Carrols Restaurant Group's (TAST) CEO Dan Accordino On Q2 2016 Results - Earnings Call Transcript

| About: Carrols Restaurant (TAST)

Carrols Restaurant Group, Inc. (NASDAQ:TAST)

Q2 2016 Earnings Conference Call

August 9, 2016 8:30 AM ET

Executives

Paul Flanders – Chief Financial Officer

Dan Accordino – Chairman, President and Chief Executive Officer

Analysts

Billy Sherrill-Stephens - Stephens Incorporated

Brian Hunt – Wells Fargo

Jeremy Hamblin – Dougherty & Company

Alex Marty – Raymond James

Operator

Welcome to the Carrols Restaurant Group’s Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be given at that time. I would like to remind everyone that this conference is being recorded today, Tuesday, August 9, 2016 at 8:30 AM Eastern Time and will be available for replay.

I will now turn the conference over to Paul Flanders, Chief Financial Officer. Please go ahead, sir.

Paul Flanders

Good morning. By now, you should have access to our earnings announcement released earlier this morning, which is available on our website at www.carrols.com under the Investor Relations section.

Before we begin our remarks, I would like to remind everyone that our discussion will include forward-looking statements, which may consist of comments regarding our strategies, intentions, guidance or plans. 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 more details, especially the risks that could impact our business and results.

During today’s call, we will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation, or as a substitute, for results prepared in accordance with Generally Accepted Accounting Principles. A reconciliation to comparable GAAP measures is available with our earnings release.

As a remainder, earlier this year we modified how we’re grouping our restaurants for reporting and analysis. Acquired restaurants refer to those restaurants acquired through from 2014 through 2016, while legacy restaurants include all of the Company’s other restaurants, including the restaurants acquired before 2014.

With that said, I will now turn the call over to the President and CEO of Carrols Restaurant Group, Dan Accordino.

Dan Accordino

Thanks Paul and good morning everyone. We delivered solid quarterly results for the second quarter of 2016, including a strong increase in revenues along with a 34.1% increase in adjusted net income. This has enabled us to raise our guidance for the full-year, which we will discuss in a moment.

Second quarter revenue increased 10.2% over the prior year period to $241.4 million and included $60.5 million in total sales from 196 BURGER KING restaurants we have acquired over the past two and a half years. Comparable restaurant sales increased seven tenths of a percent, which we consider a solid performance given the fact that we were lapping at 10.3% comparable sales increase in the second quarter of 2015, our toughest comparison of the year. We have now generated comparable restaurant sales increases for eight consecutive quarters and 18 of the last 20 quarters.

BURGER KING’s marketing and promotional initiatives during the second quarter took a balanced approach on menu and marketing maintaining focus on both value and premium offerings. It’s fair to say though that the intense competitive environment has caused most of QSR to continue using aggressive price-pointed offers, meal bundles and aggressive discounting to drive traffic.

Breakfast continues to be our strongest day part, reflecting increased advertising spending, the two-for-$4 promotion of our breakfast Croissan'wich line and BURGER KING’s introduction of the Egg-Normous Burrito. The five-for-$4 meal, which includes a bacon cheeseburger, four piece chicken nuggets, small fry, a small drink and chocolate chip cookie continued to be an effective value offering. Similarly, the two-for-$5 mix and match promotion which included the new extra long philly cheeseburger, continues to be an effective platform for promoting our limited time premium sandwiches. And lastly, grilled hot dogs and chicken fries both remain popular with our customers and have been effective in building average check.

In late May BURGER KING also began a promotion of our signature burger with the launch of the two-for-$10 whopper meal deal, which features two whopper sandwiches bundled with two small fries and two small drinks. I think it’s fair to say that with the number of promotional tactics being employed, BURGER KING has been quite active on a promotional level. As demonstrated by our overall results these offerings are resonating with customers in what’s been a very competitive environment.

As I indicated earlier, our solid top line increase translated well in terms of increased profitability. Restaurant-level EBITDA increased 16.6% to $41.5 million from the prior year period and included an $8.7 million contribution from the acquired restaurants, while adjusted EBITDA increased 19.9% to $27.9 million. Restaurant-level EBITDA margin improved 95 basis points on an overall basis from the prior year period and almost 200 basis points at our acquired restaurants. These margin improvements largely reflected a more favorable commodity environment and the contribution from improved operating performance at our acquired restaurants.

We remain focused on executing our two other strategic priorities, enhancing the competitive position of our asset base through our restaurant remodeling program and executing our expansion strategy of selectively acquiring additional BURGER KING restaurants. We completed 43 remodels in the first half of the year and for the full-year expect to complete 85 to 90 remodels and to rebuild or relocate another 11 to 14 restaurants. This will bring the total number of our locations that have been upgraded to the 2020 design image since 2012 to over 525 restaurants.

