The number of Farm Fresh Refresh remodels completed during the first and second quarters this year are expected to be greater than their respective periods last year as we finished the program. The expected year-over-year negative impact of incremental closed restaurant days during the first half of fiscal 2014 reverses to a benefit during the second half of the fiscal year. The third quarter is expected to be impacted similarly to last year, while we should have significantly fewer closed restaurant days in the fourth quarter relative to the corresponding period last year. Additionally, fourth quarter same-store sales should benefit relative to weak February 2013 sales. The company also plans to open up to 4 new restaurants during fiscal 2014.

Fiscal 2014 operating margins for Bob Evans Restaurants are expected to be in the 7.8% to 8.3% range compared to the 8.0% to 8.5% in the original fiscal 2014 guidance, due to higher forecasted commodity costs, offset partially by pricing. These margins include the effect of incremental preopening expenses compared to last year of $700,000 to support 4 new restaurant openings, as well as the incremental number of Farm Fresh Refresh remodels.

During the second quarter, we're expecting 400 closed restaurant days compared to 290 last year. The balance for the third quarter should be about even compared to last year, and then we expect the fourth quarter to compare favorably with 340 closed restaurant days compared to 535 during last year's fourth quarter. Also, during the second quarter, we plan to spend approximately $900,000 to $1.2 million, as we continue to invest in the workforce management implementation.

For BEF Foods, we're expecting fiscal 2014 sales growth of 10% to 15%, driven primarily by the side dish business, food service, frozen and continued restaurant insourcing. Fiscal 2014 operating margins are expected in the 8.5% to 9% range, strengthening in the back half of the year, primarily following the second quarter production startups at Kettle Creations and Sulphur Springs.

Sow costs are expected to remain high during the second quarter and then begin to decline back into the mid-$60s range. Overall, we think sow cost will be in the $65 to $70 range for the full year. However, the second quarter is likely to be in the $70 range, which unfavorably impacts the second quarter operating income by between $6.5 million and $7 million year-over-year. As a result, we should see significant earnings pressure in the second quarter related to the high sow cost and the startup cost of $1 million to $2 million associated with the expansions in Sulphur Springs and Kettle Creations, but followed in the second half of fiscal 2014 with $4 million to $5 million of benefits of Sulphur Springs' consolidation and expansion and reduced trade spending. Additionally, we're expecting the tax rate to drop from 34% to 35% into the 31% to 33% range for the next 3 quarters.

With that, I'll turn the call over to Steve. Thank you.

Steven A. Davis

Thanks, Paul. Good morning, everyone. Our board's confidence in the transformation strategy and execution and growth potential for Bob Evans Restaurants and Bob Evans Farms Foods is reflected in the approval of a 12.7% increase in our dividend and authorization of $150 million incremental share repurchase. We expect to continue with our balanced approach to capital allocation.

[Audio Gap]

Inc. began in fiscal year 2007, we have returned over $575 million to shareholders in the form of dividends and share repurchases, reducing the shares -- company shares outstanding by nearly 25%.

We have also invested over $550 million of capital expenditures in our current businesses and the acquisition of Kettle Creations, while prudently managing debt to facilitate efficient future investments in our businesses. In other words, while transforming the business, we also rewarded shareholders with significant dividend and share repurchase programs, along with earnings growth to drive share price appreciation.

In the past quarters, you have heard me speak of our 3 strategic pillars: transform our core businesses to enable expansion, invest selectively in growth opportunities that provide a high return on invested capital and drive shareholder value with disciplined capital allocation.

We delivered on each of these pillars this quarter. Bob Evans Farms is operating from a far more favorable margin base following the divestiture of Mimi's Café and the acquisition of Kettle Creations. Further, we have identified additional opportunities for significant improvements to achieve our 5-year 300 to 350 basis point operating margin improvement goal.

Major capital investments remain on schedule and on budget and will be key growth drivers in this fiscal year and well into the future. These include the accelerated Farm Fresh Refresh program at Bob Evans Restaurants, the acceleration of new restaurant development and the expansion of the Sulphur Springs and Kettle Creations plants at Bob Evans Farms Foods.

