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Cosi Inc. (NASDAQ:COSI)

F4Q13 Earnings Conference Call

April 16, 2014 10:00 AM ET

Executives

William Koziel – CFO, Treasurer and Secretary

R.J. Dourney – CEO and President

Analysts

Alec Jaslow – Midtown Partners

Clayton Reed – Private Investor

James Kahn – Oppenheimer

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2013 Così Inc Earnings Conference Call. My name is Tahisa, and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. William Koziel, CFO; and R.J. Dourney, CEO and President. Please proceed.

William Koziel

Thank you, operator. Good morning everyone. I’d like to welcome you to Così’s 2013 fourth quarter and full-year results conference call. Joining me on the call this morning is R.J. Dourney, Così’s President and Chief Executive Officer.

Così’s earnings release was issued this morning and is available in the Investor Information section of our website at www.getcosi.com. During the call, we will be referencing supplemental materials, which are also available in the Investor Information section of our website. If you’ve not already done so, please access those materials at this time.

As we always do, we’ll address our regulatory housekeeping matters before we begin. During our introductory comments and in our responses to your questions, certain items may be discussed which are not based on historical facts. Any such items, including expected results, and any details related to expected performance should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements involve risks and uncertainties that could cause our future performance and financial results to differ materially, and therefore, you should not place undue reliance on these forward-looking statements.

We refer all of you to our filings with the Securities and Exchange Commission for a more detailed discussion of the risks and uncertainties that may have a direct bearing on our operating results, our performance, and our financial conditions.

For the call today, I’ll begin with a brief review of results for the fourth quarter and full-year. Then R.J. will share his thoughts on the brand, the business and some initiatives. And then we’ll open the call for your questions. So let’s start.

Pages 4 through 7 of the supplemental information will guide you as I review our financial and operating performance for the fourth quarter and full-year.

For the fourth quarter, we reported a net loss of approximately $4.1 million or $0.23 per share. This, as compared with the 2012 fourth quarter net loss of approximately $2 million or $0.11 per share. Fourth quarter charges for asset impairments and store closings were approximately $480,000 and $440,000 in the 2013 and 2012 years respectively.

For the full-year 2013, we recorded a net loss of approximately $11.5 million or $0.64 per share. This compared with the net loss of approximately $4.5 million or $0.29 per share in 2012. The charge reported for asset impairments, closed store costs and lease termination expense were approximately $1.3 million and $530,000 for the 2013 and 2012 full years respectively.

Let’s now look at revenue performance, which was the main driver of our financial performance. As announced, our system-wide 13-week comparable restaurant sales in the fourth quarter decreased 4.6%, as measured for restaurants in operation for more than 15 months.

Franchise comparable restaurant sales decreased by 2.9% in the fourth quarter as compared to the prior year, due largely to a decline in sales locations in the United Arab Emirates, as well as from other non-airport locations in the U.S.

Company-owned comparable sales decreased by 5.7% in the 2013 quarter as compared to the prior year, due primarily to a 6.7% decrease in traffic, partially offset by 1% increase in average check. The increase in average check was largely impacted by the growth in catering sales for the quarter, with catering sales at 11.9% of total sales in 2013 compared to 9.5% in the prior year quarter.

Also impacting our revenue performance for the quarter was $1.5 million sales decline from company-owned restaurants that closed during and subsequent to the fourth quarter of 2012.

For the full-year, system-wide comparable restaurant sales decreased 3.9% in 2013 when compared to the prior year. 2013 franchise comparable restaurant sales decreased by 1.8% as compared to the prior year, due in large part to sales declines at units located in the United Arab Emirates.

Company-owned comparable sales decreased by 5.1% in 2013 when compared to the prior year due to a 6.5% decrease in traffic, partially offset by a 1.4% increase in average check. The increase in average check was again largely the result of year-over-year growth in catering sales as a percentage of total sales. This being at 10.9% of total sales in 2013 versus 9% in 2012.

Full-year revenues were also impacted by $6.9 million sales decline from nine company-owned units that closed during and subsequent to 2012.

At the end of the year, there were 122 Così restaurants, of which 52 were operated by franchisees and 70 were company-owned. This compared to 125 Così restaurants at the end of 2012, of which 50 were operated by franchisees and 75 were company-owned.