In 2017 we expect to reduce the level of remodeling and in turn increase our free cash flow and capital available for our ongoing expansions. We continue to opportunistically expand our restaurant base with the ongoing acquisition of existing restaurants. Through July we had completed the acquisition of 22 restaurants in three transactions. 12 Burger King Restaurants were acquired in Central Pennsylvania in February and we added another 10 units in the Detroit area with acquisitions in May and July. We are evaluating a number of potential transactions and would expect to complete the purchase of additional restaurants in the second half of the year. Acquisition multiples remain attractive and we believe these transactions will continue to be highly accretive as we acquire and integrate additional restaurants.

To conclude, we are executing well in the face of macro pressures affecting our industry and making solid progress on a number of fronts. And I will now turn the call over to Paul for our financial review.

Paul Flanders

Thanks Dan. Restaurant sales during the second quarter increased 10.2% to $241.4 million from $219.1 million in the prior year period. Restaurants acquired since the beginning of 2014 contributed sales of $60.5 million, compared to $38.8 million in the second quarter of last year. Comparable restaurant sales increased 0.7%, compared to an increase of 10.3% in the second quarter of 2015. This included a 0.9% increase in our legacy restaurants and a 0.4% decrease at comparable acquired restaurants, primarily the 2014 acquired restaurants.

The overall increase reflected a 2.1% increase in average check offset by 1.4% decrease in traffic. It’s worthy to note that our average check held up very well in light of the higher level of discounting, as promotions and customer add on purchases were effective in driving higher transaction averages.

Turning to profitability, adjusted EBITDA increased 19.9% to $27.9 million from $23.3 million in the prior year period and adjusted EBITDA margin improved to 11.6% from 10.6%. Restaurant-level EBITDA increased 16.6% to $41.5 million. Restaurant-level EBITDA margin was 17.2% and improved 95 basis points from the year-ago period reflecting more favorable commodity cost and improved operating performance at the acquired restaurants. Restaurant-level EBITDA margin increased 106 basis point in our legacy restaurants and increased a 196 basis points at the acquired restaurants.

Cost of sales as a percentage of sales was 188 basis points lower in the second quarter, compared to the prior year period. This primarily reflected the impact from more favorable commodity costs, including lower ground beef prices, along with improved operating performance.

Effective menu pricing was 2.8% and helped offset some of the impact from the higher discounting. Beef cost averaged $1.95 per pound in the second quarter of 2016, which was approximately 17% lower than the $2.36 cost per pound in the prior year period. We now expect our average beef cost to be down 10% to 12% for the full-year.

Restaurant labor expenses were essentially flat, compared to the prior year quarter of 30.5% of sales. The impact of an approximate 6% increase in our average hourly rate was offset by lower restaurant-level bonuses, medical claims and unemployment insurance.

Advertising expense increased from 3.7% of sales in the second quarter of 2015 to 4.5% due to an increase in spending on local advertising and the 2015 expiration of advertising credits that we had been receiving from Burger King related to 2012 restaurant equipment investments.

General and administrative expenses were $14.4 million in the second quarter, compared to $12.9 million in the prior year period and were unchanged as a percentage of restaurant sales at 5.9%.

Overall we posted strong increases in net income and adjusted net income. Net income for the second quarter was $9.4 million or $0.21 per diluted share, compared to a net loss of $5 million or $0.14 per diluted share in the second quarter of 2015. Net income in the second quarter of 2016 included a $1.85 million charge related to an agreement to settle and resolve the ongoing litigation with the company’s former Chairman and CEO. Net income also included $0.3 million of impairment and other lease charges, $0.2 million of acquisition expenses and a $0.5 million gain from fire insurance proceeds.

For the same period last year, the net loss included a $12.6 million loss on extinguishment of debt, related to the Company’s debt refinancing and $0.7 million of impairment and other lease charges.

Adjusted net income was $11.3 million, or $0.25 per diluted share, and increased 34.1% or $8.4 million or $0.19 per diluted share in the prior year period. As a reminder we are not currently recording any income tax expense, as a consequence of having a net deferred tax asset valuation allowance since 2014. Accordingly there was no income tax expense or benefit reflected in either the 2015 or 2016 results.

Total capital expenditures in the second quarter were $20.8 million and included $13.4 million for remodeling. In addition, we invested $12.1 million for the acquisition of six BURGER KING Restaurants in the Detroit area, including $7.1 million for the real estate.

