Einstein Noah Restaurant Group's CEO Discusses Q1 2014 Results - Earnings Call Transcript

May. 1.14 | About: Einstein Noah (BAGL)

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

Q1 2014 Results Earnings Conference Call

May 01, 2014, 5:00 PM ET

Executives

Michael Arthur - Interim President & Chief Executive Officer

John Coletta - Chief Financial Officer

Emanuel Hilario - Chief Operations Officer

Analysts

Mike Tamas - Oppenheimer

Operator

Good day, and welcome to the Einstein Noah Restaurant Group First Quarter 2014 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to John Coletta, Chief Financial Officer. Sir, 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 the 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 is Michael Arthur, Interim President and CEO. After some opening remarks from Michael, and an operations update from Manny Hilario, Chief Operations Officer, I will review our financials and discuss our guidelines for 2014.

And now, let me turn the call over to Michael.

Michael W. Arthur

Hello, everyone, and thank you for joining us this afternoon. Before walking through our results and initiatives, let me begin by saying that while our search for a new CEO is active, our talented and capable senior leadership team continues to operate effectively and efficiently in delivering the 2014 growth plan.

We are focused on several key items, including service excellence, menu upgrades, catering, remodels and the opening of 75 to 85 new company franchise and license locations. Our mission is to attract and retain customers while continually evolving the brand.

We have shown good results on revenue growth for the quarter while margins reflected one-time items, upfront investments and the timing of expenditures. Still, we believe we can maintain annual restaurant margins similar to fiscal 2013.

With respect to revenue, system-wide comparable store sales rose 1.6%, exceeding the industry benchmark. Not surprisingly, the first quarter was impacted by extreme winter weather and resulted in an unfavorable 1.3% impact to company comparable store sales and $0.02 to diluted EPS. Although we view comparable sales for the quarter favorably, we are still busy bending the trend back through continuous positive same-store sales growth.

Manny will get into greater product and operations detail, especially our plan to win. But I want to highlight the successful radio and promotion campaign on our signature Bagel and Nova Lox Sandwich. Salmon makes up more than 5% of our sales and contributes to a higher checkout. Additionally, a program is underway to upgrade and place more emphasis on the lunch day-part.

We are revisiting on our lunchtime sandwich and bread offerings and reintroducing an improved Bagel Dog, which is a quarter-pound Hebrew National all-beef hotdog encased with a daily fresh baked bagel bun.

Another area to highlight is our investment in our remodeling our restaurants. We are going to expand a program that we tested last year in 12 Orlando area locations. With an average cost to remodel of $115,000, we experienced a profitable sales lift.

We think we can replicate this success in other markets and are now planning our next 20 store remodel phase with as many as 75 total remodel projects by the end of 2014, that’s this year. About two-thirds of the remodels will be concentrated in three cities with the balance in flagship locations and their respective markets.

These additional investments in our company store portfolio will accelerate the transformation of our asset base and enhance our brand image and provide a strong ROI. As for new locations, on top of a record year of unit growth in 2013, we project 75 to 85 openings this year. 25 -- 28 franchise development agreements are in place for 199 total restaurants, 49 of which have already opened. We expect the remaining 150 new restaurants will open on various dates through 2021.

You may recall that our 2013 store openings were the best yet with volumes of approximately $1 million per store, more than 10% higher than the system average. This is the result of a more comprehensive new store strategy and better start-up operations. These same real-estate criteria were utilized in determining both company and franchise plans for this year, and should lead to continued outperformance at newer stores.

With respect to licensed stores, our 2014 growth plans include five more high-volume airport locations where revenues are approximately four times greater than our average license locations.

Manny will now explain operations in more detail.

Emanuel Hilario

Thank you, Michael. As we discussed on previous calls, we are making investments in our team, our facilities and in our brand to build momentum in driving transaction and sales growth. Our plan to win strategy is geared towards elevating the in-store experience, making sure that we uphold our most important brand attributes of bakery, cafe, quality and QSR convenience.

One of the projects completed in the first quarter was recertifying all of our bakers to ensure that each store prepares our products in a manner that reflects a strict standard for presentation and freshness. Our plan to win also entails ensuring that our crew provides better customer service, effectively manage the speed of service and maintain store cleanliness.

And these incremental people investments are paying off as evidenced by the steady increase in our service satisfaction scores. These improvements are the prerequisites for driving repeat transactions because more satisfied customers become more frequent customers. In fact, we have improved our guest satisfaction scores by more than four points since this initiative began last year.

Building a stronger team while creating events for stores ahead of their openings has resulted in lower turnover and also provides a clear roadmap for individuals eager to move up within the company. 80% of our promotions to multi-unit manager positions now come from within the organization, and this ensures continuity while also providing considerable savings on recruiting expenses.

