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

Q4 2013 Earnings Conference Call

February 27, 2014 05:00 PM ET

Executives

John Coletta – Chief Financial Officer

Michael W. Arthur – Director

Emanuel Hilario – Chief Operations Officer

Analysts

Alexander Slagle – Jefferies LLC

Operator

Good day and welcome to the Einstein Noah Restaurant Group Fourth Quarter 2013 Earnings Conference Call. Today’s call is being recorded. At this time, I would like to turn the conference over to John Coletta, Chief Financial Officer. You may begin.

John Coletta

Thank you. Good afternoon everyone, and thank you for your time today. Let’s begin by covering a few regulatory matters.

During our formal remarks and in response to your questions, certain items may be discussed which are not based on historical fact. Such items, including statements indicating our beliefs, trends, plans, expectations, assumptions, anticipations, guidance, projections, estimates or the like should be considered forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995.

All such forward-looking statements are subject to risks which could cause our actual results to differ materially. For more details, please refer to our earnings release issued today and to the risk factors in our recent SEC filings.

With me this afternoon are Michael Arthur, Interim President and CEO and Manny Hilario, Chief Operations Officer. After some opening remarks from Michael, Manny will discuss highlights of our performance and provide an operations update. Then I will review our financials and discuss some guidelines for 2014.

And now let me turn the call over to Michael.

Michael W. Arthur

Hello all, and thank you for joining us on the call. I’m excited and honored to take on this responsibility and while it’s interim, my job well here is to keep the programs moving smoothly, but with greater focus on customer satisfaction, good store openings, franchising and licensing. And to exercise, execute this plan a talented and capable management team is already in place.

The Board’s search for a permanent President and CEO has started. And at this point I would also like to thank Jeff O'Neill for his leadership and contribution over the past few years. I have been the Einstein Noah Director since 2004, and I’m very well versed in these specifics of the business.

I’ve always had key roles in other restaurant companies and other retailer consumer products concepts. As for the background, I grew up in Brooklyn, New York and I have eaten Bagels and I love Bagels my whole life. Rest assured, that I will continue to impel the tradition of quality in everything we do and the quality of our Bagels, Cream Cheese and the quality of our guests experience. I have already relocated to Lakewood and I will be here until the permanent CEO as in place, and I share the Board’s confidence in our strong brand and the future of our company.

So with that, let me turn the call over to Manny, who will discuss the fourth quarter numbers and our ongoing initiatives. I’ll be available to answer your questions at the conclusion of our formal remarks.

Emanuel Hilario

Thanks, Michael. I look forward to working with you to continue delivering value to our shareholders. I would also like to thank Jeff for his leadership and wish him well in all of his endeavors.

Turning to the quarter; even with the extreme winter weather impacts, we’ve reached the positive traffic that laid in 2013 and reported our best traffic quarter since 2010. This is a direct result of our sales-building initiatives that I will be discussing further. We also had a record year of unit growth with 61 openings achieved record-setting new stores sales volumes and almost doubled our franchise development agreements, nearing 200 original unit commitments of which approximately 150 units remain to be built.

During the fourth quarter, we made some store level investments in order to build momentum; this resulted in some short-term margin pressure, but has also had a positive impact on sales, specifically Q4 system-wide comparable store sales rose 0.1%, which virtually no unit pricing in the quarter, but more importantly, we continue to build the trend on transactions.

And despite the added pressure of weather, we exceeded industry traffic trends over the 13-week timeframe by nearly 150 basis points. And you will recall that we began the year with upfront investments in our everyday value strategy and caution that it could take some time before we would gain traction. We made progress throughout 2013 in building transactions and end of the year at material better place than we started.

Taking a peek into the first quarter of 2014, we have built on the momentum as company comp sales are positive despite the weather impact. I will discuss momentarily how we are driving frequency through our private and promotional strategy, but those efforts alone are not responsible for the trend improvements.

We made headway ensuring a better in-store experience for our guests along with a number of specific investments in marketing. For example, we are in the process of rolling out digital feature boards to all of our restaurants after successful test in the West Coast last year. Then after testing media in a number of CDs in 2013, we will be rolling out to radio advertising into DMAs representing about 200 company restaurants this year.

In addition, we will continue to pursue various targeted digital marketing strategies to promote our products. We are also excited about the potential impact these items can have on overall awareness and traffic trends in 2014. In terms of store level profitability, store level margins decreased in the fourth quarter due to the impact of any net price increases, some sales deleveraging and delaying some anticipated cost initiatives, which were first introduced in 2014.

