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Così, Inc. (NASDAQ:COSI)

Q1 2014 Results Earnings Conference Call

May 15, 2014 05:00 PM ET

Executives

Bill Koziel - Chief Financial Officer

R.J. Dourney - President and CEO

Analysts

Thomas Braziel - B.E. Capital Management

William Meyers - Miller Asset Management

James Kahn - Oppenheimer

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2014 Così Inc Earnings Conference Call. My name is [Wesley], 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 call is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Bill Koziel, Chief Financial Officer. Please proceed, sir.

Bill Koziel

Thank you very much, operator. Good afternoon everyone. I’d like to welcome you to Così’s 2014 first quarter results conference call. Joining me on the call today is R.J. Dourney, Così’s President and Chief Executive Officer.

Così’s earnings release was issued today at market close 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 the supplemental material at this time.

As we always do, we’ll address our regulatory housekeeping matters before we begin. During our introductory comments and in 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 first quarter, R.J. will then share his thoughts on the business and certain initiatives for 2014. And then we’ll open the call for your questions. So let’s start in.

Pages four and five of the supplemental information will guide you as I review our financial and operating performance for the first quarter.

We reported a net loss of $3.1 million or $0.17 per share in 2014 first quarter. This compared with the 2013 first quarter net loss of $2.7 million or $0.15 per share. There were no impairment charges reported in the current year quarter. However, in last year’s first quarter we recorded an exit impairment charge of $339,000 or $0.02 per share, this related to three underperforming locations.

Let’s now look at revenue performance, which was the main driver of our financial performance. Total revenues for the first quarter including franchise fees and royalties decreased 14.8% to $18.4 million compared with $21.6 million in the 2013 first quarter. Restaurant net sales for the quarter decreased by 15% to $17.7 million, this compared with $20.9 million in the 2013 first quarter. The decrease was driven primarily by a comparable store sales declined of 12.4% and a $653,000 sales decline from restaurants closed during and subsequent to the 2013 first quarter.

The contribution of franchise fees and royalties in the 2014 first quarter declined by $60,000 to $647,000 compared to $707,000 in the prior year quarter, this is due to a 5% decline in comparable net sales and the impact of locations closed subsequent to the 2013 first quarter. At the end of the quarter there were 121 Così Restaurants of which 49 were operated by franchisees and 72 were company-owned compared to 124 Così Restaurants at the end of the 2013 first quarter of which 50 were operated by franchisees and 74 were company-owned.

As announced our system-wide 13-week comparable restaurant sales in the first quarter decreased 9.5%, as measured for restaurants in operations for more than 15 months. Franchise comparable restaurant sales decreased by 5% in the first quarter as compared to the prior year period. Although we saw a comparable net sales increases at non-traditional franchise locations primarily locations at airport venues and at international franchise locations. These increases were offset by sales declines at traditional franchise locations.

Company-owned comparable sales decreased by 12.4% in the 2014 first quarter as compared to the prior year, due primarily to a 12.9% decrease in traffic, which is partially offset by a 0.5% increase in average check. The increase in average check was largely impacted by the increase in catering sales as a percentage of total sales in the 2014 quarter moving to 12% when compared to 10.6% in the prior year quarter. While the unseasonably harsh winter weather we experienced in most of our markets during the quarter, certainly adversely impacted our comparable sales performance, several other factors also influenced performance.

Beginning in January 2014, we reduced our hours of operation in a number of locations, which impacted our sales comparisons. Subsequent to the quarter, we have reassessed and expanded hours of operations back in certain locations where appropriate.

We have also experienced sharp sales declines in three locations in the Philadelphia market where we have tested various operational and menu initiatives.

Turning now to slide four. Cost of food and beverage as a percentage of sales was 24.9% for both the 2014 and 2013 first quarters. In the 2013 first quarter, the cost of food and beverage was adversely impacted by certain items was by the severe crop freeze that occurred in the Southwestern United States, caused by unseasonably cold weather.

Cost of food and beverage in the 2014 first quarter was impacted by a shift in sales mix as well as higher year-over-year cost for dairy products, primarily cheeses. Labor and related benefits expense as a percentage of restaurant net sales increased by 110 basis points to 40% as compared to 38.9% in the prior year period.

The increase was due primarily to the unfavorable impact on labor from the decrease in our comparable net restaurant sales. Benefits expense including payroll taxes as a percentage of net sales was comparable to the prior year at around 6%. Other operating expenses increased in the 2014 first quarter by a 130 basis points as compared to the prior year quarter, due in large part to higher cost for repairs and maintenance of existing company-owned restaurants as well as higher paper and packaging cost related to the growth in catering sales.

