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Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB)

Q2 2014 Earnings Conference Call

August 14, 2014 10:00 AM ET

Executives

Steve Carley – Chief Executive Officer

Stuart B. Brown – Senior Vice President and Chief Financial Officer

Denny Marie Post – Senior Vice President and Chief Marketing Officer

Analysts

Will E. Slabaugh – Stephens, Inc.

Alexander Slagle – Jefferies & Co.

Andrew M. Charles Hahn – Bank of America Merrill Lynch

John S. Glass – Morgan Stanley & Co. LLC

Jeff D. Farmer – Wells Fargo Securities LLC

Chris T. O'Cull – KeyBanc Capital Markets, Inc.

Stephen Anderson – Miller Tabak & Co.

Bob M. Derrington – Wunderlich Securities, Inc.

Bryan C. Elliott – Raymond James & Associates, Inc.

Peter Saleh – Telsey Advisory Group

Operator

Good morning, ladies and gentlemen. Welcome to the Red Robin Gourmet Burgers Incorporated Second Quarter 2014 Earnings Call. As a reminder, a part of today’s discussion will include forward-looking statements within the meaning of federal securities laws. These statements are commonly identified by words such as anticipate, continue, plan, expect, intend, should, will and other terms with similar meanings.

These statements include, but will not be limited to statements that reflect the company’s current expectations with respect to the macroeconomic and competitive environment, the financial condition of the company, results of operations, plans, objectives, future performance including the company’s traffic and revenue-driving initiatives and strategy, sales growth, operating margin and operating weeks, costs, expenses, expense management, deployment of capital, restaurant development and our remodels, integration and performance of acquired restaurants and other expectations discussed within the course of this call.

Although the company believes the assumptions upon which preliminary or initial results, financial information and forward-looking statements are based are reasonable as of today’s date. These forward-looking statements are not guarantees of future performance, and therefore investors should not place undue reliance on them. Also these statements are based on facts known and expected as of the date of this conference call, and the company undertakes no obligation to update these statements to reflect the events or circumstances that might arise after this call.

Participants on the call today should refer to the company’s Form 10-K and other filings with the SEC for a more detailed discussion of risks, uncertainties and other factors that could impact the company’s future operating results and financial conditions. The company has posted its fiscal second quarter 2014 press release and supplemental financial information related to the quarter’s results on its website at www.redrobin.com, in the Investors section.

And now, I would like to turn the call over to Mr. Steve Carley, Chief Executive Officer of Red Robin. Please go ahead, sir.

Steve Carley

Thanks, Aaron and thanks everybody for joining us this morning. With me today are Stuart Brown, our Chief Financial Officer; and Denny Post, our Chief Marketing Officer. After Deny, Stuart and I deliver our prepared remarks, we’ll all be available to answer questions.

Turning to slide 2, if we look at the first half of this year, we are satisfied with our top line performance and remain confident that the initiatives we have in place are improving guest engagement. That said our Q2 results were disappointing. Our marketing strategy fell short in delivering year-over-year growth in a highly competitive environment.

As you know, we are not alone in finding Q2 challenging. Weak consumer spending continued to weigh heavily on our industry and others. Unfortunately, we see little to suggest the microenvironment will provide any meaningful lift in the immediate future. We will have to earn our wins, as we have done so successfully in the past.

During the quarter, we witnessed intense and in our estimation non-sustainable discounting from some of our peers. That said, we continue to have confidence in our long-term initiatives to drive shareholder value and despite continued economy uncertainty and continuing intense competitive pressure, we remain cautiously optimistic about our expectations for the full year.

Now in terms of our quarterly results, as you see on slide 2, comp restaurant revenues increased 1.2%. Restaurant-level operating margin was 22.2%, which was 110 basis points lower than previous year. Earnings per share excluding $0.06 in acquisition and executive transition costs was $0.71 versus $0.77 last year. The comparable restaurant revenue gain stemmed from a 3.7% increase in the average check that was offset by a 2.50% decrease in guest count. No doubt, there were some drags on traffic beyond our control, but the majority of our miss was related to marketing choices this summer.

In a moment, Denny will provide an assessment on these misses. We have no intention of following the aggressive discounting of our peers, but rather seek to find a delicate balance of driving profitable traffic by differentiating ourselves through sustained everyday value, new menu innovation; our burger barbell strategy and superior RRR service. For the first time in eight quarters, Red Robin traffic performed slightly below our peers according to Black Box.

