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Carrols Restaurant Group, Inc (NASDAQ:TAST)

Q1 2011 Earnings Call Transcript

May 10, 2011, 8:30 am ET

Executives

Paul Flanders - VP, CFO and Treasurer

Daniel Accordino - President, COO

Alan Vituli - Chairman, CEO

Analysts

Jeff Omohundro - Wells Fargo

Carla Casella - JPMorgan

Kevin McClure - Wells Fargo Securities

Howard Penney - Hedgeye Risk Management

Art Roelick - Numara

Operator

Welcome to Carrols Restaurant Group Inc first quarter 2011 earnings conference call on May 10, 2011. Throughout today's presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. (Operator Instructions). I will now hand the conference over to Mr. Paul Flanders. Please go ahead, sir.

Paul Flanders

Good morning, everyone. By now you should have access to the announcement released this morning, which you can also find on our website at www.carrols.com under the investor relations section. Before we begin our formal remarks I want to remind everyone that our discussion today may include forward-looking statements.

These forward-looking statements may include comments regarding our strategies, intentions or plans including, without limitation, our planned refinancing and spinoff transaction. These statements are not guarantees of future performance and therefore undue reliance should not be placed on them.

We also refer you to our filings with the SEC for a more detailed discussion of the risks that could impact our business and our results.

On the call with me today is Alan Vituli, our Chairman and CEO, and Dan Accordino, our President and Chief Operating Officer. Alan and Dan will provide some comments on the business and then I’ll walk through the financial results for the first quarter and provide some commentary regarding 2011. We will then be happy to address any questions that you might have.

With that, I'll turn the all over to Alan.

Alan Vituli

Thanks, Paul, and good morning. Dan and Paul will cover our first quarter performance in a minute. But before that I would like to briefly update you on the planned tax-free spinoff of our Hispanic and the status of our refinancing.

As we indicated on the last call, we're planning to split the company into to separate publicly traded companies with a spinoff of our Pollo Tropical and Taco Cabana business into a new entity by way of a dividend to Carrols' shareholders.

We believe that this will offer each company the ability to pursue its own business plan and its own growth strategies and offer better potential for improving the shareholder value for each company and that of keeping them together.

Pollo Tropical and Taco Cabana are both well positioned for new unit growth and good expansion. We believe that as a [stepford] company, our franchise Burger King business will have better growth potential, including acquisitions within the Burger King system.

We have been primarily focused on completely a refinancing to put the capital structure in place for each of the companies in anticipation of the spinoff. We currently contemplate that the refinancing would be comprised term loan borrowings under a senior secured bank credit facility for our Burger King business and the issuance of senior secured notes for our Hispanic brands.

We are well into the process and anticipate that this will be completed by the end of June or early July at the latest. Currently, we've been working on a number of the details regarding the spinoff itself and continue to make progress as we move through this process.

At this time, our plan is to complete the spinoff by the end of calendar year 2011. With that, I'll turn the call to Dan to give you an overview of our first quarter results. Dan?

Dan Accordino

Thanks, Alan. We're pleased to have started 2011 with a strong performance from our Hispanic brands. That is, total revenues for these two brands increased 7.5% for the quarter. Both Pollo Tropical and Taco Cabana posted positive comparable unit sales with results at Pollo particularly impressive.

We believe these sales gains are reflective of our successful efforts to gain new customers and to increase customer frequency with our newer menu items, effective promotion and our brand elevation initiatives.

At the same time, we also experienced continued softness at our Burger King restaurants. While sales were certainly impacted by the unusually severe winter weather, our first quarter results mostly reflected the negative sales trends that have persisted for some time now at Burger King.

If the brand is in its early stage of repositioning and refocusing its marketing efforts, we believe that we will begin to see stabilizing trends in the second half of this year. With that said, I will now discuss our three brands in greater detail.

At Pollo Tropical, comparable restaurant sales increased to solid 13.5% including a 13.3% increase in customer traffic. This marked the sixth consecutive quarter of positive comparable unit sales for Pollo Tropical.