Looking forward, our overall commodity position is favorable and we have a number of margin friendly cost initiatives in place of the year. We also took some pricing in January and aimed at offsetting inflation. In addition, the strength of our book business, our continued growth in catering and the focus on specialty beverages is having a positive impact on check. So we feel our margin improvement and margin management is back on track and well positioned for 2014.

We continued to focus on our position as the best nation for healthy options with our revamps smart choices menu. Smart choices bodes to a selection of better free alternatives with less than 380 calories in 15 grams of fat. It already comprises of about 15% of our sales and we believe this will remain an important element of our menu going forward.

We added a number of items like our Thintastic Bagels, which have 35% fewer calories, which can be added to your favorite sandwich to make it thin. Our Nova Lox Sandwich is one of our fastest growing items and is a favorite of health-conscious customers since it’s packed with Omega-3, provides 24 grams of protein and tastes great.

We think these many additions and enhancements reflect foreign consumer expectations especially in the breakfast day-part. And when consumers see our current Smart Choices menu they know that we’re committed to healthier innovation. Bulk and catering represent important check drivers and how often the first opportunity we have to showcase our brand to people who have never experienced our food.

Given sales increased 20% in the fourth quarter on top of similar growth in the prior year period. And our sales force continues to do a great job promoting our breakfast and lunch catering capabilities at the store level and city-by-city. This year we are enhancing our call center and are excited about how this can drive catering royalty and growth going forward.

Our wholesale business which is reported to our manufacturing line item represents a growing channel that supports both overall revenue generation and increased gross margins. Revenues increased about 12% in the fourth quarter and slightly more than 8% for the full year as we continue to expand our distribution within third-party accounts. This year, we have identified additional savings opportunities that will encompass both manufacturing and store level operations.

Turning to the development, we opened a record 61 stores in 2013 and we build on that track record with an expected 75 openings to 85 openings in 2014. We tend to score, will include our company franchise and license that channels and with a particular focus on our strong asset like development plans. Across the system, we are applying greater rigor to site selection and this is facilitating higher volume stores and better returns. For example, our 2013 class of new company stores generate average volumes of approximately $1 million which is over 15% higher than our system average.

Our licensees are building more airport locations where revenues are approximately 4 times greater than our average licensed location. Licensees built five airport locations in 2013 and we currently have a total 16 in operation. This year, we’ll be adding another five terminals to our airport presence haven’t been awarded contracts in San Diego, Atlanta, LaGuardia, Miami and San Jose.

Now with respect to operations, I have three quick takeaways that I believe are important to considering when assessing our business and our performance in 2013. First, we have implemented our own plan to win strategy with the focus on raising the bar on the in-store experience through execution. As you already know, we have a great deal of pride in providing our customers with the quality of a bakery café product and the convenience of a QSR. We believe that these brand attributes already set us apart but we have redoubled our efforts to ensure that we are also regarded for the friendliness of our crew and for the cleanliness of our stores.

As a result, our overall service satisfaction scores grew significantly last year, starting to exceed industry averages which we believe is an important factor in driving repeat transactions, because more satisfied customers become more frequent customers.

Secondly, our plan to win is being made possible by building a stronger team and talent pool through our new step-up program. Investing our people at all levels of the organization filling General Manager, [Indiscernible] roles that had been left vacant during the strategic alternatives process and creating a bench for stores that are being developed but have not yet opened.

Management turnover has fallen significantly over the last year and as we get better recruiting quality managers. Currently 80% of our promotions to multi unit management decisions after within the organization and lastly we are going to be more aggressive in remodeling all the stores within our portfolio so that we can better much the quality of our foods with the quality of the Einstein atmosphere. In 2013, we remodeled 10 institutional lands. This year included in our capital expenditures plan intent to remodel and update another 50 to 60 locations across various markets.

And now I will turn the call back over to John to discuss our fourth quarter performance and thoughts on 2014. John?

John Coletta

Thanks, Manny. In terms of our fourth quarter financial results, total revenues increased $3.5 million or 3.2% to $114.2 million from $110.6 million. System-wide comparable restaurant sales increased 0.1% which consisted of 1.1% increase in average check that was offset by a 1% decrease in transactions. The estimated impact of unfavorable December weather and one pure holiday shopping week between Thanksgiving and Christmas on our system-wide transactions totaled near 1%.

Inclusive of these impacts, the change in system-wide transactions was the best since the fourth quarter of 2010 and exceeded the industry benchmark as the commitment to expand to our expanded value strategy that began in early 2013, continue to gain traction with our customers.