On slide 3, our average check grew 3.7%, which was lower than the first quarter as we rolled over highly successful prior year initiatives. And while we do not discuss specific mix numbers, the increase in average check was facilitated by the ongoing trade-up from our gourmet burgers into the finest line, the expansion of our specialty beverage and craft beer offerings and a higher incidence of appetizers and desserts.

Moving onto our brand transformation initiatives, we’ve been pleased with the guest response and traffic increases achieved to date. This is especially gratifying, given the fact that most are still waiting to complete their new exteriors and new signage. Guests are responding enthusiastically to the new layout and updated look and feel.

In light of this performance, we have decided to increase our remodel activity for this year and expect to complete a total of 95 remodels by the end of the year, assuming timely landlord and municipality approvals. Stuart will give you some more specifics shortly.

As I’m sure you have seen at the start of the third quarter, we completed the acquisition of 32 restaurants in the United States and Canada. The integration of the U.S. stores into our operations is on track, and implementation of a Project RED type initiative for the Canadian business is also underway. This acquisition is a significant step in our expansion strategy and we are pleased to welcome over 2,000 Red Robin team members into our expanded company.

Regarding Red Robin Burger Works, during the quarter, we opened two new locations in downtown Chicago and have been encouraged by the initial guest acceptance and sales volumes. The updated prototype is more closely aligned with the flagship Red Robin brand and is designed specifically for dense urban areas where we expect heavy daytime traffic. We have one location opening in Washington DC, during the third quarter and two more underdevelopment in downtown Chicago. We continue to look for other downtown business sites that would be ideal for Burger Works.

Finally, we made some key organizational changes. We realigned our senior ops team by increasing the number of regional vice presidents to reduce the average span of control and also provide career advancement for some of our most talented regional operations leaders. We will be announcing these promotions, as well as our new Senior Vice President of operations early next week. I am proud of our leadership team and confident that it provides us with solid bench strength to bring renewed focus to our restaurant level execution and deliver the Red Robin brand promise. This step contributes to an even stronger team with a more effective ops organization.

As previously announced, we eliminated the Chief Operating Officer position, which was a difficult call, but necessary as part of the evolution of the operations leadership structure. we thank Eric Houseman for the significant contributions he has made to Red Robin over more than 25 years and wish him well in his future endeavors.

With that, I’ll now pass it over to Denny, to discuss our learning on the Q2 marketing programs.

Denny Marie Post

Thanks, Steve. I appreciate you highlighting the challenging competitive environment. It is the marketing team’s responsibility to anticipate those issues and successfully lap strong results year-over-year, no matter how challenging the competitive environment.

It requires insightful decision-making with little or no room for error. Unfortunately, we had three issues this quarter which caused us to fall short. The good news is that we now have a clear handle on what went wrong and what we can do to regain momentum. The first issue was a poor choice. After a strong Q1, where we benefited from incremental weeks on-air, coupled with ads focused on everyday value and a high-end product launch. We led Q2 with ads, which did not as successfully drive in guest traffic. We will make different choices is in our advertising messages going forward.

The second issue was a premature move. We took our foot off the pedal on our Finest lineup, which is still building trial, featuring only one of our three finest burgers on our promotional card. This negatively affected our average check billed. Despite the fact that our delicious LTO Colossus Burger mixed above expectation at $10.99, it could not make up for the decrease in finest mix.

We will work more diligently to balance the elements of our barbell menu on our features card in the future. And the third issue, we launched our Burgers and a Movie promotion into the teeth of the worst box office summer in eight years. Although we saw great gift card sales from visiting guests, we were not able to attract new guests, as successfully as we did last summer. Our Burgers and a Movie gift cards outsold last year’s offering by a factor of 2x, and our free ticket redemption continues to exceed industry norms. As such we remain committed to the Burgers and a Movie program, because the free movie ticket adds value for our guests, and we will continue to work to optimize our activation tactics with future movie partnerships.

I want to close with three marketing advantages, which have considerable runway for our business. First, we continue to see remarkable strength and potential in our growing Red Robin Royalty program, which delivered at or above expectations during this quarter, continuing to demonstrate the responsiveness of our most loyal guests to targeted rewards and product news.

Secondly, our brand transformation initiatives, as Steve referenced, which includes both menu upgrades, plating and menu presentation and our growing fleet of refreshed locations with new signage are well and guests provide the new options and a great guest experience; third, we continue to leverage partnerships that make sense for our brand.

