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Carrols Restaurant Group, Inc. (TAST)

Q2 2012 Earnings Results Conference

August 07 2012 08:30 AM ET

Executives

Daniel T. Accordino - CEO, President, and Director

Paul R. Flanders - CFO, VP and Treasurer

Analysts

Bryan Elliott - Raymond James & Associates, Inc

Andrew Gadlin - CJS Securities, Inc.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Bryan Hunt - Wells Fargo Securities

Howard Penney - Hedgeye Risk Management

Operator

Thank you for standing by. Welcome to the Carrols Restaurant Group Second Quarter 2012 Earnings Conference Call. As a reminder, today’s call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. (Operator instructions.)

I’d now like to turn the call over to Paul Flanders, Carrols’ Chief Financial Officer, for opening remarks. Please go ahead, sir.

Paul R. Flanders

Good morning, everyone. By now you should have access to our earnings announcement released earlier today, which can also be found on our website at www.carrols.com under the Investor Relations Section. Before we begin our remarks, I want to remind everyone that our discussion today will include forward-looking statements, which may include comments regarding our strategies, intentions 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 a more detailed discussion of the risks that could impact our business and financial results. Please note that during today’s call, we will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. Presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP in the reconciliation of comparable GAAP measure is available in our earnings release.

I’ll now turn the call over to the President and CEO of Carrols Restaurant Group, Dan Accordino.

Daniel T. Accordino

Thanks, Paul, and good morning everyone. Let me begin with an update on our recent acquisition before moving on to more general brand initiatives, a brief discussion of our quarterly performance.

As you’re likely aware we closed on our acquisition of 278 restaurants from Burger King Corporation on May 30th, and in doing so became the largest franchisee within the Burger King system. Total consideration to Burger King Corporation included a 28.9% equity interest in Carrols as well as cash payments of approximately $17 million.

The $17 million included $9.4 million in refranchising fees, $3.7 million for inventory and cash, and the remaining balance to be paid over a 5 years in conjunction with the assignment of Burger King’s right of first refusal and on franchisee sales of restaurants in 20 states. We do this transaction as a very important step in Carrols evolution as we increased our operating scale and establish a foundation for significant growth in the future. Also BKC’s President in North America, Steve Wiborg and CFO, Daniel Schwartz were appointed to our Board of Directors on final completion of the transaction.

Concurrent with the acquisition, we completed a financing in which we raised funds to refinance our existing debt to fund the cash consideration for the acquisition and to undertake the remodeling and transformation of over 450 restaurants over the next 3.5 years.

The refinancing included the sale of a $150 million of 11.25% senior secured second lien notes, due in 2018 along with the new $20 million revolving senior credit facility. The acquisition has nearly doubled the scope of our Burger King operations, added a number of new markets to our existing footprint and strategically positions us for future expansion. We now have 574 restaurants in our portfolio, up from 297 at the end of the first quarter and have substantially expanded our presence in States, such as Indiana, Virginia and North Carolina.

Our near-term focus is on integrating the acquired restaurants improving their operating and financial performance, a longer term we intend to capitalize on the consolidation opportunities that we believe are present within the Burger King system. To put this opportunity in perspective, there are more than 2,000 restaurants operated by other franchisees in the markets covered by our right of first refusal.

To be sure, we will have our hands full for some time absorbing the recently acquired restaurant and with the remodeling that I don’t want to signal that you should expect any large scale acquisitions any time soon, although we may pursue some smaller transactions as opportunities present themselves.

As we’ve outlined in our SEC filings, there are substantial differences between the profitability of the acquired restaurants and our legacy Carrols restaurants. With restaurant level profitability about a third of our legacy units, narrowing these differences should provide significant upside to profitability as we improve operations, implement our inventory and labor management systems and impose our cost management disciplines.

Additionally, we see opportunities to raise sales and profitability at all of our restaurants as Burger King’s strategic brand initiatives stake hold, including the new products and products enhancements, the new advertising and marketing campaigns, and finally from image upgrades from the 2020 restaurant remodeling program.