Following the divestiture of Mimi's Café, we announced yesterday a number of organizational changes necessary to help achieve our objective of $6 million of cost reductions to offset the original $10 million of corporate cost that were allocated to Mimi's Café. Our capital expenditures in fiscal years 2013 and 2014 are higher versus prior years.

As part of the transformation of Bob Evans Restaurants and Bob Evans Farms Foods, these investments are critical to providing the solid foundation required to deliver sales and profit growth in these businesses for many years to come.

We have a strong track record of balancing capital investments in our businesses, with meaningful dividend and share repurchase programs for creating value for our shareholders. We are reiterating our full year non-GAAP earnings per share guidance of $2.60 to $2.67 for fiscal year 2014, despite the recent run-up in commodity costs. We are also reiterating our net sales guidance for both businesses.

We have adjusted our menu and marketing with the expectation of improving sales trends for the remainder of the year to enable Bob Evans Restaurants to achieve our original fiscal 2014 same-store sales guidance of 1% to 2%. Furthermore, the year-over-year negative impact of incremental closed restaurant days reverses to a benefit during the second half of the fiscal year, as fewer restaurants will be closed relative to last year, along with our expectation of opening 2 new restaurants, 1 in the third quarter and 1 in the fourth quarter.

At Bob Evans Farms Foods, we continue to deliver profitable sales gains while managing the margin pressure associated with a high sow cost market. During the first quarter, we grew overall volume 13%, with food service, refrigerated side dishes and sausage generating positive growth of 24%, 13% and 5%, respectively.

I will now briefly review the performance of each of our business segments, and more importantly, how we expect to manage them for the remainder of the year to achieve our earnings guidance. Then I will discuss the recent evolution of our approach to balance capital allocation and key elements of Bob Evans Farms' long-term strategy for enhancing shareholder value.

At Bob Evans Restaurants, we remain focused on successfully completing the Farm Fresh Refresh remodel program in our remaining restaurants by the end of this fiscal year. During the quarter, we continued developing our off-premise carryout bakery and catering platforms. Off-premise sales comprised 11% of total sales during the quarter. On a same-store sales basis, carryout sales grew 6%, bakery sales grew 46% and catering grew 12%.

Dine-in sales were down 1%, due primarily to closed restaurant days associated with construction for the Farm Fresh Refresh remodeling program.

And as I said earlier, we remain committed to achieving the same-store sales guidance we provided at the beginning of the current fiscal year, and we are taking appropriate steps toward that objective, which include the recent launch of a new menu on August 1 that is more on trend with a revitalized griddle-oriented breakfast offering, headlined by our new sweet and stacked hotcakes, as well as featuring our key high-margin breakfast items in a more compelling format.

The new menu is also better organized with a design that highlights the freshness and quality of our locally sourced ingredients. The introduction of a new value offering beginning in September with a $6.99 endless soup, salad and sandwich meal that tested very well in driving traffic. Our guests responded positively to the addition of a sandwich component at this price point, a key differentiator from other offerings in the casual dining and family segments.

The testing of a new approach to our highly successful 3-course dinner platform to drive further gains in the sales layer, which was up nearly 25% relative to the first quarter last year.

We'll have more focused promotion of our key carryout layers with digital and traditional media, including our $20 meal Family Meals TO GO and a newly expanded $5 layer that now include salads and sides in addition to our highly successful soup program. And the execution of a new restaurant opening process, which highlights extensive training and new employee support, while delaying marketing until the restaurant achieves above average guest satisfaction scores. Now we used this approach at our most recent new restaurant opening in New Albany, Indiana, and so far, we have been very pleased with the result.

Historically, we focused marketing expenditures on the grand opening period, creating high demand, which in retrospect, our new restaurants were not equipped to handle effectively.

The stress of the early peak in demand led to low guest satisfaction scores and lower-than-projected repeat business. In response, we are spending more money in training and less in marketing to improve employee retention rates and thereby improving guest satisfaction.

We are seeing early success with this modified approach. Our New Albany restaurant team opened the restaurant in late May with strong but manageable sales levels and had time to develop their skills. As a result, the restaurant is nearly retaining almost 90% of its initial sales level, which exceeds the retention rate associated with our prior restaurant openings.