For example, we have four NFL partnerships again this fall. Our hometown Broncos the world champion Seattle Seahawks and the Arizona Cardinals will return along with a new team, the Carolina Panthers taking the place of last year’s Chicago Bears. We have made a few changes to the program to further enhance the profitability.

Notably, we have eliminated pre-season games from the promotion. As a known consequence of this move, our year-over-year traffic will take a hit, but we will be back to full traffic driving potential assuming the teams do their part and play some serious football with the start of regular season September 4.

In summary, Q2 reminded us that the power of everyday value, thoughtful PPA management and successful promotional activation. We will most certainly remember these lessons and make smarter choices in the future.

With that, I’ll hand it over to Stuart.

Stuart B. Brown

Thank you, Denny and good morning everyone. while we were disappointed in our second quarter results, we have often acknowledged that in a highly competitive environment, sometimes the healthiest course of action for the brand is to limit reaction and this is one of those times. Still we are confident that we understand the root issues within our control and the path forward. Top-line revenue growth reflected a meaningful change from our very strong first quarter and missed our internal expectations. The 2.5% decline in traffic caused us to underperform our casual dining peers by 40 basis points as reported by Black Box, which was our first underperformance in two years.

Last year we had gained market share with over 200 basis points of outperformance so we cycled against a pretty strong quarter. Year-to-date, though, our traffic still outperformed our peers by 170 basis points. Our average check increased 3.7% compared to the year ago resulting from an increased mix of our Finest line of half pound black angus burgers and increased sales of alcoholic beverages and desserts.

With appetizers sales lapping the launch of our $3, $5, $7, and $9 lineup last April, our appetizer increase this quarter was more marginal. Though the average check grew at a sequentially slower pace in the first quarter the second quarter faced a more formidable comparison of 5% growth last year.

Restaurant level operating profit as a percentage of restaurant revenue declined 22.2% from 23.3% a year ago. We had projected a margin decline due to increased labor costs and commodity prices combined with last year having benefited from a $700,000, or 30 basis point one-time favorable Worker's Compensation adjustment. Margins, though, were below our expectations due to the deleverage of the lower-than-expected revenue on labor and occupancy costs. Cost of sales was 25.3%, a 60 basis point increase from a year ago and largely in line with our outlook with ground beef costs up 11% higher than last year.

Our new labor management system continues to function effectively, but operationally we should have adjusted labor hours more quickly to the slowing traffic. General and administrative costs decreased $1.4 million from the second quarter of 2013 to $20.4 million this year due mainly to lower accruals and performance incentives. This and other reductions more than offset increased salaries, professional services and $500,000 of pretax executive transition costs.

Selling expenses were 3.9% of revenues compared to 2.7% a year ago. Costs were generally in line with our expectations, though, up from last year due to timing of spend on media relative to the balance of our national advertising fund and increased cost associated with the sales of gift cards. Pre-opening and acquisition costs totaled $2.3 million in the quarter and $4.4 million year-to-date, which includes $700,000 and $1.2 million respectively of acquisition costs. Looking at cash generation and capital deployment as shown in the supplemental on slide 12 we have generated EBITDA of $66.2 million year-to-date which compares to $62.2 million in 2013.

Year-to-date capital investments totaled $56.6 million including approximately $28 million in new restaurants almost $13 million in remodel and expanded restaurants and $8 million in maintenance and corporate systems. Additionally, we spent $8 million to acquire four restaurants from a franchisee in the first quarter.

Since the start of the year we have opened seven Red Robin restaurants and closed one unit which together resulted in a 6.4% increase in Red Robin operating weeks. Further, we opened two Red Robin Burger Works bringing our total amount to seven. We've been pleased with the initial performance of these First Chicago Burger Works and optimistic about our plans to grow the concept based on our refined brand and the real estate strategies.

We continue to also be pleased with the initial results at our remodeled locations. Although they have a limited impact in the second quarter revenue and sales left where interior remodels have been completed were offset by sales disruptions at locations under construction. We have completed interior remodels of 52 restaurants since the onset of BTI including 20 in the first half of this year. With the exterior and signage design now finalized we are gathering the required approval and permits from landlords and cities. The process is taking a bit longer than anticipated.