Segment EBITDA improved significantly to $10.1 million from $6.7 million last year and segment EBITDA margin expanded by 447 basis points to 19.26%, which is reflective of the strong operating leverage we achieved on higher sales.

With regards to promotional initiatives, we were on TV promoting our $4.99 combos and in the West Palm Beach market our Create Your Own TropiChop as we move towards providing the customer more menu customization options.

During Lent, our promotions featured a grilled trim quesadilla wrap combo for $4.99 and a grilled shrimp quesadilla salad for $6.99. In terms of development, we plan to build on our recent success in Jacksonville with a second new unit to be open later this year in that market. Also, we are currently under construction with our first unit in the Atlanta market, which is slated to open in the third quarter.

On the international front, our franchise business is also poised to see further development this year with the anticipated opening of several new restaurants in the Caribbean as well as Central and South America.

At Taco Cabana, comparable restaurant sales increased 2%, continuing the positive trend we have experienced for the past several quarters. As indicated in the last call, Taco Cabana was impacted by winter weather in Texas and Oklahoma early in the year. However, sales rebounded nicely with a combined increased in comparable unit sales of about 4% for both February and March.

Segment EBITDA for Taco Cabana fell modestly to $6.5 million from $6.8 million last year and segment EBITDA margin was 66 basis points lower from increased promotional spending due to the timing of such spending this year and from commodity price increases.

Key product promotions included our popular Shrimp Tampico, which was brought back during Lent, Street Tacos and our Build-A-Bowl products. With regards to our brand elevation initiatives at Taco Cabana, we have substantially completed the remodels in the Dallas market. Compared to the rest of the system, we're experiencing incremental sales increases of about 6% in that market. We plan to begin similar initiatives in Austin later this year.

With respect to development, we opened one new Taco Cabana restaurant in the Dallas market during the first quarter and in April opened two more units, one in Dallas and one in Houston.

Lastly, I'll address Burger King. For the quarter, comparable restaurant sales were down 5% against a 6.4% negative comparison for the same period last year. Segment EBITDA declined to $1.1 million from $3.8 million in the first quarter last year due to decline in sales.

During the first quarter, the brand introduced new and improved chicken tenders and shifted its value focus to its Stacker products featuring a single, double and triple stacker at a price range of $1 to $3.

In the second quarter, Burger King will focus on the Whopper, which has not been promoted for some time and also on the Stuffed Steakhouse product.

As I said, the brand is currently repositioning its marketing, including the selectin of a new agency and we hope to see comparable sales trends stabilize and begin improving the second half of this year.

With that, I'll turn it over to Paul to review our first quarter financial results.

Paul Flanders

Thanks, Dan. For the first quarter, total revenues increased 1.1%, to $197.2 million in 2011 compared to $195.1 million in the prior year with revenues from our Hispanic brands increasing to $115.6 million or 7.5% over the first quarter of 2010.

Pollo Tropical revenues increased 14.8% to $52.2 million with comparable restaurant sales up a solid 13.5% against a 3.7% increase from the prior year. Taco Cabana revenues increased 2.2% to $63.4 million with comparable restaurant sales up 2% against a negative 2% comparison from the prior year.

Burger King revenues decreased 6.8% to $81.6 million with comparable restaurant sales down 5%. We also had a net closing of eight Burger King restaurants since the beginning of the first quarter last year.

For the quarter, net income was $2.2 million or $0.10 per diluted share compared to net income of $2.3 million or $0.11 per diluted share the first quarter of 2010. Adjusting for impairment and the lease charges in both years and insurance gain this year, net income in the first quarter of 2011 was $2.9 million or $0.13 per diluted share compared to $2.5 million or $0.11 per diluted share in the first quarter.

I'll also point out the results in the first quarter of 2011 included approximately $300,000 of the cost related to the proposed spinoff of $0.01 per diluted share.

Overall, cost of sales were 30.6% of total restaurant sales and increased 23 basis points compared to the first quarter of 2010. We're experiencing increasing commodity pressures at all three brands and in the first quarter temporary increases on certain product items, mainly tomatoes and lettuce, due to shortages following the adverse affects of weather on the crops in Florida and Mexico earlier this year.