Occupancy cost increased in the 2014 first quarter by 390 basis points as compared to the prior year due primarily to the impact on the fixed portion of occupancy costs from the decrease in comparable net restaurant sales, as well as a year-over-year increase in utility cost.

Total restaurant cash flow for the 2014 first quarter was a loss of approximately $780,000 when compared to a cash flow of $400,000 in the 2013 first quarter. General and administrative expense decreased by almost $400,000 or 14% to $2.4 million in the 2014 first quarter, as compared to $2.8 million in the prior year quarter. The decrease was due primarily to labor and related benefit savings resulting from headcount reductions expected during 2013, a year-over-year reduction and corporate insurance costs and one-time charges during 2013 for prototype restaurant design costs. All this was partially offset by higher legal fees in the 2014 first quarter.

Cash, cash equivalents and short-term investments were approximately $2.8 million as of March 31, 2014. Subsequent to the end of the quarter and as previously announced, the company secured 5 million in additional liquidity to the issuance of a senior secured promissory note with the lender. Capital expenditures for the first quarter of 2014 were approximately $190,000 were primarily for the repair and maintenance of existing company restaurants.

Additionally as part of our headquarter relocation initiative, we have entered into an agreement to exit the Deerfield corporate office lease at the end of May. One-time termination fee of $500,000 we paid at the end of the month. A temporary space in downtown Chicago will be utilized as we transition to the permanent office in Boston. Subsequent to the end of the quarter, we closed two underperforming locations and three additional underperforming locations will be closed by the end of this month.

On slide five we are providing a reconciliation of the non-GAAP measures on slide four to reported quarterly results.

I would like to now turn the call over to R.J.

R.J. Dourney

Thank you, Bill. Good afternoon, everyone. We are very clear that losing $3.1 million for the quarter and running at a deficit of 12.4% in comp store sales is not acceptable. So looking forward, I would like to begin with the following. First is that you are going to watch a very talented team come together and take an aggressive position to move this forward. We are not going to sit back, take it slow and see if we can slowly move this forward. This team is very focused on taking an aggressive position to correct the past trends.

Second, there is absolute clarity of vision for the leadership team in moving this forward. We don’t wonder what’s going to work. We know and we are aggressively implementing our strategy.

The third is that I will share with you that I came into this confident in our ability to move this forward and to move Così to being profitable. And after 60 days, I will tell you I am more confident than the day that I arrived.

So what I would like to do is update everyone on seven key strategic initiatives that are in play. The first is one that Bill mentioned, which is the shuttering of underperforming units. On April 16 we mentioned that we had a number of locations that were unprofitable and that have to doing a deep dive analysis of the historic of these locations, we realized that these restaurants are not profitable.

We have engaged [HELCO] to assist us as our third-party both in removing extracting ourselves from these unprofitable units, as well as engineering cost out of many of our leases in our portfolio. So I am encouraged by the progress that HELCO is making so far.

The second is, I was very clear the last time we spoke that one of the reasons I am as confident as I am in Così is that we know that there is a compelling economic model embedded in the brand. I shared with everyone that Hearthstone; the franchise company that I own in Boston has been very successful for eight years with Così.

So there is a process in play of extracting that compelling economic model, taking the initiatives, taking the operating system and spreading that throughout all of Così. So what has been deployed so far to give you an example is a merchandizing focus where we have increased the number of items that we sell per location. We’ve increased the number of skews that we sell at the unit level. And we are seeing a sizable uptick in comp store sales where that initiative has been fully embraced, so again I am encouraged.

The third, I mentioned on April 16, the importance of us building a superior team to move this forward. And I am excited to tell you that we are attracting best-in-class leadership. And you publically are aware of this, but there is above that starting about Così and I am thrilled to be a part of that.

We are attracting discipline experts that are aggressive passionate leaders that share our culture. Let me give you a few examples.

Within the last 30 days, we brought on board Kate Shehan as Vice President of Human Resources. Kate was formally Vice President, Human Resources at Legal Sea Food and Morton Steakhouse. Kate is world class. [Brian Marks], Vice President of Operations, again just a spectacular example of an aggressive passionate leader. Jim (inaudible), our new VP of IT. Jim is arguably best in class in the information technology arena and is going to lead our initiative to make technology a competitive advantage for us and there will be more to come.

What is in play is an initiative of blending, both the best of Così with this new talent that we bring to board. But to wrap up this section, I will tell you that I'm extremely excited by the levels of talent that we're attracting.