We expect revenues in the remodeled restaurants to continue to build once the new signage is installed and on all remodeled locations later this fall. 95 locations approaching 25% of all company-operated restaurants should have total brand transformation remodels complete by year end and future remodels will have interior and exterior completed simultaneously.

On July 2, 2014, we replaced our existing credit facility with a new $250 million five-year credit facility that reduces our interest rate by 25 basis points at the same leverage compared to our previous facility. At the end of the second quarter our interest rate on the facility was 2.4%. Our borrowings increased by $40 million at the end of the quarter in order to fund the acquisition of the 32 franchised restaurants which closed on the first day of the third quarter.

In updating our outlook for the year we have revised expectations to reflect changes in the market as well to account for the 32 units acquired in the U.S. and Canada from our franchisee Mach Robin and its affiliates. Please refer to slide 16 in the supplemental for the updated outlook. We continue to expect comparable restaurant revenue growth in the low single-digits for the year. Year-to-date comparable restaurant revenues increased 3.6%.

Seasonally, the third quarter comp growth will remain challenging amid aggressive discounting by some peers and will likely be at the lower end of our annual guidance as we cycle over our strongest traffic growth period last year and eliminate preseason football promotions, as Denny mentioned. We expect somewhat stronger comp revenue growth in the fourth quarter due to a growing impact on traffic from our remodel program and moderately increased media compared to a year ago albeit still at low levels compared to our peer group.

As you model sales remember that we are comping against strong traffic growth in the third quarter last year when we outperformed our peers by 420 basis points, while in the fourth quarter outperformance was 140 basis points. The acquired restaurants will be treated like new restaurants and will therefore will be added to the comparable restaurant base after five full quarters of ownership. The 32 restaurants recently acquired are projected to add $44 million to restaurant revenue this year and reduce royalties by about $1.5 million.

Further, operating weeks are expected to increase about 6.5% from new restaurant development including Burger Works. The two acquisitions should add a further 928 operating weeks or 5% to the year. Restaurant level operating margins and are expected to be 21.3% for the year, 10 basis points lower than our previous guidance as lower margins at the restaurants that were acquired more than offset lower labor than assumed in our previous guidance.

General and administrative costs are expected to approach $94 million in 2014 including about $1.5 million of costs associated with our new office in Vancouver, Canada and increased stock and amortization expense related to a change in retirement provisions. Selling costs as a percentage of revenue were unchanged from our previous guidance at 3.2% of sales, though have some upward pressure due to our successful gift card programs including our Burgers and a Movie Program we launched earlier this year.

Pre-opening and acquisition costs are projected to be approximately $9 million including about $2.5 million for acquisition and integration costs of which $700,000 remains to be spent in the second half. Depreciation and amortization is expected to be around $64 million, an increase of $2 million from our previous guidance related to the acquired restaurants.

Interest expense will be about $3 million and the tax rate expectation has been reduced to 26%, which includes a $500,000 R&D credit we expect to record in third quarter. We will open a total of 20 new full-service Red Robins and 4 to 5 Burger Works this year and expect to complete about 65 brand transformation remodels during the year. While we anticipate the acquisition of the 32 restaurants from Mach will be dilutive to net income in 2014 exclusively due to the acquisition and integration costs being incurred, we expect it will contribute over $6 million to EBITDA and $2 million to net income in 2015 on an absolute basis.

With that I will now turn the call back over to Steve.

Steve Carley

Thank you, Stuart. We certainly recognized Q2 as a tough quarter especially for a team that has the track record we have had at Red Robin over the last four years. As we've mentioned to you multiple times in the recent past, we suspected that a confluence of many factors, some of them macroenvironment, some competitive and some of our own making could all coalesce in the same period and negatively impact our results.

That said we have a solid understanding of the root cause of many of these factors especially the ones in our control. And we have a clear vision going forward on how to positively and proactively address them to mitigate their impact on our business going forward. And that is our objective. We are forging ahead with our strategic roadmap and are determined to stay the course as we navigate through the current rough waters in the category. We will not get distracted with short-term tactics that inhibit our ability to build an even stronger foundation for the future.

Rather we will continue to make progress in serving more guests more often and leaving them more delighted each and every visit. Before we take questions I would like to thank the entire team at Red Robin for their dedication and hard work. They are a focused, motivated group who are passionate about living up to our brand promise each and every day. We truly appreciate their efforts and on behalf of the Company and our shareholders we appreciate them significantly.