Pollo Tropical and Taco Cabana cost of sales increased 42 and 38 basis points respectively. Chicken costs were up 7.5% at Pollo and increased about 4.9% at Taco Cabana. In Pollo, these increases were partially offset by favorable sales mix shifts. Mix changes at Taco Cabana were slightly unfavorable but we have the benefit of about 2% from pricing taken in mid-2010.

Cost of sales for Burger King was 25 basis points lower than the first quarter last year. Although beef costs at Burger King were 18% higher, this was offset by a 16% reduction in beef usage and by favorable sales mix changes as we move further away from the heavy discounting and the $1 double cheeseburger offer from early 2010.

Restaurant labor costs decreased 63 basis points in the first quarter to 29.7% of restaurant sales as we leveraged sales increased in our Hispanic brands by 146 basis points on an overall basis, partially offset by about 80 basis points of sales deleveraging at Burger King.

Restaurant operating expenses, which exclude rent and advertising, were 14.2% of total sales or 32 basis points lower compared to the first quarter of 2010, again due to the sales increases at Pollo and Taco.

The advertising expense was $7.5 billion or 29 basis points higher in the first quarter compared to the first quarter of 2010, mostly due to an increase at Taco Cabana of $835,000 due to the timing of our ad spending.

General and administrative expenses were almost $1.4 million higher in absolute dollars compared to the first quarter of 2010 and 62 basis points higher as a percentage of total revenues. These increases included about $300,000 for costs related to the spinoff, $370,000 in higher bonus expense of the Hispanic brands and an increase in stock compensation expense of $286,000.

Impairment and other lease charges were $1.1 million in total and included $816,000 for impairments of five Burger King restaurants and a lease charge of Pollo Tropical due to a closing of an Orlando restaurant that was impaired last year.

At the end of the first quarter, total outstanding debt was $267 million. Interest expense decreased to $4.6 million for the quarter from $4.7 million in the first quarter of 2010 due to a reduction of $20.4 million in outstanding debt since the end of the first quarter last year.

Our financial leverage ratio, or debt to EBITDA, was 3.37 times as calculated for purposes of loan compliance, right about where it was at the end of 2010.

Capital expenditures in the first quarter of 2011 were $8.8 million, including new store CapEx of $3.8 million and remodeling of $3 million. We opened one new Taco Cabana in the first quarter and opened two more Taco units in April. We also opened one new Burger King in the first quarter, which was a relocation of an existing unit in its market.

As has been our policy, we're not providing specific earnings per share guidance for 2011. However, we are providing the following updated information which doesn’t include any impacts in potential spinoff transaction or the refinancing.

Given sales trends, we expect sales at our Hispanic brands to be better than initially anticipated. We now expect comparable sales to increase approximately 6% to 8% for Pollo Tropical compared to 3% to 5% announced previously and approximately 2% to 3% for Taco Cabana compared to the 1% to 2% announced previously.

Burger King comparable sales are expected to be negative for the full year but to improve from current trends in the second half of 2011. As I said, we are experiencing increasing pressure on commodity costs, which are now expected to increased 3% to 4% for Pollo Tropical, 7% to 8% for Taco Cabana and still around 5% to 6% for Burger King.

For the full year, our current plans are to open a total of five to seven new Hispanic brand restaurants and to close on Pollo Tropical unit, the one that closed in the first quarter. With regards to Burger King, our plans are to close a total or seven restaurants, excluding the unit that was relocated in the first quarter.

Total capital expenditures are still estimated to be $45 million to $55 million. Lastly, our annual effective tax rate is now estimated to be 32% to 33%.

With regards to more recent sales trends, in April, Pollo Tropical comparable restaurant sales remained strong at about 10.5% positive and Taco Cabana comparable restaurant sales increased approximately 6.5%. On the other hand, Burger King comparable restaurant sales were down about 5.5%.

With that, we will now open the line for any further questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Jeff Omohundro - Wells Fargo.