Four, I’d like to talk about our brand focus. And there are three specific areas that we'll address in brand focus. The first is culinary. I mentioned the last time that we spoke that we will leverage the healthy halo that Così enjoys. We have done focus groups on products; we've now deployed a test on a new item. And I'm extremely encouraged by the list that we are seeing both in preference as well as in guest counts as a result of this new product offering. So, the results that we are seeing in Boston, if we can replicate them across this system, will give us the lift that I think we would be encouraged to see.

The second area of the brand focus is the brand position. There are two areas I like to talk about here. The first is there is no doubt that we need to instill confidence in our consumer base in our ability to execute. That is where we're leveraging two things here. The first is that operating system that I spoke about earlier from Hearthstone and the second is the superior team that we are building that Kate and Brian and working very hard to pull together.

Again, where we are getting traction, we're seeing positive momentum and I'm encouraged. The second area under brand position that I'll offer is that you will continue to see us focus on Così being seen as a brand that people want to do business way. So how we engage in our communities, how we position the brand will all be focused on being that type of company.

And the third is the area that I mentioned just a second ago under brand focus which is making technology a competitive advantage. This is what Jim [Lucks] does very, very well; he’s world class at it. You're going to see that happen over the next 12 months.

The fifth area that we'll talk about this afternoon is SG&A. I mentioned last time, we spoke the importance of us right-sizing G&A. Short-term, we have to invest to make this happen. Bill mentioned the relocation process and the status of the relocation of the support center from Deerfield to Boston. That is well underway. The short-term expense certainly will be offset by the long-term saving. By the fall, we will be able to tell you what our go forward run rate will be for SG&A. But I will tell you two things. One, I'm encourage by early indicators of where we're going to land and what we will be able to share with you and the second is a cultural imperative. We are creating a culture into support center where we need to run on the balls of our feet. This is not a day and time where we can have 10 people all doing the job of three but rather we need to have three people doing the job of five.

The sixth area we will talk about this afternoon is a refresh project that again is well underway. We have brought together a team of best and brightest interior design folks; we have hired King-Casey who is arguably one of the best menu strategy companies. We have a refresh project that we will launch within 30 days; we will have our first location up and running with this refresh in Manhattan. And this is a three pronged approach as we’ve spoken about.

The first is an image update. So this is the part that the guest wants to see. It’s a freshening of the image. The second is leveraging the operating system to help us drive throughput. It’s about speed. So it may not be the sexy part of what we do but it would be very focused on helping us drive comp store sales. And the third will be a combination of technology and menu deployment.

The seventh area and the final that we will talk about specific to strategies is regarding franchising. Starting with this, we are leveraging Hearthstone’s operating system and culture not just to the benefit of the company operators but as for our franchisees as well. For us that to be a world class franchisor or a franchisees need to make money. So that process is well underway.

Regarding new development and refranchising of locations, I am extremely encouraged by the caliber of prospects that we are meeting with both the internal prospects or existing franchisees that are interested in purchasing additional locations and developing as well as external. But there are two key steps that need to happen before we deploy the strategy. Now we are aggressively deploying these steps but they need to happen, but first is that we need to make sure that the franchisees we engage are the right franchisees. We need to replicate the Hearthstone model, franchisees that have the financial wherewithal, knowledge, the operating savvy to become world class franchisees within this organization.

The second is about us. We need to be setup for success so that when a franchisee deploys who may join this system that we know that we have an operating system that they can replicate and that they are going to make money.

So in wrapping up this portion of the call, as I began the call, you are going to see us be very aggressive as we move this forward, there is absolute clarity as to what we need to work on. And as I have said now a couple of times, I have enormous confident in our ability to execute this strategy. Bill?

Bill Koziel

Thank you R. J. Operator, we would like to open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Thomas Braziel with B.E. Capital Management. Please proceed.

Thomas Braziel - B.E. Capital Management

Hey, guys.

R.J. Dourney

Good afternoon.

Thomas Braziel - B.E. Capital Management

So, I just had one quick question, I had other ones but just curios this one, unfortunate quarter in terms of cash burned. So how do you guys see making it through next quarter with now $2.6 million or $2.8 million cash position and turn rate around $3 million even with operational improvement. I'm just wondering if you guys could comment on how you will see getting over that?

R.J. Dourney

Well first off, couple of things. We do have the infusion of additional liquidity which allows us, gives us some greater flexibility. But as we can tell you coming out of this difficult first quarter, we have taken steps to continue to reduce costs, you see the G&A went down, we'll continue to work that down in the second quarter. We are taking steps to drive traffic back into restaurants. I can tell you that we won't share what those numbers are specifically, but the performance in the second quarter has improved against the first quarter.