With that, operator, we will open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we will go first to Will Slabaugh with Stephens.

Will E. Slabaugh – Stephens, Inc.

Yes, thanks guys. As far as the marketing goes, I don't want to mix your words here, so does it sound like we should expect you to go more aggressively toward everyday value with your messaging outwardly and then maybe once they get inside the restaurant you mentioned you didn't talk about more than one of your Finest line items, should that be a little more aggressive inside the restaurant, or how should we think about that?

Steve Carley

That combination has certainly worked for us in the past, Will, so I think you can expect that we will be revisiting it.

Will E. Slabaugh – Stephens, Inc.

Okay. And this may be tough to quantify, but as you mentioned this is probably the worst movie market we've seen in a long time. I know you are close, I think maybe it's 80% or so of your restaurants are close to movie theaters. Is there anyway to quantify what that impact was at all, maybe you can talk a little bit anecdotally about it?

Stuart B. Brown

Well, this is Stuart, I mean in terms of the impact of the movie season being down, it certainly was one of the factors that contributed to it given the convenience of Red Robin and the way we have marketed to theaters and there's been a couple of other factors as well. I think if you look at the Fourth of July falling on a Friday night that really hurt that weekend. I think more people traveling and things like that. So the movie theater traffic being down certainly didn’t help.

Will E. Slabaugh – Stephens, Inc.

Got you. Last one for me. I didn’t know if you would be willing to talk anymore about the trends you saw throughout the quarter, anything quarter to date that you have seen? You mentioned you do expect a lot of the competitive nature that you have seen from your peers to continue. So I assume probably not a big change there?

Stuart B. Brown

No, again, we’re cycling over an incredible third quarter last year. So when you combine that, I think my indicated remarks on guidance is third quarter will look a lot like, more like the second quarter than the first quarter, I’m sure.

Will E. Slabaugh – Stephens, Inc.

Thanks, guys.

Operator

And we’ll go next to Alex Slagle with Jefferies.

Alexander Slagle – Jefferies & Co.

Hey, thanks. Just want to follow-up on the second quarter traffic dip. Was there, outside the media strategy reasons, was there anything else like a certain regions where you saw particular weakness?

Stuart B. Brown

Alex, this is again, Stuart. Like I think the reasons where we’ve seen weakness is more I think where the industry has been seeing them, particularly in the Northeast and Florida has been a little bit weak. The Pacific Northwest was a little bit softer for us than it normally is year again, I think that’s partly because of what we’re cycling over tremendous growth last year where they really actually outperformed.

Alexander Slagle – Jefferies & Co.

Okay. And a question on Canada for Denny, I guess. Updated thoughts on the implementation of Project RED? I know it’s early there, but maybe initial ideas about where you can add value to that system of stores? And maybe what your outlook is for potential growth opportunity out there in Canada?

Denny Marie Post

Sure, happy to address it. We are doing the fundamental research now to help us determine where our best top line opportunities will exist and what our stance is with the guests relative to competition. So that’s the first key piece. There is no doubt that cost of goods and labor are higher in Western Canada than many parts, most parts of the United States. so at the rate we’re moving here, I suppose on labor particularly there are some corollaries.

We see some opportunity certainly in the immediate term and a lot of opportunities to do better menu item management, which might affect our COGS and also implementing like Watson and some of the other tools that we have here in the U.S. to help with labor.

So I think there’s significant opportunities following the RED group blueprint process to improve profitability in Canada. We also have an opportunity to modernize those restaurants. They are some of the oldest in the system and doing that, I think will certainly move the brand forward in Canada and then perhaps open up opportunities for growth down the road.

Alexander Slagle – Jefferies & Co.

Okay. Thank you.

Operator

(Operator Instructions) And we’ll go next to Andrew Charles with Bank of America Merrill Lynch.

Andrew M. Charles Hahn – Bank of America Merrill Lynch

Thank you. Thank you. I was surprised to hear the impact of advertising on preseason football to have an impact on your traffic and especially as you have now got the pulsing strategy, lapping pulsing from last year, so maybe kind of size of the impact from these two methods of advertising.

Denny Marie Post

It’s two separate things entirely. So the promotion that we do with our football teams is a triggered promotion. We do not advertise it in a broad basis. but we chose this year to eliminate the preseason games from the promotion and begin the triggers with the regular season. So last year, we had a certain number of games that triggered in preseason, as well as our regular season. So it’s really a promotional choice. The advertising choice is a separate one that affects the national business.