Now turning to Slides 4 and 6. The cost of food and beverage for the fourth quarter and full-year 2013, increased over the prior year by 130 and 150 basis points respectively, due primarily with shift in daypart sales and menu mix towards products with higher food cost and a percentage of sales as a percentage of sales as well as the impact of higher costs for certain seasonal limited time product offerings as compared to those items that we promoted during fiscal 2012.

Also driving the increase in cost of food and beverage was the introduction of a new product line of bowls in 2013, which as a category has a higher cost of goods as a percentage of net sales than our other entrée categories.

Beverage sales, primarily fountain drinks and coffee, which historically have a lower average costs than non-beverage product offerings declined during the 2013 fiscal year. We also experienced higher costs on certain commodities during the year.

Labor and related benefits expense as a percentage of restaurant net sales, increased by 360 basis points to 41.1% as compared to 37.5% in the prior year period. For the 2013 full-year, labor and related benefits expense as a percentage of restaurant net sales increased by 270 basis points to 38.8% when compared to 36.1% in the prior year.

The increase was due primarily to the unfavorable impact on labor from the decrease in comparable net sales primarily the impact on the fixed portion of the manager labor as well as to the deployment of additional hourly labor primarily in the latter half of the year as part of an initiative to improve guest experience and speed of service. Also the cost of healthcare-related benefits was higher during fiscal 2013 when compared to the prior year.

Other restaurant operating expenses increased in the 2013 fourth quarter and full-year by 260 and 160 basis points respectively when compared to the prior year. This due in large part to higher costs, repairs and maintenance of existing company-owned restaurants, as well as higher paper and packaging costs primarily related to the growth in catering sales.

Occupancy costs increased in the 2013 fourth quarter and full-year by 200 and 120 basis points respectively, as compared to the prior year, due primarily to the impact on the fixed portion of occupancy costs from the decrease in comparable and net restaurant sales, as well as higher utility costs in the fourth quarter.

Total restaurant cash flow for the 2013 fourth quarter was a loss of $600,000 compared to cash flow of $1.4 million in the 2012 fourth quarter. For the full-year, cash flow was approximately $1.3 million, compared to $8.1 million in the prior year. General and administrative expense was $3.3 million in the 2013 fourth quarter, as compared to $2.9 million in the prior year, with the increase largely due to a charge of $450,000 that was recorded in the quarter as a reserve against a franchisee note receivable, as well as higher marketing expenditures when compared to the prior year.

The 2013 full-year G&A expense was $11.7 million, as compared to $11.6 million for the 2012 year. The increase was due in large part to a charge of approximately $600,000 for severance pay resulting from administrative workforce reductions during the year, as well as the $450,000 charge to reserve against the note receivable from a franchisee. These partially offset by labor savings from the workforce reductions that were affected during the year, lower expenses for third-party professional fees and the cost of certain executive relocation expense that was recorded during the fiscal 2012.

Cash, cash equivalents and short-term investments were approximately $6 million as of December 30, 2013.

On Slides 5 and 7, we have provided a reconciliation of the Non-GAAP measures from Slides 4 and 6 to our reported quarterly and full-year results respectively.

Finally, as reported this past Monday, the company secured $5 million of additional liquidity through the issuance of a senior secured promissory note with the lender. We look to use these additional funds to support various initiatives to move the company forward.

I’ll now turn the call over to our President and CEO, R.J. Dourney. R.J.?

R.J. Dourney

Good morning everyone. At the end of the day, this is a great concept. So Così is well positioned in the category, in fast casual and it’s a tremendous concept. Let’s put this out there right away. Over the past 12 years, we’ve lost over $200 million. And if I were sitting in your shoes, I’d want to know what’s going to happen in the coming year to change that course.

At 50,000 feet, I offer the following. The first is that we will take a very disciplined approach as to how we move the company forward. The second is that we will have absolute clarity as to where we’re taking the concepts and where we’re taking the company. So let’s get into some specifics. Let’s talk this morning about two specific strategies. The first is a short-term strategy; how do we move the company to profitability. And the second is a long-term strategy, which is how do we maximize the potential of the concept as well as the company. Let’s get into the short-term strategy.

The first is that piece I mentioned just a minute ago, which is to establish a clear vision and strategy for both the concept and the company. I would tell you that after spending the past three weeks, internally involved with the entire team here, respectfully I think we were working on too many initiatives. At the same time, while by department they did not have clarity as to what we should be working on, those initiatives did not tie in together. So we had set priorities by department to ensure that we are both moving the company forward, as well as delivering the appropriate results.