While on the topic of innovation in new restaurants, I'd like to highlight 2 important developments at Bob Evans Restaurants. First, we are excited to announce the opening of a new restaurant, incorporating a new design in Finneytown, Ohio late next month. As with our new menu, this design is clean and simple, a more modern and simplified reflection of Bob Evans Farm heritage. We believe this design will broaden our appeal to a younger customer base, as well as to our traditional guests, while the overall footprint is similar to our existing restaurants, the new design features an optimized back of the house that comprises less than 40% of the total building square footage compared to the nearly 50% of our existing restaurants. Guests will be treated to an upgraded bakery and carryout area that will include ovens relocated to the bakery counter to bring a bit of theater and, not to mention, tempting aroma to the front of the house.

In terms of look, tone and feel, the new building will retain an iconic exterior red brand wall and our traditional keyhole through a more modern interpretation. The materials used throughout, warm woods, truss beams, vaulted ceilings and exposed concrete floors will create a unique guest experience. From a financial perspective, we are targeting a 10% to 15% reduction in our new restaurant building cost.

The other noteworthy development at Bob Evans Restaurants is our recent licensing agreement with Warren, Ohio-based AVI Foodsystems, Inc. AVI is the largest independently owned food service company in the United States. Together, Bob Evans Restaurants and AVI are developing Bob Evans Express, a new concept that will be located in nontraditional venues such as hospitals, universities, airports, malls, corporate cafeterias and manufacturing plants. Bob Evans Farms already has a strong relationship with AVI as some of the bestsellers in AVI's vending business are items produced by Bob Evans Farms Foods.

The target market for Bob Evans Express will be consumers on the go in a fast-paced environment, seeking great food and convenient service. The menu will offer a combination of self-serve and prepared-to-order selections, featuring a limited selection of popular Bob Evans favorites across all 3 dayparts.

We view this as an exciting opportunity to innovate with Bob Evans to penetrate nontraditional venues with new product offerings. Of course, lessons learned at Bob Evans Express will be incorporated where appropriate within our traditional full service locations.

The first Bob Evans Express location opened up at the BMW USA plant in Spartanburg, South Carolina. The second location will open in October at the Bob Evans Farms' new corporate campus in New Albany, Ohio. This location will give us an on-site learning laboratory as we develop and perfect the concept. We will provide additional details as we move forward with this project.

AVI's geographic footprint complements Bob Evans Restaurants' full-service footprint while extending beyond to new geography -- or to new geographic territories for Bob Evans. This partnership offers a one-two punch in terms of brand development. We will grow the Bob Evans brand through strategic partnerships such as this in alternative venues alongside the traditional growth of our company-owned full-service restaurants.

Now turning to developments within the Bob Evans Farms Food business. At Bob Evans Farms Foods, our vertical integration and product diversification strategy delivered another quarter of double-digit volume growth on the strength of our refrigerated side dish and food service businesses. Our focus at Bob Evans Farms Foods during the second quarter is to maintain profitable growth of the business as we bring on new production capacity at the end of the quarter, resulting from the expansion projects at the Sulphur Springs and Kettle Creations plants.

We will incur plant start-up costs during the second quarter, which will be offset by projected cost savings of $4 million to $5 million generated by the expansion projects during the second half of the fiscal year.

We are facing a sow market currently trading in the high-$70 to low-$80 range, which further highlights the importance of our diversification of our product mix to non-sausage products and effective management of our trade promotion and strategies to mitigate the effect on our P&L.

The expansion of the Kettle Creations plant in Lima, Ohio and the Sulphur Springs, Texas plant are important to Bob Evans Restaurants, as these facilities will provide a significant portion of the increased volume insourced to Bob Evans Restaurants.

Our success with developing internal food service sales to Bob Evans Restaurants has led to our current success in growing external food service sales at a double-digit rate. First quarter sales volume of Bob Evans Farms Foods products to Bob Evans Restaurants grew approximately 22% compared to the prior year and represented 5% of Bob Evans Farms Foods' overall sales volume.

As I conclude my comments this morning, I want to underscore Bob Evans Farms' commitment to enhancing long term shareholder value. As shareholders ourselves, we are highly motivated to manage and grow the company's business, to enable continued earnings and dividend growth, ongoing share repurchase programs and, importantly, investments in high return on invested capital projects to drive long term share price appreciation.