So, we are taking steps to drive top-line business. We are taking steps to drive improvement in margin performance, whether it'd be around labor or cost of goods sold. So, we think that based on our projections, we are going to, we'll see an improvement in the second quarter and we'll be fine as we move to the balance of year to be able to execute our plan with given the capital that we have.

Thomas Braziel - B.E. Capital Management

Okay. Thanks guys. That's it.

Operator

Your next question comes from the line of William Meyers with Miller Asset Management. Please proceed.

William Meyers - Miller Asset Management

Hi, I'm interested in -- you have been talking about some shift in the mix between corporate restaurants and towards franchise restaurants. And I'm wondering how you would see that impacting your cost and revenues for the overall corporation? Thanks.

Bill Koziel

So I think we can break it into a couple of areas. One is, as the model shifts from a company-owned portfolio to a predominantly franchiser portfolio, it gives you a huge opportunity to take significant cost out of G&A. So the amount of expense to be deployed to run a franchise unit or to oversee a franchise unit from the corporate perspective, it’s significantly less than what it takes to run company restaurants. So that's a huge opportunity.

Additionally, the reinvestment of capital into the restaurants, when you move to a franchisee model that ongoing capital investment disappears. I mean also, the other advantage you have with the franchising model is that the highs and lows of the sales performance given whether it would be whether, economic are buffered in a franchising model. You're drawing out 5% royalties of the system and the highs and lows don’t really impact you as much.

I think it allows you, it also allows us to grow faster, farther, because that diversity of a number of people building restaurants at the same time versus the capital consumption trying to build the number of company-owned restaurants. I think the company needs to have a basic corporate restaurants which to operate, but it can significantly improve its leverage by minimizing that base.

The other thing when you look at our portfolio today, we're very scattered throughout the United States. We don't have critical mass in any one market, but we have a number of markets in which we operate. So that again makes it very difficult for us to kind of manage that from an oversight level, at the G&A level. Hopefully that gives you some perspective on and I think what the benefits are moving to franchise model.

William Meyers - Miller Asset Management

Yes, actually. Thank you for that level of detail. I really appreciate that.

R.J. Dourney

Anytime.

Operator

Your next question comes from the line of James Kahn. Please Proceed.

James Kahn - Oppenheimer

Hi guys. Well in spite of the difficulties of the quarter, I am encouraged, I got to hear what I hope to hear, which a lot of specific steps with specific progress is. So that was one of the things I was concerned about. I have a number of different questions. One is, you said that you hired HELCO, I trust that’s -- you concluded that expense is better than doing it yourself, is there a savings there, net savings or not?

Let me just do a couple of more and then I will hop back in the line. You mentioned refresh in Manhattan, can you tell us which stores we can look at it in progress? And a third question for alluded is, in your last, in your 10-K it was mentioned that within 120 days of the end of the fiscal year you were going to as required file a proxy with notes of the annual meeting, but I have not seen any such proxy where and when is the annual meeting? Thanks.

R.J. Dourney

So Jim, thank you. I think Bill and I will probably tag team on responding to your three questions. First regarding the engagement of HELCO, absolutely it is working investment. Without divulging too much of our hand, I will tell you that HELCO is very aggressive and typically in these situations they are able to negotiate better terms than we would be able to negotiate ourselves.

The second regarding the refresh, I can’t divulge just yet which location it is, but we will follow-up with you within the next 60 days and let you know which location it is. And the third regarding the 10-K, the date of the annual meeting is June 24th. I believe that the announcement is going out, it was filed last night and it will be in Boston at 53 State Street in Boston on the 24th.

James Kahn - Oppenheimer

Thanks.

R.J. Dourney

Just to add on to that [HELCO] just so you have some perspective there, the [HELCO] fee structure as negotiated it’s a fee for saving. So, the better they do for us that’s how they earn their fee. So by driving our savings into a better position they’re able to earn a little bit more so it really is worth that kind of investment.

James Kahn - Oppenheimer

Okay. May I do one more? I realized it was the cash burn you might have to raise capital and I just want to say talked to a number of investors who agree that if you do so we don’t mind that you did it before once with Lloyd Miller, but we want the next one to be a rates offering so that everyone can participate. In my experience it’s a bad tone if one group is favored and gets a better price and the other shareholders, who’ve been loyal shareholders are locked up. There is a lot of people who believe in Così and who love to have it done by a rates offering.

R.J. Dourney

Thanks Jim.

James Kahn - Oppenheimer

Okay. You’re welcome.

Operator

There are no further questions in queue at this time.

R.J. Dourney

Thank you operator. Again we’d like to thank all of you for joining us on today’s call and we’re very excited and look forward to continuing to update on our progress in the coming months. Thank you again.

Operator

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

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