Andrew M. Charles Hahn – Bank of America Merrill Lynch

Okay. And just taking a step back on the advertising, can you just talk about if you are happy with the mediums that are being used, as well as the television campaign you started a little over a year ago?

Denny Marie Post

Yes. I think we’re always looking to optimize both. and our media approach is continued to do the best we can with the dollars we have to spend. We continue to look for ways to make it stronger and stronger every turn. same goes for the campaign, but it’s more about message choice and tactics than it has been about the campaign overall. I also just wanted to clarify that the promotion has unique triggers, for example, and of course, last year with our Seattle Seahawks and the Broncos in particular going all the way through to the Super Bowl, they both triggered on a very high frequency.

Stuart B. Brown

And that would result in a Tavern Double Tuesday event where guests can come in on a Tuesday and…

Denny Marie Post

Yes. it drives tremendous traffic during the week if they trigger the next Tuesday; when we do a buy one get one on Tavern Double.

Andrew M. Charles Hahn – Bank of America Merrill Lynch

Okay, thank you.

Denny Marie Post

Thanks, Andrew.

Operator

And we’ll go next to John Glass with Morgan Stanley.

John S. Glass – Morgan Stanley & Co. LLC

Thanks. I’m just sort of trying to understand again the comp decline. So some casual diners have talked about weakness particularly at dinner. Others have cited the family business which you would be particularly exposed to. Did you find that those particular occasions, particularly family, was weak this quarter?

Stuart B. Brown

No, we didn’t see anything in the data or the trends or mix on kids meals that would indicate any of that. In terms of the family dining we sort of hear some of the same things that families are dining out a little bit less. We have not had that experience. And in terms of daypart, our daypart hasn’t changed that much between lunch and dinner either.

We saw a little bit of shift between end of the week from the weekend, but even that wasn’t dramatic, and I think it had to do with World Cup, the Fourth of July and things like this, things that happened during the quarter.

John S. Glass – Morgan Stanley & Co. LLC

Okay. And then Denny, you led by talking about the wrong choice, I guess the wrong choice of ads is one of the reasons. What did you mean – maybe I wasn’t aware of the campaign, but what was it that you thought was the wrong choice, was it the type of ad specifically, or just the product you promoted that you alluded to?

Denny Marie Post

The ads themselves didn’t focus on news that was the kind of news that would drive urgency into the restaurant. They were focused on existing items on our menu and a program that actually drove registrations for Red Robin Royalty quite successfully but not – didn’t give guests a good enough reason to come into the restaurant today.

John S. Glass – Morgan Stanley & Co. LLC

And have you now been able to adjust that quickly enough, or is there still lead time in changing that so that it may not have effect as soon as you would like?

Denny Marie Post

We have adjusted.

John S. Glass – Morgan Stanley & Co. LLC

Thank you.

Operator

And we’ll go next to Jeff Farmer with Wells Fargo.

Jeff D. Farmer – Wells Fargo Securities LLC

Sorry to beat a dead horse on this one, but just one more cut on Q2 same-store sales. So, I know it’s impossible to fully disaggregate, but just in terms of looking at I think what you referred to as the marketing missteps versus the increased competitive discounting from the peer group, which of those two do you think that the greater influence on the slightly disappointing same-store sales for you in the quarter? Which played a greater role?

Denny Marie Post

I think the marketing played a greater role. As I said it’s up to us to compete effectively. It is something we certainly could have been more effective at combating. We have a great everyday value proposition with our Tavern Double. It isn’t a limited time promotion and it isn’t a lunch-only offer. It’s $6.99 for a Tavern Double with bottomless fries every day and a lot of people still don’t know about that.

Jeff D. Farmer – Wells Fargo Securities LLC

All right. You touched on it and I realize you don’t provide EPS guidance, but with the Q3 2013 EPS growth comparison still tough you guys pointing to sounds like pretty modest same-store sales growth in Q3 2014, are we looking at another situation where we could see EPS contraction year-over-year Q2 2014 versus Q3 2013?

Stuart B. Brown

I think it depends a little bit upon the environment. But it could be – I would expect it to be probably more flattish in the third quarter, as again given the marketing that we have talked about and that turning around that will start to pick up. And again in the third quarter you’ve got that’s almost the entire $700,000 of acquisition and integration cost will be in the third quarter and some other things. But it will be plus or minus flat.