Let me give you an example. And I’m going to try not to get too granular, specific to our culinary focus. You will see the evolution of Così in two areas. The first is we will feed the consumers demand for healthier options. Così has a healthy halo. We’re going to leverage that healthy halo. The second is we are going to move Così forward in the direction where the guests sees us, which is that the brand has a culinary creative edge.

Finally, I would offer that we will not play defensive role, rather we’re going to play offensive role. Time this all together. Every decision we make specific to the culinary offer and the brand will be strategic in nature. We won’t be reactive. We will have clear vision.

There is a compelling economic model within Così, which brings us to the second initiative. Within the Hearthstone organization, which is the franchisee in New England as well as other franchisees in a number of company operations, we have a compelling economic model that we can replicate. So leveraging what Hearthstone does right, what Cap C does right and then deploying that throughout the entire system is going to move us towards profitability.

The third area is one you probably heard about in the past which is we will shutter underperforming units. I’m going to be really specific about this, because we did a very deep dive to ensure that when we talk about what units that we’ll shutter, these are the units where we know that it is not worth our time and energy to deploy against these locations. Bill and I are engaging a third-party to help us with this strategy.

Next, we will correct the G&A. And I think if you look at our current run rate which, Bill, correct me if I’m wrong, is just north of $9 million. I think many of us would suggest that we still have opportunity there. So, here are some primarily initiatives that are going to help us correct G&A.

First is the location of the office here in Deerfield is not strategic in nature. It’s over 20,000 square foot office. It does not help us move the company forward in its location. So we’re changing that. We have bought out of the lease here and we are relocating Così’s office to Boston. And we’re doing this for two primary reasons. The first is, it’s critical that the office be embedded in our most successful market. Boston reveres Così. We have a tremendous reputation as a company and a brand in Boston, and we’re going to leverage that.

The second is it will be easier for us to move the company forward and recruit into Boston than it has been here in Deerfield. There are other initiatives that we have in play for correcting G&A.

Next, if we take a minute and we talk about what better companies have in their DNA. Great teams are at the core of every organization. I’ve been blessed to work with a few over the past 25 years. And the common ground is always when you have great people, we’re attracted to work for a great company.

There are a number of outstanding people within this company right now. But at the same time, we need to continue to build on that. We need to attract world class people to be part of this team. We need to create a culture where great people want to do amazing things. I think we have the opportunity to do that.

Now let’s switch gears and let’s talk about the long-term strategy. There is a brand essence in Così that is unique to better brands. Now you hear this when you talk to our guests, and very often you hear it when you talk to investors. You’ll hear people say there is something about Così. When you walk in the door of Così and there is a baker in front of the oven, and they’re rolling out the bread and you grab a piece of hot fresh bread and pull apart and steam rises out, there is essence to the brand that’s very compelling. We’re going to leverage that position.

We have the opportunity to replicate this compelling economic model and move us towards a franchise model. Once the brand is heading in the right direction, once the restaurants are heading in the right direction, we are going to deploy a franchise model, where we’re going to duplicate what we’ve seen successfully happen both in casual dining as well as fast casual, where you partner with the right franchise group in a territory where they have the operating wherewithal, the financial wherewithal and the market knowledge. We will launch this strategy over this upcoming year.

Selling company store strategically will be part of this strategy. I have to tell you that I am very excited that we have a number of our current franchisees that are interested in participating in this event. Our focus on franchising will begin with our current base of operation and then push out. We will focus on the lower 48 as well as Central America. I am very excited to tell you that our group – our franchise partners in Costa Rica are doing very well and want to continue to grow with us.

So before we turn this over to your questions, I’ll offer this. The stock price, market cap is largely a factor of confidence. When all of us have confidence in management’s ability and the company’s potential, the stock price goes up. The confidence is earned. I’ve shared with you how we’re going to navigate Così to profitability. Now it’s time that I get things done. Thank you. Bill?

William Koziel

Thank you. That concludes our presentation. Operator, we’ll open the line to calls.

Question-and-Answer Session

Operator

(Operator Instructions) All right. And your first question will come from the line of Alec Jaslow from Midtown Partners. Please proceed.

Alec Jaslow – Midtown Partners

Good morning guys.