In the second quarter of 2016, we completed the sale leaseback of nine restaurant properties for net proceeds of $12.7 million. In the second half of 2016 we expect to complete the sale lease backs for net proceeds of an additional $10 million to $15 million consisting of restaurant properties acquired in our 2016 acquisitions and certain owned restaurants recently constructed or remodeled.

At the end of the quarter, our cash balances were $9.7 million, total outstanding debt was $208.8 million and lease adjusted leverage ratio was approximately 4.5 times.

Lastly, I will provide an update regarding our 2016 guidance. We now expect total restaurant sales to be $945 million to $960 million, up from our previous guidance of $935 million to $960 million. This projection includes an estimated 2% to 4% growth in comparable restaurant sales on a comparable 52-week basis which remains unchanged.

Our outlook for commodity costs continues to improve. We now expect commodities to be down 2% to 3% with beef cost down 10% to 12%. We previously projected commodities to be flat to down 2% with bee costs decreasing 5% to 10%.

General and administrative expenses are expected to be $51 million to $53 million, excluding stock compensation costs. This is a little bit higher than our previous estimate of $50 million to $52 million, due to higher projected bonus levels.

Adjusted EBITDA is now expected to be between $90 million and $95 million, up from $85 million to $90 million previously estimated.

We now expect total capital expenditure excluding acquisitions of approximately $85 million to $90 million, up from our previous estimate of $75 million to $85 million. This includes the remodeling of 85 to 90 restaurants, the rebuilding of four to six restaurants and the construction of seven to eight new restaurants, all of which are relocations of existing restaurants.

Lastly, for 2016 we expect to complete sale leasebacks of owned restaurant properties for net proceeds of $27 million to $32 million. Net proceeds from sale leasebacks completed in the first half of 2016 totaled $17.7 million.

And that concludes our prepared remarks, so with that operator, it looks like I can open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We will go ahead and take our first question from Will Slabaugh with Stephens Incorporated. Your line is open.

Billy Sherrill-Stephens

Yes, hi thanks guys. It is actually Billy on for Will this morning. Congrats on a good quarter by the way. Could you talk a little bit about the labor for a minute? Like you said, you were able to essentially hold it flat this quarter, so wondering if you could break that out into the legacy and the acquired base? So we could get a little feel for the magnitude of the improvements? And also just how you might be thinking about labor for the back half of the year, should we expect kind of a similar amount of inflation or will that pick up a bit?

Paul Flanders

Yes, when we look at the breakout in our labor between the legacy and the acquired restaurants, we actually de-levered about 35 basis points on the acquired restaurants. And we actually reduced labor as a percent of total of sales at the legacy restaurants by about 20 basis points. If we just look at our hourly and management payroll, we deleveraged on both. The offsets came in the form of some bonus differences relative to performance, so that those were more favorable taxes. Unemployment insurance has been lower this year. And then in New York State, which primarily affects our legacy restaurants, we received some credits against the wage rates for some of the workers that are under 19, which benefitted us there, as well.

Billy Sherrill-Stephens

Got you, that’s helpful. And I know you don’t typically breakout monthly cadence, but kind of given the volatility in the space, would you be willing to speak at a high level about what you saw throughout the quarter. And what gives you confidence coming out of 2Q in the quarter to date period to reiterate your comp guidance?

Paul Flanders

Well, I mean to start, the second quarter was our toughest comparison of the year with 10.3% last year. Having said that, we did see – we saw acceleration in our comps throughout the quarter. So our best month was, it turned out to be June and we were up on a two-year basis, it was up about 12%. If we look at July, we were just very slightly negative on a comp basis in July, but we had the shift of the 4 of July. If we take that one day out, that Monday, and analyze the rest of month we were actually up slightly positive for the month of July. July, on a monthly basis was in fact our hardest comparison of the whole year, last year. We were almost 12% in 2015.

So I think if you look at where we went from April through July we see some solid acceleration in the comps.

Billy Sherrill-Stephens

Got it, that’s helpful. And just one last one kind of along with that. Are there any notable daypart trends that could you can speak to?

Paul Flanders

Well I think the most significant one that we’ve touched on - Dan touched on it, is the fact that breakfast continues to be very strong. We’re spending more advertising against that daypart, there have been some new product introductions, and some promotions around breakfast as well which has then helped. Other than that, I wouldn’t say there’s really anything of note.

Billy Sherrill-Stephens

Got you. And sorry, one last one if I could, just could you talk us through the rationale for the sale leaseback transaction and kind of whether there’s any motivation there beyond just bringing up more capital for acquisitions? And I guess maybe whether or not we should be expecting that trend to continue into next year?