Company-owned restaurant sales increased 1.9% to $101.4 million compared to the year ago period. Comparable restaurant sales decrease 0.5% and consisted of 1.8% increase in average check that was offset by 2.3% decrease in transaction. Franchise and license revenues increased 21.6% to $4.09 million reflecting hired in accounts for both franchise and license stores and a combine positive comparable sales performance during the quarter.

As I discuss costs, in general many cost ratios were higher by our deliberate choice, not to take net price increases to offset inflation as a short-term strategy and promoting value and offerings. Our prime costs which consisted cost of goods sold and labor cost increased 60 basis points for a combined total of 56.8% of restaurant sales compared to 56.2% in the prior year. The margin erosion in our cost of sales line reflected a timing delay in some of the efficiency initiatives along with this in place to be inflationary impact. Still we manage labor costs extremely well during the quarter as they fell 70 basis points to 28.5% of restaurant sales.

Rent and related expenses increased 60 basis points to 11.3% from 10.7%; this was primarily due to the 10 new restaurants that we’ve added over the last four quarters and higher costs, higher quality location along with sale of deleveraging as the remainder of our base with company-operated stores. Other operating costs increased 70 basis points to 10.9% from 10.2% for similar reasons.

Our investment and marketing initiatives increased $0.7 million from the same period in 2012 or 80 basis points as the percentage of restaurant sales mainly due to the timing of expenditures within a year versus an increase in total spending per se. In fact, marketing cost fell 20 basis points on an annual basis to 2.8% of restaurant sales, but we did spend about $2 million as we performed research in tested media.

Turning back to the quarter, overall gross margin in our company stores fell 270 basis points to 17.8% restaurant level profit due to inflationary pressures and our focus on promoting everyday value.

Manufacturing revenues from our Whittier facility increased 12% to $8.8 million due to the strength of orders from third parties, which included an increased footprint within our wholesale partner stores. In addition, gross margin as a percentage of manufacturing revenues increased to 26% from 23.2% as we have completed an upgrade to our core bank manufacturing process. Our gross margin expanded by 280 basis points in the fourth quarter and 430 basis points for fiscal 2013.

General and administrative expenses increased to $10.2 million in the fourth quarter of 2013 from $9.4 million last year. G&A was at the low end of our guided range of $10 million to $11 million per quarter and included higher costs related to the recent hiring activity. As a reminder, these efforts had slowed considerably during the strategic alternatives review which was concluded in the fourth quarter of 2012.

Pre-opening expenses were $118,000 compared to $711,000 in the prior year period and were related to the three company openings in the fourth quarter as well as expenses for several openings that are planned for the first quarter.

As a side note, we had a legal settlement related to our Whittier facility during the quarter which impacted our after-tax diluted EPS by $0.03 per share. Income from operations increased 46.3% to $9.2 million from $6.3 million while adjusted EBITDA was $14 million in the fourth quarter of 2013 compared to $15.4 million in the fourth quarter of 2012.

I refer you to the reconciliation tables located in our earnings release for a detailed presentation of how we arrived at those numbers.

Total debt at December 31, 2013 was $107 million compared to $136.7 million at the end of fiscal 2012. Using excess free cash flow, we paid down $10.3 million in debt during the fourth quarter of 2013 and $29.7 million for the entire year. We also amended our facility in June which resulted in a 75 basis point reduction to our interest-rate and this amendment coupled with pay down with strong leverage ratio management resulted in interest expense of $1.2 million for the fourth quarter of 2013, an increase of only $0.1 million for the fourth quarter of 2012.

On an annual basis for fiscal 2013, interest expense increased $2.6 million to $6 million, as a consequence of the re-capitalization in December 2012, which impacted earnings per diluted share by $0.10. Net income in the fourth quarter of 2013 was $4.9 million or $0.27 per diluted share. Net income in the fourth quarter of 2012 was $3.2 million or $0.18 per diluted share.

In terms of a system count, we ended the quarter with 852 restaurants across 42 states in the District of Columbia. We opened 61 restaurants across the system at a record pace in 2013 and this consisted of 10 company-owned restaurants, 14 franchised restaurants and 37 licensed restaurants.

In terms of our guidelines for 2014, we look for 75 to 85 system-wide openings comprised of 15 to 20 company-owned stores, 20 to 25 franchise units and approximately 40 licensed units. Our CapEx budget is $24 million to $26 million and will be used to support new company stores to remodel the managed I spoke about earlier as well as corporate initiatives.

Cost of goods inflation is projected approximately 1% to 2%. Preopening expenses remain at $65,000 to $75, 000 per new company-owned restaurants and interest expense is $4.5 million to $5 million.