To that end, we remain highly focused on our responsibilities to our guest and our customers and our employees in the communities in which we operate. We strongly believe that our shareholders benefit from the company providing products and services in a compelling and ethical manner by employees who are engaged and committed to Bob Evans Farms' future growth.

Our long term 8% to 12% annual adjusted earnings per share growth guidance is predicated on each of our businesses delivering a 300 to 350 basis point operating and margin improvement by fiscal year 2018. This objective will be achieved in part through improvements within the individual Bob Evans Restaurants and Bob Evans Farms Foods business segments, in addition to leveraging the synergies these business units have within the Bob Evans Farms family.

Also important are 2 key elements in the wake of the Mimi's Café divestiture. First, we expect to complete the requirements of the transitional services agreement by the end of fiscal 2014. And second, we are on track to achieve our objective of $6 million of cost reductions to partially offset the original $10 million of corporate cost that were allocated to Mimi's Café in the past.

The underlying health of our business enables us to increase our use of debt and free cash flow to enhance our dividend and share repurchase programs over the long term. We believe our business now supports a leverage multiple more in line with restaurant industry norms. As a result, through ongoing internal evaluation and discussions with our financial advisors, we determined the company has the capacity to increase its return of capital to shareholders through the new dividend rate and share repurchase authorizations.

In closing, Bob Evans Farms, Inc. is committed to executing on a solid strategic business plan to deliver sustainable, long-term growth while simultaneously enhancing shareholder value. We are committed to seeking out and executing on high return on invested capital growth opportunities.

In addition to organic growth investments, future investments may include scalable bolt-on acquisitions like Kettle Creations and/or investments in incubator-stage concepts in the restaurant space. These investments will continue to be paired with a dedication to rewarding shareholders through dividends, share repurchase and share price appreciation.

With that, I thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Brian Bittner of Oppenheimer.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Just a question here on kind of, you talked about levers about buying back stock. If I put 3x leverage on your EBITDAR, it looks like -- maybe my math's wrong, but that's an incremental $400 million of capital. And at the exact same time that you would be doing this, your CapEx needs dramatically decrease going into fiscal '15. So it looks like the cash capacity will be pretty large. So that's a lot of money, $400 million in incremental debt capital. And then free cash flow, that's actually going to be positive. So can you talk a little bit more about when you talk about the $175 million of stock buyback, I mean is there -- is that just something you're going to be consistently doing? Is there a target? The time of when you want to use that by? You talked about the dividend payout ratio stepping up, is there some capital investments that are going to happen in '15 that we don't know about that you want to talk about or acquisition target? It just seems like there's a lot of potential use of cash coming.

Paul F. DeSantis

Okay. Good question. This is Paul. So one of the things to kind of consider when you think about that is that we are still in the middle of a very heavy capital year. And so we said in our notes that we would get to this around the end of this fiscal year. And so part of our anticipation is to do the incremental $150 million or the entire $175 million this fiscal year on an open market basis along with -- we've got one more year of capital spending at high levels. That's this year. And so our expectations, as we get to the end of this fiscal year that we will be approaching that 3x range that we talked about. And so, and then the anticipation going forward is, as we talk about our balanced capital allocation strategy, we're going to invest in the underlying business. And we've talked about those investments, and what we think they're going to be. Obviously '14 is an investment year. We expect that to drop off in '15 as some of the big investments that we're making, like Farm Fresh Refresh and renovating the plants and the like or expanding the plants and the like go away. And then we'll give guidance for '16 and '17 as we start to get our hands around what Farm Fresh Refresh Version 2.0 looks like or anything else. But obviously, we're expecting a drop in that capital spending. And so our expectation is that, as we go through and we look at our capital needs, as we look at our needs for the dividend, whether we have a bolt-on acquisition or not that we've identified, we'll apply that against what we expect our cash flow to be and the difference to keep us in that 3x leverage range will go into share buyback. So that we will be ramping up our borrowing over time to keep ourselves at that 3 -- or that 3x range and the offset will be share buyback after we've invested in the other items I talked about.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

No that makes sense. So just a clarification. So you anticipate to use the authorization by the end of this fiscal year?