Jeff D. Farmer – Wells Fargo Securities LLC

Okay thank you.

Operator

And we’ll go next to Chris O’Cull with KeyBanc.

Chris T. O'Cull – KeyBanc Capital Markets, Inc.

Thanks. Good morning guys. The Company raised its CapEx guidance for the remodels. Can you kind it gives an update on how the remodels are performing? And then just as a follow-up, Steve, is there risks that the additional remodels become a distraction to operations at all?

Stuart B. Brown

Let me start off with the first part and I think Steve will talk about how excited the operators are to get – they are begging to get them. Just to remind everybody in terms of what the hurdles are, on the BTI again, we expect a minimum IRR of 12% to 13% on a cash return of 20% to 30%. To get that you need basically a minimum 4% to 4.5% traffic lift which we are confident in. Again the initial ones that we are getting we are getting a 6% lift. We are a little bit below that 4% to 4.5% pre-signage and then post-signage, once we get the new signage up we have been exceeding that comfortably. So we are very pleased with the results and not to mention the team member reactions people talk about and the guest reaction has been great, too.

Steve Carley

Yes, the general managers, the management teams and the team members in the restaurants are very excited about the remodel transformation and we are getting fantastic feedback from our guests. We do not generally close the restaurant so there is some dislocation over the construction period. And as we approach our fleet we tend to be working West to East and dealing with the oldest, most unique restaurants in the system first. And when we do that we get some surprises when we open up the walls and find out it doesn't match the plans we have. So there is some element of dislocation. Our guests have been very forgiving around that and our team members and managers have been terrific.

But distraction is not the right word. I think it is just a little bit of a complication in the operating environment while we are under construction.

Chris T. O'Cull – KeyBanc Capital Markets, Inc.

Just as a follow-up, if I may. Stuart, I know there's going to be some incremental depreciation, but is there any incremental labor costs or any other costs that affect the margin initially after the remodel is completed?

Stuart B. Brown

No, really the rest of the operating expenses – the variable operating expenses sort of stayed in line. So you get a better flow through on the incremental guest counts. Flowthrough on the profitability is great.

Chris T. O'Cull – KeyBanc Capital Markets, Inc.

Okay. No additional training costs or anything like that?

Steve Carley

No, we rolled out the key elements of plating and presentation and RRR service about a year ago. And what this does for us is actually a major positive because it allows us to use the transformed environment, which the team members are really excited about and get feedback from the guests to sit down and reinforce all the service elements that we put in place, revisit, refresh and recommit. And that's the process we are using.

Chris T. O'Cull – KeyBanc Capital Markets, Inc.

Great. Thanks guys.

Stuart B. Brown

Thanks, Chris.

Operator

And we will go next to Steve Anderson with Miller Tabak.

Stephen Anderson – Miller Tabak & Co.

Good morning. You mentioned earlier in the call that you have your labor-management model but you did not adjust labor accordingly to reflect lower traffic levels. Is this something you have corrected so far in third quarter as you anticipate probably another quarter of similar same restaurant sales?

Steve Carley

This is Steve. The labor model we rolled out is incredibly accurate. But one element of it of course is the accuracy of the general managers' forecast of their business in the coming week or so. Given the tremendous success we've had historically on growing our business when the sales begin to fall off faster than the general managers anticipate it is anticipate it is like trying to catch a falling knife. And what we found is that they don't react as quickly as they should to declining sales. And given their level of optimism about the business, they tend to forecast that things are going to turn in the next week and it’s just a matter of getting that calibrated. So the system is working just like we thought. there’s always a human element in the forecasting piece and our folks are getting smarter on that. We’ve just rolled it out now. this is only the, really, the second full quarter that we’ve had it in place.

Stephen Anderson – Miller Tabak & Co.

Okay. Thank you.

Operator

And we’ll go next to Bob Derrington with Wunderlich Securities.

Bob M. Derrington – Wunderlich Securities, Inc.

Yes, thank you. Could you give us a little bit of color, Denny, possibly on how do you find the best balance between both addressing the value that consumers want versus the check average benefit that you get out of the line of Finest burgers? And then I’ve got a follow-up.