Finally, our annual effective tax rate should be approximately 39% which excludes several work opportunity tax credits which have not yet been renewed for 2014 and we’ll continue to only pay the minimal cash taxes for the next several years.

And now, I’d like to turn the call back over to Michael.

Michael Arthur

Thanks, John. 2013 was a transition year which followed this strategic alternative process in 2012. The company worked on improving the business, implementing new sales and marketing strategies and with an operations team focused on plan to win. These initiatives combined with increased traffic and highly volume unit openings will serve us the foundation for our future growth.

In 2014, we will continue our momentum, continually improving our product line, sales and traffic growth and with the strong pipeline of company, franchise and licensed locations. EVM [ph] marketing strategies will continue to be strengthened to ensure a better awareness and traffic fall through. Importantly, we will continue to focus on elevating the guest experience.

The solid feedback we’re getting from our guest satisfaction and Mystery Shopper’s scores tells us that we are on the right path. We have the management in place that will accomplish these and group objectives and they are motivated to keep the momentum moving upward.

We have great franchise and licensed partners and our company development team is building more stores and the results show that they are opening width and maintaining high volumes. This positions us for better returns of our investment dollars and generates strong cash flow. These dollars will be used for further investments in organic growth, debt repayment and the return of capital to shareholders.

With that said, let’s ready to take questions. We are ready to take questions. Operator?

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically (Operator Instructions) And we’ll go to Alex Slagle form Jefferies.

Alexander Slagle – Jefferies LLC

Hey guys, thanks. Touching on the margins, just wondered if you could provide some more granularity on what surprised you in the rollout of the everyday value menu especially in the fourth quarter maybe if there are any reasons if you think for the disconnect between the test results and actual as in fact there if really were?

John Coletta

Yeah Alex at the end of the day I think we got the overall the value on our menu whether it’s the 399 and the 599, the other things we do. We think it’s working and at the end of the day in the margins for the quarter and for the year are really due to the fact that not only the everyday value but across the menu we didn’t take a price offset inflation. And so, getting down into the 17 range is primarily due to that, but the everyday value is working.

Michael W. Arthur

I just want to reiterate that again. So having no net pricing was really the pressure on the margin and then item number two is, we did have our best traffic performance in the fourth quarter since several years ago. So, we’re pretty contempt with the performance that we saw in the transaction side.

John Coletta

And now it’s really across the year, we ended the year much stronger than we started and progressively traffic got better and better and we’re seeing it as we come into to positive comps year-to-date here in 2014.

Alexander Slagle – Jefferies LLC

Okay, thanks for that clarity on that, and then on development maybe there is some more color around the fourth quarter opening assuming whether it was in line with what you are expecting are little lower and just any issues you ran into?

Michael W. Arthur

I think our fourth quarter development is on track with what we are expecting. end of the year with 61 opening was our record year in openings, I think actually looking forward to 2014 our pipeline is trying to look really stronger and effect the majority of our 2014 openings already in the leasing stage. So as we look here forward to the year we feel very bullish about our opening plan for 2014?

Operator

Thanks. And it appears are no further questions, however I would like to give everyone one final opportunity that is (Operator instructions). And it appears are no further question. So I will – actually I apologize, we have a follow-up from Alex Slagle from Jefferies.

Alexander Slagle – Jefferies LLC

Thanks. [Indiscernible], pricing assumptions head into the first quarter, I might have missed that but what are you thinking, you took some in January?

Michael W. Arthur

We did and generally, I know we are not giving guidance overall, in the comps that generally be thinking, we are taking price to offset inflation and in similar ranges most people. So whereas last year, we did not have net pricing, this year we will maintain net pricing in that couple percent plus range to offset inflation.

Alexander Slagle – Jefferies LLC

And manufacturing, I mean it seems like it sort of kicked back-up in the quarter and is there any reason that see sort of volatility going forward in the next couple of quarters or are there any drivers through upside, downside risk there?

Michael W. Arthur

I think it’s going to continue growing at a similar page if not better and our partners are expending the footprint internationally actually.

John Coletta

And from a margin perspective, we expect it to stay in that 25% range somewhere between 25% to 30%, like we’ve historically delivered there.

Alexander Slagle – Jefferies LLC

Okay, thanks for that.

Operator

And there are no further questions. I’ll turn the conference back over to our presenters for any additional and closing remarks.

Michael Arthur

Well, we’d like to thank everyone who have been on the call today and we truly appreciate your interest on Einstein Restaurant Group. Thank you very much.

Operator

This concludes today’s presentation. Thank you for your participation.

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