Paul F. DeSantis

That is correct, assuming that -- we said, pending market conditions and also any refinancing we may have to do if we run up against borrowing limits.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Okay. And what type of rate interest, cost of that rate, interest rate should we be assuming that the debt that's coming on comes on that?

Paul F. DeSantis

We're borrowing at LIBOR plus a spread, and the spread is based on leverage. So as leverage moves up, our rate is going to move up. And then as LIBOR moves up, our rate -- as LIBOR moves, then that has the offset. So right now, we're borrowing around LIBOR plus 50 or LIBOR plus 60, somewhere in that range. So as we go further into leverage range, that's going to change. One of the things we said was that we were going to give more detailed guidance in the next quarter as we really start to lay out and get a much better idea of what the timing is of this and then what the ultimate impact is, as well as the impact on any additional financing if we put it in. So I apologize for not being able to answer more directly, but there are still some other shoes to fall.

Operator

Your next question comes from the line of Will Slabaugh of Stephens.

Will Slabaugh - Stephens Inc., Research Division

I want to ask you about pork. Obviously, that's been spiking only a bit recently, and you've mentioned the headwinds in your release along with the idea of mitigating that, which you've done very successfully in the past. Can you just remind us a little bit of how you managed to keep that, the sow inflation from materially impacting you previously? And then what those plans look like going forward?

Steven A. Davis

This is Steve Davis. Well, first -- and we've been talking about this for couple of years now -- as we grow our side dish business, and we think that with the higher sow prices, you'll probably see flat to slower growth consumption on the sausage side of the business, where the side dish business continues to grow. Couple that with vertical integration as a result of the acquisition with Kettle Creations, that should put us in a more favorable margin situation than we have been historically on that side of the business. And then Paul can talk to you about some of the things that we've done within products to not just offset the sow cost, but just to improve overall productivity of which sow cost does impact the profitability.

Paul F. DeSantis

Yes, so Will, one of the things that -- if you think about it, we have sort of medium and then longer-term things that we do to help us manage that sow cost. And so I talked a little bit about it in my prepared remarks, where we look at trade spending. And so trade spending is sort of the offset the sow cost. And as sow cost moves, we move trade spending to make sure that we're still controlling for the impact on the bottom line. And then over the longer term, we have really our efficiency initiatives that we're using to drive that. So we have what we call a lean manufacturing. We internally call it the GEAR Program, but we have a lean manufacturing process that we're trying to squeeze, excuse me, efficiencies out of the work that we are doing in our plants. And so we've been applying that over time, and you've seen us make changes to our plant network, for example, but we've also made a lot of efficiency improvements and capital investments that help us continuously drive efficiency in the facility. So we're constantly trying to offset this to the best we can, as well as diversify the product line.

Will Slabaugh - Stephens Inc., Research Division

Got you. That's helpful. And then I wanted to ask you also about same-store sales growth within the restaurants. You noted that the closures impacted that number negatively. I wonder if you could speak more to the broader base and then more importantly also to those restaurants that have already received a remodel and that have been remodeled for over a year now.

Steven A. Davis

Yes, and as we had mentioned earlier, we've accelerated the number of refreshes. So obviously, you're going to have more closed store days, you're going to have more operating expenses, more G&A expenses and the like. And as we mentioned, that's going to ramp down, because remember, we started to accelerate the program last year. So in the third and the fourth quarter is when you'll start to see the benefit of having those closed store days decline, which will obviously positively impact the positive same-store sales. In addition to some of the programming that I mentioned earlier, we did test this endless soup, salad and sandwich program. We're pretty pleased with that. We're going to put some more emphasis against the carryout side of the business, and we'll continue to drive the bakeries and beverages and all the other growth layers that we talked about. So the good news is, we'll be through this program pretty soon. Obviously, it is an investment. It does take 5 to 7 days to do a remodel, but pretty soon, that headwind will be behind us, and then we'll be full steam ahead on driving our growth layers.

Will Slabaugh - Stephens Inc., Research Division

Got you. And just lastly for me, I wonder if you could talk a little bit more about the plans for Bob Evans Express, just any idea of the scope of that rollout in the coming years?