Paul Flanders

Well we historically see leasing – we prefer leasing because we think we can employ the capital for higher returns by buying stores versus holding the real estate. I mean it is just pretty simple as that frankly. And so clearly when we do these acquisitions, if we can, we want to purchase the real estate because we can finance in the sale leaseback market at very attractive rates, and again, at the end of the day, have more favorable leases than what we would probably be able to negotiate with third parties. And so, yes, we will continue to do that. We want to buy real estate and we will continue to do sale leasebacks.

Billy Sherrill-Stephens

That’s it that’s helpful. Thanks guys. Congrats a good quarter.

Operator

Now we’ll take our next question from Brian Hunt with Wells Fargo. Your line is now open.

Brian Hunt

Yes first question is, I was wondering has the pace of same store sales improvement at remodels changed at all. I mean I think you’re historically saying 8% to 10% or slightly over 10%. So what are you saying now?

Paul Flanders

Yes I think we probably used to say 12% to 15% and then we said 10% to 12%, I think generally what was happening, remember a lot of systems have been remodeled, particularly in our market. And so the incremental affect that we’re getting and the ones we’re doing now, while it varies, it can be all over the board, but just generally is still in the 8% to 10% range.

Brian Hunt

Great. My next question is when you look at same-store sales, are your rebuilds and relos in the same store sales number?

Paul Flanders

Yes.

Brian Hunt

Okay. And I imagine those are getting a bigger pop or are they similarly in that 8%, 10% range?

Paul Flanders

It’s a small number relative to the total base. It’s a small number of restaurants.

Brian Hunt

Yes, okay.

Paul Flanders

They are getting bigger increases.

Brian Hunt

Got you. And thinking about 2017 as your remodel pace drops materially I imagine your best use of excess cash is to make the acquisitions. But as you go down the path, if acquisitions aren’t available, how should we evaluate your uses of cash? Is there enough white space to start to open restaurants within your network? And if so how big is that number?

Dan Accordino

I would expect – this is Dan. First of all, I think, the acquisition pipeline continues to be robust. So I expect that there will be many opportunities in the balance of this year as well as 2017. And in terms of new construction, yes, there is opportunity for us to build organic growth restaurants and we will continue to do that as well. My guess is that number should be somewhere in the six to ten range per year.

Brian Hunt

Alright. And then my last question. I was wondering do you believe we’re almost getting to the point of saturation on promotion? Or do you feel like there’s any confusion in the marketplace, because there just seems to be a lot of it – whether it’s five-for-$4 or two Whoppers for $10, it just seems there’s a lot thrown against the wall. Maybe that’s too simplistic, but it feels like the market is become saturated with it?

Dan Accordino

Well I think certainly that it’s a very competitive environment. And I think, certainly that that’s an expectation on behalf of the consumer that they are certainly attracted to various promotional offers. And I think the consumer expectation is that that will continue.

Brian Hunt

Very good that’s it from me, I appreciate your time.

Operator

And we will go ahead and take our next question from Jeremy Hamblin with Dougherty & Company. Your line is open.

Jeremy Hamblin

Hi good morning guys. Congrats again on the nice quarter. Wanted to just ask a question about ground beef prices, you mentioned they were a $1.95 a pound in Q2. How have been the prices over the last couple of weeks?

Paul Flanders

So I’ll go through the, well since July we’ve been closer to $2 a pound, pretty consistent.

Jeremy Hamblin

Okay so that’s kind of roughly the level that you’re expecting for the remainder of the year?

Paul Flanders

Yes, we think it will be. Again we’re sort at the peak obviously of summer grilling and all of the rest and we hope that may be it tails down a little bit, but our guidance assumes we’re going to stay around $2.

Jeremy Hamblin

Okay, and then in terms of the marketing and advertising cost, you noted that you kind of had expiration of some credits from the 2012 deal. Can you help me think about how we should be looking at that line item in terms of percent of sales, I think historically it’s kind of run between 4% to 4.5%, it was a little below that in 2015, but it jumped back up to that kind of high-end of your range, should we be thinking – it’s going to be towards that 4.5% or how should we be thinking about that?

Paul Flanders

Yes, I think 4.5% is the way, you should think. I mean the contribution of the national advertising fund is 4%. And we’re doing more investment spending and spending locally now without the benefit of the credit to offset, obviously.. And we would anticipate that incremental spending is probably going to be 0.5% going forward, near term at least.

Jeremy Hamblin

Okay. And then in terms of just thinking about kind of putting these two things together with your local spend, what you guys are doing different? Obviously, you were lapping much tougher comps than corporate was and yet you guys delivered comps that were 150 basis points above their level. What do you think you’re doing differently to generate kind of the much better than corporate average sales trends?