Elevating the experience also means investing in higher-quality products, positioning our brand as a leading choice for breakfast, quality and value. First quarter product introductions included two premium bagel egg sandwiches, the Applewood Bacon and Cheddar Sandwich and The Santa Fe Turkey-Sausage Egg Sandwich and a new premium Smoke Salmon Sandwich. These products reflect our ongoing strategy to innovate with premium ingredients that provide our customers attractive alternatives to fast food for both breakfast and lunch.

While our operating teams and facilities are show-time ready, we are beginning to spend on media and the results are favorable. As more locations improve their operating-level guest satisfaction, they will earn their right for added media and marketing investments.

We’re also pursuing various targeted digital marketing strategies to promote our products and are excited about the potential impact these items can have on overall awareness and traffic trends such as affordable digital menu boards and a mobile commerce app under current consideration for testing.

And now, I’ll turn the call back over to John to discuss our financial performance and updated thoughts on 2014.

John Coletta

Thanks, Manny. Before we delve into the numbers themselves, I would like to first make you aware that beginning with the first quarter of 2014, we reclassified certain manufacturing revenues and cost of goods in order to present a more useful depiction of cost and sales as they occur on our wholesale business with third parties.

Historically, we have recorded bagel costs for bagels manufactured at our Whittier plant and transferred to our company stores at a standard cost determined by the price charged to us by our largest third-party supplier. To the degree that our actual costs at Whittier were less than that standard cost, we recorded a benefit in the manufacturing line.

Starting in the first quarter 2014, we have begun recording these amounts in the cost of good line of our company-owned restaurant at actual costs instead of standard costs and we’ll continue to reclassify historical values on the same basis. Additionally, we adjusted our manufacturing revenues to reflect additional historical sales to our franchisees.

To help understand this presentation’s impact on previously reported quarterly amounts, we have provided the fiscal 2013 quarters on a reclassified basis within the details of our Form 10-Q filing.

Turning to our financial results, total revenues increased $3.5 million or 3.3% to $109.9 million from $106.4 million. System-wide comparable restaurant sales increased 1.6%. Company-owned comparable restaurant sales increased 1.7%, our best quarterly result since the first quarter of 2008, which consisted of a 5.3% increase in average check that was offset by a 3.6% decrease in transactions. Company-owned restaurant revenues increased 2.5% to $96.6 million, compared to the year-ago period.

Average check was favorably impacted by moderate pricing increase in recent months aimed at offsetting store-level commodity inflation. Our check was also favorably impacted by increased mix in both catering, specialty beverages, and the promotion of the Nova Lox and our new Smoke Salmon. Lox, which is a higher priced item with significant mix, was temporarily removed from the menu a year ago due to the proactive management of supply concerns.

In return, back by promotion was favorable to mix and thus check for the first quarter. Catering, in particular, benefited from an effective sales force promoting our breakfast and lunch catering capabilities in conjunction with an enhanced call center. Total catering was up 21.3% over the prior year.

With regards to traffic, we estimate that the extreme weather-related impact reduced company same-store sales by 1.3% or $0.02 per diluted share. Franchise and license revenues increased 28.8% to $3.8 million, reflecting higher unit counts for both franchise and license stores and positive comparable sales during the quarter. A total of 12 franchised and licensed stores opened during the period compared to 10 openings a year ago, creating greater franchise fee revenue recognition and royalties over the prior year.

Turning to costs, our prime costs, which consist of cost of goods sold and labor, decreased 50 basis points for a combined total of 57.4% of restaurant sales, compared to 57.9% in the prior year. The inflationary impact of cost of goods was essentially offset by pricing and we leveraged and managed labor costs well during the quarter as it fell 50 basis points to 29.9% of restaurant sales.

Rent and related expenses increased 30 basis points to 11.7% from 11.4%. This was primarily due to the addition of higher-cost, higher-quality locations and our newer store openings and related accounting. Other operating costs increased 80 basis points to 11.7% from 10.9% due to increased utility rates during weather extremities as well as our baker certification costs and the timing of insurance claim expenses.

Our investment and marketing initiatives increased $0.8 million from the same period in 2013 or 70 basis points as a percentage of restaurant sales, mainly due to expanded use of radio advertising and the timing of our marketing spend in the first quarter whereby we expect the total spend to be closer to 3% of sales for the year.

Overall gross margin in our company stores fell 130 basis points to 15.9% for the reasons just described. While timing and one-time events impacted the first quarter margins, we generally expect to maintain company store margins near the rate realized in the prior fiscal year for the full fiscal year.

Manufacturing revenues from our Whittier facility increased 3.2% to $9.5 million primarily due to additional orders from wholesale customers such as Costco as they expand their footprint with us. Gross margin, as a percentage of manufacturing revenues, increased 110 basis points to 19.8% from 18.7% on account of various cost saving initiatives. The prior year fiscal quarter realized unusual revenues estimated near $300,000 as our Whittier plant temporarily supplied our East Coast stores while our third-party supplier reorganized its operations.

General and administrative expenses increased to $10.8 million in the first quarter of 2014 from $10.2 million last year, increasing from 9.6% of sales to 9.8%. Higher G&A generally reflects inflationary costs and additional staffing over prior year to support our plan.