Jeff Omohundro - Wells Fargo

First, on the [muddy] outlook, does your guidance incorporate potential future price increases and how are you thinking about pricing relative to commodity pressures? How much of the commodity pressure do you think you can offset through higher pricing?

Alan Vituli

Paul, do you want to take the first part of that with respect to the projection?

Paul Flanders

Yes, those cost projections, Jeff, are anticipated inflation rates on just the commodities, excluding any benefits from price increases.

Alan Vituli

With respect to the question of price increases, both Pollo and Taco have enormously high values for us from their consumers. We take that temperature on a pretty frequent basis. We've got pretty good pricing power in both brands.

Think of commodity costs, Jeff, gets stubborn for too long and can get out of hand. We should be able to really sustain ourselves for an awfully long time and not lose value scores or sales.

Jeff Omohundro - Wells Fargo

So at this time, do you have any -- maybe some details on your specific thoughts about maybe taking some pricing later in the year?

Alan Vituli

The answer is yes, both brands are -- both Pollo and Taco are slated to take some additional price increases during the year. Pollo took a slight price increase when it adjusted the price of its sandwich in the first quarter.

But we're going to see -- we're clearly under pressure to take additional price increases. We're clearly discussing the magnitude of the price increases and we probably will be taking price increases probably somewhat beyond what we've got baked into the projections.

Jeff Omohundro - Wells Fargo

Then another topic, given the success of the Jacksonville Pollo Tropical -- and maybe you can give us an update on how those sales trends have continued there -- maybe you can talk to how that success is impacting your thinking around the site selection process for future store development for Pollo Tropical.

Alan Vituli

Some time back, Jeff, as we've said in the past, we exited the Florida market with a view toward replicating our demos in the Florida market in the Northeast and other densely Hispanic markets.

We found differences clearly between most of Florida market and the Hispanic lifestyles outside of the Florida market, which is what gave rise really to our elevated concept and our vision of tomorrow for Pollo which is that there was a big void in the market in terms of this convenient cash flow consumer who wanted a quick dinner and that ethnicity was less relevant and income levels and family size was much more relevant.

So we basically with Pollo have rethought our expansion and [with this] restaurant that we really opened up clear focus and consistency with what our expansion model is. It was the Jacksonville and that criteria is what outside of the South Florida and Central Florida markets, that's what's going to pervade our thinking.

Ultimately, some of those components that we brought to the expansion market will [trickle] away into the South Florida market. So it's totally changed perception with respect to the expansion strategy with Jacksonville being the first unit that it's a clean -- what we would call a clean unit with respect to the clear perception. We evolved to that but Jacksonville is the ideal.

Jeff Omohundro - Wells Fargo

How has sales trended there? Has it continued?

Alan Vituli

Sales has stayed above $70,000 a year. Sales have essentially been in the $70,000 to $80,000 range on a consistent basis.

Jeff Omohundro - Wells Fargo

Weekly sales?

Alan Vituli

Per week, yes.

Operator

Your next question comes from the line of Carla Casella - JPMorgan.

Carla Casella - JPMorgan

My questions relate to Burger King. Could you say how many remodels you plan to do this year and what the average expense you're spending on the remodel?

Daniel Accordino

We'll do between 10 and 13 remodels this year and the average cost is around $400,000.

Carla Casella - JPMorgan

Then are you seeing any early benefits in terms of the new advertising or marketing? I guess I’m wondering what are the biggest changes you've seen with Burger King now that it's under -- the corporate is under new management?

Daniel Accordino

Well, there really hasn't been any -- the new advertising - they're in the process of selecting a new advertising agency now. S that new advertising agency won't actually be determined until June and their first work will be in September.

The marketing calendar has been a subject of some discussion and evolution through the second half of 2011. So up to this point what's really transpired is there's been a transformation from the constant focus on value menu to differentiated products and more full-margin products.

Carla Casella - JPMorgan

You find it any easier or harder to work with the new management?

Daniel Accordino

We worked well with the old management and we're working very well with the new management.