Steven A. Davis

Yes. We're taking a partnership approach. AVI is a company that we've actually done business with on the food product side of the business. They're a great business partner. They play in the space. The thing about getting into these nontraditional venues is having the relationships. I mean, it be tough for us as individual companies to go out and pursue universities or airports, malls and the like. These are companies that typically already have those relationships in place, and they're usually tied to some type of a contract over a period of time. So what they're bringing to the party is expertise in the space. What we're bringing to the party is the strength of the brand and also a partnership to move this along faster. We'll give you more details quarter by quarter. We just opened up our first one, so we'll probably have some insight around that. But in a prior life, I've had experience with nontraditional venues. And you're also familiar with WingStreet. So most important thing is get the idea scalable, get it profitable and then find strategic partners that can help you expand it.

Operator

Your next question comes from the line of Michael Gallo of CL King.

Michael W. Gallo - CL King & Associates, Inc., Research Division

So a couple of questions. I just want to dig in the margins a little bit. When I look at BEF Foods, obviously, the sow costs are about $5 at the midpoint, higher than you expected going in the year. But the overall net sales number isn't changed at all, so I was wondering if you plan to pass through pricing or you'd hit it in the margin or just with reduced trade spend. And then also the operating margin outlook, the 8.5% to 9% wasn't changed. If I look at where you are in the first quarter and presumably with the $6.5 million to $7 million increase in the second quarter, it would seem that would imply probably a double-digit margin in the back half of the year despite sow cost being relatively high. So help me reconcile why the sales wouldn't go up. And again, I presume there'd be some price. And two, why you wouldn't see any impact at all to the operating margin, given fairly sizable sow cost increase, even if we assume it just hits in the second quarter.

Paul F. DeSantis

So a couple of things. We gave a pretty broad range of the top line increase. So within that is an expectation that we're going to be adjusting trade spending a little bit. So trade spending has -- so we have gross sales then there's trade spending after that, then we start to publish net sales. We break the gross sales out in trade spending in our investor fact sheet. And so within that range of 10% to 15%, it's fairly broad. So our anticipation is that we're going to bring the trade spending down a little bit as we move forward. In terms of the seasonality of the business and our expectations, keep in mind the third quarter is the highest seasonality period for the business. So that's when we're running the most volume through our fixed assets. And on top of that, our expectation is, we're going to have 2 brand-new assets up and running that we've disclosed $4 million to $5 million worth of savings coming in for, starting in Q3, when Kettle Creations line 3 is up and running and when Sulphur Springs is up and running, and we've consolidated the volumes out of Bidwell and Springfield in Ohio. So we're expecting to see that kind of benefit coming through in the second half of the year, and our expectation is that sow cost is going to come down as we move forward through this period.

Michael W. Gallo - CL King & Associates, Inc., Research Division

Let me ask the question in a slightly different way. If sow costs were to remain in that $70-plus range. Obviously, it's been even higher than that quarter-to-date here in the second quarter. But if it were to stay in the $70-plus area, can you do enough with trade spend to kind of offset that? And also, do you factor in some potential for the consumer to perhaps look at other product categories in the supermarket?

Paul F. DeSantis

Yes. So one of the things that -- if sow cost were to remain this high for the -- indefinitely, then we would have to look at -- ultimately look at pricing beyond just adjusting the trade spending. And then you're right, they have become protein category trade-offs. As we look at that, one of the things that's happening in the grocery store right now is that bacon prices are exceptionally high, and so we're already seeing some of that pressure out there.

Michael W. Gallo - CL King & Associates, Inc., Research Division

Right. Okay.

Steven A. Davis

Keep in mind that side dishes continue to grow. The trade rate for side dishes is lower than it is for sausage products. And we continue to have success with that. So as we continue to drive that business and bring online our vertical integration with Kettle Creations, that should give us some margin favorability that we didn't have last year.