Pre-opening expenses were $156,000 compared to $287,000 in the prior-year period and were related to the one company opening in the first quarter as well as expenses for several openings planned for the second quarter.

Income from operations decreased 16% to $4.5 million from $5.4 million while adjusted EBITDA was $10.1 million in the first quarter of 2014 compared to $10.4 million in the first quarter of 2013. 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 April 1, 2014 was $108.8 million, compared to $130.8 million at the end of the first quarter last year. Using excess free cash flow, we returned capital to shareholders via a $2.3 million dividend during the quarter. We have lowered our indebtedness by $22 million since the end of the first quarter last year.

Interest expense decreased by $0.6 million to $1.1 million in the first quarter of 2014 from $1.7 million in the first quarter of 2013. We used an effective tax rate of 39.2% in the first quarter of 2014, compared to an effective rate of 34.8% in the year-ago period. I remind you in the first quarter of 2013 we recognized the retroactive benefit of federal employment tax credits related to the 2012 period, because President Obama signed them into law in early January of 2013.

Although federal employment tax credits have decreased our effective tax rate annually by an average of 1.8% over the past three years, the recognition of these federal employment tax credits for 2014 new hires cannot be predicted and cannot be included in our estimated annual effective tax rate until enacted into law.

Net income in the first quarter of 2014 was $2.1 million or $0.11 per diluted share, compared to net income in the first quarter of 2013 of $2.4 million or $0.14 per diluted share. Net income for the first quarter 2014 included pre-tax senior management transition costs of $1.1 million or $0.04 per diluted share after tax. In addition, we estimate that the adverse weather conditions hurt our diluted earnings per share by approximately $0.02 after tax.

In terms of our system count, we ended the quarter with 862 restaurants across 42 states in the District of Columbia. During the quarter, we opened 13 restaurants across the system and this consisted of one company-owned restaurant, three franchise restaurants and nine licensed restaurants.

Turning to our 2014 guidelines, we are making changes to our CapEx range, but leaving everything else the same. Specifically, 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. However, our CapEx budget is now $30 million to $35 million, compared to $24 million to $26 million previously and will be used to support new company stores, the additional remodels that Michael spoke about earlier, as well as corporate initiatives.

As Michael indicated earlier, despite margin pressure in the first quarter, full-year store-level margins should be on par with 2013. Pre-opening expenses remain at $65,000 to $75,000 for new company-owned restaurant and interest expense is $4.5 million to $5 million. Finally, our annual effective tax rate should be approximately 39%, which excludes federal work opportunity tax credits which have not been renewed yet for 2014, but we will continue to only pay 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. We have a well-defined plan to win focused on elevating the guest experience and raising the caliber of our teams. We’re confident this will serve as the foundation of our future growth. The operational initiatives and media outreach effort are in place and the tangible benefits of our business should become more apparent as we move through 2014. Expanding our system unit count and raising our brand image are also taking center stages here.

We have a strong pipeline of company, franchise and licensed locations as part of our accelerated development plans. These are high-quality sites that should open and maintain strong sales volumes. And while making investments in the business, we will continue to deploy capital for further debt repayment and the return of capital to shareholders through dividends. More importantly, our management team is battle-ready and eager to accomplish what we have set out to do.

With that said, we are ready to take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Brian Bittner with Oppenheimer.

Mike Tamas - Oppenheimer

This is Mike Tamas on for Brian. Just a couple of questions. First, on the remodels, can you talk about any sales that you are seeing from that program? And then, is there any associated margin gains that you are seeing from that as well outside of just increased sales leverage? And then I have a follow-up. Thank you.

Emanuel Hilario

Yes, this is Manny. I’ll start off and then John will add some more color to it. So, we’re early on the remodels and here is a couple of things we do know is the breakeven on those remodels is modest looking at about 2 points in sales. So, as soon as that we achieve those, we’ll breakeven and we should be able to achieve some margin improvements if we establish our internal projections on it. So, I would say overall it should be good for the margin. John, do you have anything else to add to it?

John Coletta

Yes. I would just add generally that is, the breakeven is pretty low. We think we’ll be better but the flow through is generally 45%, 50% on a marginal sales, so it will benefit in the margin line.

Mike Tamas - Oppenheimer

Just two quick questions. On the re-class of the restaurant margins, you’re guiding a flattish year-over-year, so can you share what the re-class was from 2013, so we know how to think about that accurately?

John Coletta

Overall, approximately the change from the manufacturing line went from the mid-to-upper 28 margin to the upper 18 margin. And approximately the company-owned restaurants benefited some 70, 80 basis points. I don’t have the exact number, and it’s in the 10-Q, but it’s approximately 70, 80 basis points. I’d refer you to the 10-Q to get the exact numbers.

Operator

(Operator Instructions)

Michael Arthur

If there are no more questions, thank you all.

Operator

This concludes today’s conference and thank you for your participation.

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