Operator

Your next question comes from the line of Bryan Hunt - Wells Fargo Securities.

Kevin McClure - Wells Fargo Securities

Just a couple of follow-ups on Carla's questions related to Burger King; recently I know the cost of relaunch breakfast and [day part comps] were tracking up in the double digits. What's been the stickiness of that business? Has that continued?

Paul Flanders

The question was the sales trends around breakfast?

Kevin McClure - Wells Fargo Securities

Correct, yes.

Daniel Accordino

No, breakfast has been negative for the last few months. But, again, we haven't talked about breakfast since the relaunch, either. So until we put breakfast back on air, which will be in the third quarter, I would expect that the breakfast trend will continue pretty much as it has been.

Alan Vituli

Recognize the fact that Burger King's new owner's really in the process of looking at the business and repositioning that business. So a lot of these early -- are barely indicative of what their plan is.

Kevin McClure - Wells Fargo Securities

Just to clarify, you said that Burger King is planning to promote the Whopper in Q2 2011, so this quarter. Is that correct?

Daniel Accordino

That's true, yes. That's correct.

Kevin McClure - Wells Fargo Securities

With these prices so high, how will that factor into the margin equation?

Daniel Accordino

Yes, these prices have been high, certainly, but we haven't talked about the Whopper in 30 months. So from a brand standpoint, the Whopper still is the primary driver of the brand and consequently I think it's important that we put that on air. The Whopper is not a value menu proposition. Consequently, the erosion would be not something we would be concerned about.

Kevin McClure - Wells Fargo Securities

Lastly, for us, given Burger King's locations and earnings trends, how much leverage do you believe you could -- that concept could support, the standalone entity?

Paul Flanders

Yes, I think is where we're going through this refinancing, certainly our concern is how do we properly balance leverage against the two entities and, particularly, so with each company post spinoff it has a capital structure that would adequately support their growth plans.

The challenge, of course, in this environment is given the declining Burger King trends I think it's caused us to rethink that a couple times and I think our view has been to probably shift a little more than that of the Hispanic brand, so we have to not over leverage the Burger Kings.

Operator

Your next question comes from the line of Howard Penney - Hedgeye Risk Management.

Howard Penney - Hedgeye Risk Management

I was wondering if you could speak to a little bit more specific -- you alluded to it earlier in a question -- but full [wall] unit economics in the new growth model and then compare that to the more traditional market.

Alan Vituli

The cost structures are only slightly higher. Certainly some of the finishes are a little better. But we have acceptable returns in those units once we get to the $1.9 million mark. Our expectation has annual sales for the new Pollo unit. I assume that's what you're talking about.

Howard Penney - Hedgeye Risk Management

Yes, is there some pro forma numbers that you can put together just how you envision it, margins, costs, sales, and then compare that to the traditional?

Alan Vituli

The food cost -- our sales menu prices is slightly higher in the elevated unit, which leaves our food costs pretty consistent with what our food cost is for the balance of the brand. We have some additional labor but, again, the pricing -- slightly higher prices offset that, so it's pretty consistent.

As I said, $1.9 million gives us what is our requisite return on investment. The investment is only slightly higher. So if you take any by historical units, this should look an awful lot like our historical units and beginning of $1.9 million we would be building as many of these as we could.

I don't know if that helps you. Paul, do you want to try to put that answer into -- ?

Paul Flanders

Yes, in terms of cost, as Alan said, these new units are costing roughly the same, maybe a little bit more. So in terms of the investment cost, we're investing, let's say, it's $2.8 million to $3 million, I would say typically if you include land, the average units at the volumes that Alan is talking about, $2.1 million is probably about $500,000 of cash flow.

So our margins are in the 20% plus range, which I think is consistent with where the overall brand is. Hopefully that gives you a little more color.

Operator

Your next question comes from the line of Art Roelick - Numara.

Art Roelick - Numara

My question has been answered already. Thank you.

Operator

(Operator Instructions). There are no further questions, sir.

Alan Vituli

Thank you for joining us and we look forward to speaking with you on the next quarter.

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