Michael W. Gallo - CL King & Associates, Inc., Research Division

Right. And in terms of just to get in the margins now on the restaurant side of the business. Obviously, the commodity headwind looks to be greater than you expected. It looked like the guest count declines were meaningful, pretty much offset the the pricing you put through. This quarter, obviously, you'll lap some of the pricing initiatives last year. Comps at 1% to 2%. You have a lot of comfort that you'd be able to do that. I mean, it sounds a little bit back-end loaded with the February commentary, but given some of the slowness in the industry, are you seeing something that suggest it's going to meaningfully improve from the levels you saw, obviously, particularly at the tail end of the quarter? Or is it pretty much the same kind of muddle along with some benefit from the remodel, but not enough to really move the needle up materially?

Steven A. Davis

I think there's 2 things going on. This is Steve Davis. One is, you've got the benefit of the Farm Fresh Refresh. Two, we talked about the value promotions. Three, we do have the benefit of more bakeries coming on stream. And then also, as you think about what's going on in the restaurant space, you got to be strong at value. So as I reflect on this last quarter, we launched a promotion that featured ribs and also had pulled pork sandwiches. So if we had known that pork prices were going to run up the way they did. We test these things months in advance. We lock these things down usually 6 months in advance, just so that the team can get ready for the execution. So none of us knew that we'd see both the record high prices on the food side, but also correspondingly the high pork prices. So we're moving out of that promotion and also into more favorable-type proteins where we've had success in the past, turkey, chicken and the like. And then also the $6.99 promotion did well in test. So we're putting our emphasis against those. And then just coming out of the Farm Fresh Refresh, as we expect to see the teams perform at a higher level in terms of driving sales. It is a commitment to be close for 5 to 7 days and reopen back up. We're going to have that headwind behind us, and we'll be moving towards, hopefully, more sustained sales growth.

Michael W. Gallo - CL King & Associates, Inc., Research Division

And then just final question for Paul. Paul, did you have the quarter-end cash and total debt numbers handy?

Paul F. DeSantis

You know what, I did not. I did not bring those. Cash is going to be at the absolute minimum, like we tend to keep it, and debt's going to have ticked up a little bit from the end of the fiscal year, reflecting a pretty heavy CapEx quarter. We spent about $50 million in CapEx. So we're still -- we'll be publishing that when we publish our 10-Q.

Michael W. Gallo - CL King & Associates, Inc., Research Division

Okay. Yes, if you can put that number and all. I know you guys used to put it in the release or in a supplementary table, that is helpful even if we don't have the full balance sheet.

Paul F. DeSantis

Yes, we...

Operator

Your next question comes from the line of Michael Halen of Sidoti.

Michael Halen - Sidoti & Company, LLC

Some color on how restaurant level margins at the remodeled stores are comparing to those at the units yet to be refreshed?

Steven A. Davis

Yes, we're seeing the margins at refreshed restaurants to be favorable to the non-refreshed restaurants. So that's one of the hallmarks of the refresh program. And in fact, we see that really continue into the second year where we've seen the differential in lift between the second year refresh programs and the rest of the chain. So we're getting a little bit of a benefit in labor, in particular, repair and maintenance cost will go up during the refresh process, but then comes down afterwards as we have a refresh restaurant takes time to start to realize that decline. But over time, we start to see the margins improve a little bit. Of course, we have a different mix because we're selling more bakery, and we're seeing the growth in the carryout and the dine-in, so the sales leverage helps as well.

Michael Halen - Sidoti & Company, LLC

And can you talk about -- can you give us, I guess, any update on the performance of carryout at the remodeled units versus the units yet to be refreshed?

Steven A. Davis

Sure, if we think about what's going on with carryout, so part of the incremental lift between the base business and the refresh business is the carryout layer. So we're seeing incremental lift come in on carryout. We've got -- as you know, we redesigned the restaurant in order to support carryout. And so that's very helpful in terms of driving that incremental lift.

Operator

Your next question comes from the line of Steve Anderson of Miller Tabak.

Stephen Anderson - Miller Tabak + Co., LLC, Research Division

Just want to get a couple of metrics from you with regard to second quarter expectations. First, do you have a number on the start-up costs under the costs for the plant expansion at Sulphur Springs and Kettle Creations? And the second and final question is, what are your incremental costs going to be for second quarter as you complete the rollout of the workforce management tools?