Denny Marie Post

Well, it’s the importance of the barbell strategy. One that might lead somebody to actually cross our threshold, another piece may actually cause somebody to trade up on the menu. So it’s providing the choices across the broad spectrum of media and merchandising. So it is a fine balance and it is one that we missed with letting the Finest slip off our promo cards this summer.

Bob M. Derrington – Wunderlich Securities, Inc.

Okay. And then Stuart, could you give us a little bit of color on the company’s commodity outlook? Any kind of, how is the inflation percent overall during the quarter and then how do you see things developing through the balance of the year? I apologize if I missed that already.

Stuart B. Brown

No. Bob, in terms of the commodity outlook ground beef is really the biggest volatility. It was up pretty meaningfully here over the summer. Commodity inflation in the second quarter was 3.1%, which is pretty much in line with what our guidance with ground beef being a little bit higher and a couple of items coming in more favorably. For the balance of the year, we expect it to continue to be sort of in that 3% to 3.5% range.

Bob M. Derrington – Wunderlich Securities, Inc.

Great. Thank you.

Operator

And we’ll go next to Bryan Elliott with Raymond James.

Bryan C. Elliott – Raymond James & Associates, Inc.

Good morning. Just a couple of things. One, Denny, just to clarify for me, you talked about the Finest, only one of the Finest lines being on the card, are you talking about just the in-store table card on the table?

Denny Marie Post

No, it’s the feature card that we distribute with the menu at the beginning of the meal, which calls it out for many guests. Yes, we had only the DGP, our Damn Great Burger on that one.

Bryan C. Elliott – Raymond James & Associates, Inc.

Okay. And then do I understand also the commentary around the Tavern Double that it was not a component of the advertising messaging in the quarter?

Denny Marie Post

That’s true. It was not.

Bryan C. Elliott – Raymond James & Associates, Inc.

Yes. Okay, all right. And then I guess for Steve, could you just drill down a little bit more on quantifying kind of the change in span and control for the multiunit supervisory structure?

Steve Carley

Yes, thanks, Bryan. We had a couple of our most seasoned regional vice president with double-digit direct reports. We did that consciously in an effort to see how that would play out. and well, we were satisfied with how that worked we found out that the folks reporting to that individual weren’t getting the one-on-one attention, the coaching and counseling and the direction that they needed. And as we sat down and evaluated the results of that test we really felt it was important that every regional vice president have somewhere in the neighborhood of six to eight direct reports where the span of control was good and they can spend quality time with their people providing guidance, and coaching and counseling.

And so as we reorganized, the operations group we used that as a standard. The expectation being that the RBP will be able to give the ops director, more quality time and feedback and that that flows to a higher quality relationship and communication with the General Manager, which then leads to better execution in the restaurants.

Bryan C. Elliott – Raymond James & Associates, Inc.

Very good. Thank you.

Steve Carley

You bet.

Operator

(Operator Instructions) And we will go next to Peter Saleh with Telsey Advisory Group.

Peter Saleh – Telsey Advisory Group

Great, thanks. Just a couple of questions. First, Stuart, I think you mentioned the World Cup. Do you think that hurt you at all in the quarter in terms of maybe people staying home and watching the games?

Stuart B. Brown

Yes, we think it was one of the factors when we look at those other individual days. It was one Saturday, particularly during the weekend we think it was one of the factors that hurt us.

Peter Saleh – Telsey Advisory Group

Okay, and then on the alcohol sales, where do you stand today as a percentage of your mix?

Stuart B. Brown

It was up about 10 basis points year-over-year on alcohol mix. We are sitting at about 7.6, 7.7.

Peter Saleh – Telsey Advisory Group

Okay. And then just lastly on the Finest line, any plans to expand the Finest line in terms of the offering in the back end of the year?

Denny Marie Post

We are always looking for opportunities in all parts of our menu, Peter. I don't want to give away any competitive news, particularly.

Peter Saleh – Telsey Advisory Group

Okay. Thank you very much.

Stuart B. Brown

Thank you.

Steve Carley

Thanks, Peter.

Operator

And that concludes our question-and-answer session. I'd like to turn the conference back over to our speakers for any closing remarks.

Steve Carley

This is Steve. We appreciate everybody's time and attention and look forward to talking to you in about – at the conclusion of the third quarter. Thanks. Have a great day.

Operator

And this does conclude today’s conference. We thank you for your participation.

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Source: Red Robin Gourmet Burgers' (RRGB) CEO Steve Carley on Q2 2014 Results - Earnings Call Transcript
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