R.J. Dourney

Good morning, Alec.

Alec Jaslow – Midtown Partners

I was just wondering, do you have a sense, maybe you could tell us how many company-owned stores you expect to have by end of the year, or when the transaction – yes, this was the right number you think for Così?

William Koziel

I think it’s difficult for us to tell you the right number by the end of the year. I think to R.J.’s point, you will see us start to move to a more predominantly franchise-driven concept. So to the extent we find the right partner and the right – to operate in the right market, and it makes sense for us and our partner to make that transaction work, we would then transition potentially certain company restaurants over to a franchisee, like we did in Cap C in D.C. So, as well as entertain new franchise partners.

So I think franchise goals is primary for us. But I think it’s very difficult for us to sit here today and give you a number for the end of the year.

Alec Jaslow – Midtown Partners

Okay. And then I was just wondering if you could talk a little bit more about what drove the success in catering, and maybe the difference between margins in catering versus just sales at the regular store?

R.J. Dourney

So great question. I think a large part is success on the catering model has been driven by two things. One; the quality of execution from the call center to the store level. I think it’s one of the areas as a portfolio where we perform at a high level. The second is, I think it speaks to the compelling offer that we have.

Così really resonates with a business consumer where you have a group coming in. It’s the right offer at the right time.

William Koziel

Okay, as far as the – I’m sorry, as far as the margins are concerned. The average check per guest runs a little bit higher. So your commodity costs and your food costs are the same, your average check is higher.

Alec Jaslow – Midtown Partners

Okay. And I guess the other question – it seems like the cost of goods went up a bit. Do you plan on raising prices, or could you test that out, I guess maybe you can talk a little bit about that, to combat that raising cost of goods sold?

William Koziel

Sure. We always assess the opportunity to raise price where we can. We want to make sure that we study it. We look at it individually by certain markets. So is it possible for us to take price this year, absolutely we’re looking at that. Secondly, some of the incremental cost is a function of consumer preference, mix shift. The erosion of certain beverages, coffee and fountain drinks are extremely margin favorable. So when those decline, it has an impact on the cost of goods sold.

I think we talk about that cost of goods sold percent. We want to focus on gross margin dollars. How many gross margin dollars are we able to drive into the business, and drive to the bottom line? I am okay with selling something that has a higher percent to sales if it means adding to the overall revenue line, and growing the overall gross margin dollar line.

Alec Jaslow – Midtown Partners

Okay, thanks guys. That’s helpful. Appreciate it.

Operator

Your next question will come from the line of Clayton Reed, Private Investor. Please proceed.

Clayton Reed – Private Investor

Good morning. Thanks for taking my call.

R.J. Dourney

Good morning.

Clayton Reed – Private Investor

Just wondering, could you provide some color on the real estate strategy for the franchise model. I’m thinking, what would be the approximate breakdown between in line, end cap and non-traditional units?

R.J. Dourney

So I might answer that question slightly little differently. Così has the ability to develop in four trade channels. And those trade channels are urban, suburban, university and transportation. Each of those, Clayton, has respective drivers, demographic and psychographic drivers.

One of the things that we’ve done at Hearthstone over the last eight years is really understand, what are those requisite drivers, from density of population to co-tenancy to daytime population, things like that. So I think we have within the portfolio now a very clear understanding of what that looks like.

As far as the breakdown goes, it really depends on the geography. If I were the franchisee developing Northern New Jersey, I might develop my portfolio differently than I would be if I were developing Così in say Northern Virginia.

Clayton Reed – Private Investor

Great, okay. Thank you. That’s helpful. Could you also speak to the IT strategy, specifically loyalty program and perhaps even online ordering which would complement the catering initiatives very nicely?

R.J. Dourney

Yes, great question. We’ve just made an offer to a fellow to take over our IT development. And this fellow is best-in-class. He is cutting-edge and will help us leverage the fact that our consumer, Clayton, is tech savvy, right. So, if you look where our restaurants are located, and look at who our consumer is. These are people that are used to using apps and want a brand that connects with that.

So you’re going to see us address our technology needs in two areas very quickly. But first is we have a platform issue that we’re in the process of addressing, as our POS system is out-of-date. And the good news is that the industry is moving towards a hardware agnostic cloud-based opportunity that we’ll deploy here in the next 90 days.