Paul F. DeSantis

Sure. So startup costs, we're expecting $1 million to $2 million for start-up costs and somewhere between $900,000 and $1.2 million for the rollout of the labor tool.

Operator

[Operator Instructions] Your next question comes from the line of David Carlson of KeyBanc Capital Markets.

David Carlson - KeyBanc Capital Markets Inc., Research Division

I have a follow-up on the capital allocation commentary, and I preface the question by saying, I completely understand if you can't answer it directly. But any help you can provide, so that we can think about the strategy a little bit more clearly. Should we be reading into the comments that you're close to making another acquisition? And if not, does increasing your leverage by purchasing stock, does that ultimately limit your ability to make acquisitions after '14? Or would any potential acquisition subsequent to this year come purely from cash from operations?

Steven A. Davis

We don't give forward guidance on any acquisitions or the like. I think we've demonstrated that we can be acquisitive with the Kettle Creations acquisition. So we're in a unique position in that we do have a great balance sheet. We do have our transformative investments coming to pretty much a conclusion at the end of this fiscal year. So I'll turn it over to Paul to talk a little bit about the capacity that we have. But when we looked at our capital allocation strategy, acquisitions was contemplated in terms of do we have "dry powder". So Paul, why don't you walk through that analysis?

Paul F. DeSantis

Sure. So Dave, I think that's a great question. One of the reasons that we're talking about doing an open market share repurchase is that, that gives us the kind of flexibility. So that if the right bolt-on acquisition comes up, then we are able to go after that. And so our expectation is that over time, our cash from operations continues to increase. We're driving 300 to 350 basis points of margin improvement. We're diving top line growth. All of that is going to drive expanded cash flow from operations. And so that gives us an increasing lever, if you will, over time for bolt-on acquisitions. But part of the reason we have a balanced capital allocation strategy is so that we can invest where we think we need to invest, and particularly to protect our ability to do more Kettle Creations-like bolt-on acquisitions.

David Carlson - KeyBanc Capital Markets Inc., Research Division

Okay, fair enough. And then my last question relates to the AVI announcement. What do you guys see as the -- I know it's very early on, but what do you see the total market potential for the Bob Evans Express? And also, I believe you mentioned in your commentary the geographical footprint AVI currently has complements your geographical footprint well. Are they also located in areas where -- which would allow the you to leverage the addition of this partnership with AVI to open more of your traditional locations?

Steven A. Davis

Well, like we said earlier, it's kind of a one-two punch for us. We've got a great brand, especially here in Ohio. It made sense. This is where the brand started. This is where we have over 190 restaurants. We still have, believe it or not, opportunities to open more Bob Evans in the State of Ohio. Some of our highest volumes and our best profits are here. So this is a good place to start. You're right. Their geographic footprint not only overlaps ours, but actually extends it by a few states. So their penetration in nontraditional avenues got us into the relationship we currently have in Spartanburg, South Carolina. I wouldn't say we're very dense in the State of South Carolina. So think of it as, not only is it a way for us to penetrate our core markets, but it's a great way to also get into new markets at a much lower capital expenditure. And then with the licensing agreement, this is an opportunity for us to kind of dip our toe into licensing and franchising, but more to come. We'll see how this plays out. For us, speed to market and getting into these venues is critical in learning, and putting together an economic model that we can scale. And as we do that, like we did the Farm Fresh Refresh program, we'll keep you updated.

Operator

Your next question is a follow-up from the line of Steve Anderson of Miller Tabak.

Stephen Anderson - Miller Tabak + Co., LLC, Research Division

I think that last question answered my questions with regard to the potential for licensing and franchising, and I think that's something I won't keep on to ratchet[ph] at this point.

Steven A. Davis

Okay, great.

Operator

There are no further questions at this time. I'd like to turn the call back over to Mr. Steve Davis for any closing remarks.

Steven A. Davis

Thanks again, everyone, for joining us today. If you have additional questions, please give us a call. We're always available to discuss the business with our stockholders. We always welcome comment and feedback from all of you, and we appreciate the dialogue as we strive to drive shareholder value, guest satisfaction and employee engagement. And if we don't hear from you in the meantime, we look forward to sharing our second quarter results with you in November. So operator, back to you.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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