Dan Accordino

This is Dan. I’m not sure that we’re doing anything terribly different. I think you have to look at this thing geographically. And it might very well be that the markets in which we operate are trending a bit better than some of the other geographic parts of the BURGER KING system.

Jeremy Hamblin

Okay. And then I just want to clarify something, because the press release reads a little bit funny, Paul, where it’s talking about the acquired restaurant-Level EBITDA was $41.5 million in Q2, which included $8.7 million contribution from acquired locations. That includes the acquired locations from 2014, so really…

Paul Flanders

Correct.

Jeremy Hamblin

On an apples-to-apples basis because I think there was some question about whether or not EBITDA actually grew outside of the acquisitions you’ve done over the last year. But as you look at that EBITDA table, you can see the legacy restaurants clearly improved by a couple of million dollars. I’m reading that correct, right?

Paul Flanders

Yes, the legacy restaurants are up about $2 million. Yes, that is correct and margin is expanding. And the acquired restaurants obviously have gone up because we’ve acquired more restaurants and those increased about – well from $4.8 million to $8.7 million and margins expanded a couple of hundred basis points.

Jeremy Hamblin

Okay. And then just a question into the pipeline that you see out there, how would you describe the pipeline in terms of potential deals that are in the works? Do you see anything that’s larger than kind of 10 unit, 20 unit deal out there? How does the pipeline compare today versus, let’s say, where it was in May and where it was at the beginning of the year?

Dan Accordino

I think it’s probably – we’re further along in terms of the deals that we had been contemplating, that’s for sure. And a number of restaurants per transaction tend to range between three and 20.

Jeremy Hamblin

Okay. And then one last question for you Paul. Just in thinking about lapping the 14-week fourth quarter, from last year, how should we be thinking about restaurant operating expenses line-item, which I know you leveraged pretty nicely last year? Should we be thinking that’s going to be deleveraging because you don’t have that extra week?

Paul Flanders

Well, I think in total that's a function of obviously how strong comps are for the balance of the year.

Jeremy Hamblin

Understood, but just if you take the mid point of your guidance…

Paul Flanders

No, I am expecting – I’m still expecting the other operating we should get leverage on operating expenses.

Jeremy Hamblin

Okay, but – okay, alright, thank you. I’ll hop back in the queue.

Operator

[Operator Instructions] We will take our next question from with Alex Marty with Raymond James. Your line is open.

Alex Marty

Good morning, guys. This is Alex Marty on for Brian Vaccaro. I appreciate the color on the labor line. I was just wondering with the impact of the overtime rule changes that could take effect later this year could have on the business in the sense of magnitude or how many employees could be impacted by those rules?

Dan Accordino

This is Dan. The law takes effect December 1st. And we’re actually starting to look at how we’re going to address that currently. We are putting all of our salaried managers on an hourly basis. It will not cost – I mean we’re not going to change the compensation of the managers. We’re simply taking i.e., 50-hour work week or 55 hour work week wherever we end up and converting their current salaries into an hourly rate, assuming the overtime. But the effect on employees, first of all it effects all of our salaried managers, number one; and number two, from an economic standpoint we won’t really know what the effect is going to be until after we go through this for a couple of months to see if our – the number of overtime hours that we’re paying is consistent with what we’re modeling.

Alex Marty

Very helpful, thank you. And can you guys quickly comment on the gap between legacy and acquired unit comps?

Paul Flanders

The gap between, I mean, let me if I could just maybe annualize it. The legacy restaurants I think are about $1,360 million or $1,370 million now. And the restaurants we acquired in 2014, as we said, were a little bit lower. 2015 acquisition were more in line with our legacy averages. So those as a group are a little bit below about $1.3 million or a little bit below $1.3 million. The ones we’re buying this year are about a $1,350 million, so they’re very close to the legacy restaurants. So the only batch of acquisition that's really that’s much different than our legacy is the 2014 acquisitions just because there was a couple of transactions there that had a few lower volume restaurants that may be closed over the longer-term.

Alex Marty

Understood that was helpful. And last quick one, do you guys have ending store counts for legacy versus acquired units?

Paul Flanders

Yes legacy count was 527 and then the balance was the acquisitions since 2014.

Alex Marty

Perfect. Thank you guys and have a good day.

Dan Accordino

Thanks.

Operator

And once again, is there anyone to ask a question? And we have no further questions at this time.

Paul Flanders

Okay. Well, we appreciate everybody’s attendance today and we look forward to speaking next quarter again. Thanks. Have a good day.

Operator

And this concludes today’s program. Thank you for your participation. You may now disconnect.

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