The second though is the initiatives that you’re talking about, which is moving the company forward so that technology is a resource, is a competitive advantage. You’ll see that happen. It will be in test within 90 days and you’ll see us move pretty quickly on it.

Clayton Reed – Private Investor

Great. That’s fantastic to hear. Is it too early to start thinking about licensing opportunities as in the CPG channel? I am thinking soups, frozen pizza, salad dressing and coffee. Maybe I am going to hand [ph] myself. I’m just trying to think about incremental profit opportunities?

R.J. Dourney

Yes, I’ll tell you it’s not even on our radar right now.

Clayton Reed – Private Investor

Thanks. I had a couple of more modeling questions, but I’ll hop back in line.

R.J. Dourney

All right. Thank you.

Operator

(Operator Instructions) Your next question will come from James Kahn from Oppenheimer. Please proceed.

James Kahn – Oppenheimer

Hi. Well, I like what I heard so far from R.J. Dourney, but of course it’s an open question as to whether Così can even survive. So, and if it does – I mean I think that if you implement everything that you do, the results could be great, but so my first question is what assurance can you give us that this can be done without diluting existing shareholders? That is, if the one thing as the company turns around and then – but at the cost of existing shareholders and somebody else profits from it. I also, by the way, couple of quick follow-up questions. I like the fact that you’re moving to Boston from Deerfield, but is it being done cheaply? How much of a charge-off is this going to require? And a comment I’ve been trying to make for years. I kept trying to get through to Carin Stutz and never did is that, I am wondering if there is an opportunity in pre-selling cards. I go to Così all the time. I work next door, one of your most profitable ones, but in 200, Park Avenue in New York City, there is a restaurant called Cucina. And every two weeks, I give them $100 on a credit card. And they immediately credit me with a $110. So always prepaying for meals. I haven’t even eaten yet and won’t for months. And I don’t understand why more restaurants don’t do this. And finally, can you take a page out of Starbucks and just imitate them as much as possible? That’s a lot of questions, but…

R.J. Dourney

Yes, well some really good points. So to state the obvious, I’m not going to go near the first question. Can I ensure that we won’t dilute the current shareholders. Our objective clearly is to get Così on a cash flow positive trajectory, right. That’s mission critical. I’ll do everything in my power to make that happen. This team is going to work very hard on the right initiatives.

I think what I’ll focus on is we know that we’re in the right category in the right time. We’re not in family dining. We’re not in casual dining. We’re in fast casual, and we’re a brand that has a tremendous cachet. When we do it right, when we choose the right real estate, when we execute at a high level, these are very, very profitable little boxes. I know because I’ve owned a number of them for the past eight years. So that – a disciplined approach, a strong team working in the right direction leveraging our strengths. That needs to be our focus.

To your point about the cost of moving the office. Yes, the good news is we were able to buy out of a very expensive lease. The simple activity of going from, Bill, 23,000 square feet down to 7,000 or...

William Koziel

Roughly a third of the size.

R.J. Dourney

Third of the size. We were able to take advantage of the situation in Boston where the area that we’re going to which happens to be in a financial district. There is a lot of inventory of office. We’re leveraging that. So there will be a cost to the P&L of the relocation clearly, but that’s the right long-term strategy both in a G&A expense consideration, as well as moving the company forward.

Your point about what internally we refer to as stored value cards, like the one you use at Cucina. I think that’s brilliant. It’s absolutely brilliant. Everything that we can do to continually reinforce that bond between you and Così is critical. Marc Lapides, who was our Director of Marketing, is all over stored value, taking our loyalty program to the next level. So more to come, but I couldn’t agree more to what you said.

I am not sure if I understand your point about Starbucks, but I’ll offer this. I think that there is a lot that Starbucks does right. They have created a cult following for their lattes Asian coffee, good for them. You know what? I think that there are certainly lessons to be learned on their disciplined approach, their understanding of who they are, how the consumer sees them. There is a lot to learn there.

James Kahn – Oppenheimer

Thank you.

William Koziel

Thank you.

Operator

Ladies and gentlemen, that concludes the Q&A session. You have no more questions in queue. I would now like to turn the conference back over to Mr. William Koziel for any closing remarks.

William Koziel

Thank you operator. Again we want to thank all of you for joining us on today’s call. And we look forward to updating you in the future. Thank you again.

Operator

Ladies and gentlemen that will conclude today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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