Turning to the brand, Burger King introduced more than a dozen new menu items in early April, which marked the broadest menu expansion on the brands history. The new menu items range from Garden Fresh Salads, Snack Wraps and Crispy Chicken Strips to Real Fruit Smoothies and Frappes. These new products have addressed gaps in the menu on a number of day parts and are appealing to a broader consumer audience including women, children and seniors. In the future, we anticipate the introduction of additional new products as Burger King takes advantage of the investments that have been made a new equipment to support the various menu platforms.

For the second quarter comparable restaurant sales increased 8.8% marking the third consecutive quarter of positive results and our best quarterly performance in a number of years. Sales and traffic were up across all day parts as the featured products, promotions and brand messaging resonated with our consumers.

New products and promotions were accompanied by effective marketing, messages helping drive the strong quarterly sales results, including new ads featuring celebrities that are part of a national multi platform marketing campaign, but also it stands across social media applications.

More recently BK launched the series of barbecue-inspired menu items and of positioning the brand as the home of the summer barbecue. The barbecue menu items included new twist on classics for whopper sandwich fans as well as other innovative offerings. The new limited time menu includes a Memphis Pulled Pork Barbecue Sandwich, Carolina Barbecue Whopper and Chicken Sandwiches, Texas Barbecue Whopper and Chicken Sandwiches, Frozen Classic Lemonades, Strawberry Lemonade, Sweet Potato Fries, and Bacon Sundae.

The summer menu was also being accompanied by a new tag line Taste is King. So while we have been keeping rather busy over the past several months, this is an exciting time for our Company and we’re very encouraged by the positive momentum we’ve experienced from the brand transformational initiatives. While there is much work left to do, we’re encouraged by our top line improvements and believe that we can create sustainable traction in our bottom line performance as well.

With that, I will turn the call over to Paul to continue our financial review.

Paul R. Flanders

Thanks, Dan. I want to point out that Fiesta Restaurant Group’s financial results for all periods prior to the spin off, that was completed May 7, 2012 has been reclassified as discontinued operations. Our comments regarding financial results will focus only on results from continuing operations or in other words our Burger King business. Results from the acquired Burger King restaurants are included from May 31st, the day after the acquisition close.

Restaurant sales grew 37.8% to $122.1 million, which included $27.5 million in sales from the 278 acquired restaurants compared to $88.6 million in sales from the same period last year, [the event] as comparable restaurant sales increased to 8.8% for the quarter. This increase included an increase in customer traffic of 4.9% and an increase in the average check of 3.9% including an effective price increase of 2.3%.

Adjusted EBITDA, a non-GAAP measure, was $7.9 million in the second quarter compared to $7.7 million in the prior-year and adjusted EBITDA margin was 6.5% compared to 8.7% in the prior-year. Before the effect of general and administrative expenses, the acquired restaurants contributed $1.3 million to adjusted EBITDA for the month or so that we own that. That indicated the profitability of these units substantially below our legacy Burger King restaurants. Inclusion of their results reduced overall adjusted EBITDA margin by approximately 2.2%, which partially offset the improvements that we experienced in the rest of our restaurants.

In one of the tables, attached to the earnings release, we provided supplemental data on restaurant level expenses for the second quarter for which you can get a better idea of the differences in operating margins between the acquired and the legacy units. You can also find comparative P&L data in our SEC filings where we’ve presented the acquisition on a pro forma basis. Where it is evidenced from this data is the considerable opportunity that we have to narrow these differences and to significantly improve the financial results of these units as we move forward.

In the second quarter there was a difference in operating margins of more than 950 basis points. I’m not going to go line by line to the P&L for the stake of revenue, but you can see that the most restaurant level costs for the legacy restaurant is the percentage of sales were lower in the quarter compared to last year as we leveraged the higher sales volume. The exception was cost of sales, which increased to 120 basis points for the legacy restaurants due to higher commodity costs namely ground beef and from slightly higher discounting in the quarter.

I do however, want to spend a moment discussing general and administrative expenses, which in the aggregate increased $3.2 million to $8.1 million for the quarter from $4.9 million in the second quarter of 2011 and as a percentage of sales increased 1.1% to 6.6%. Included in general and administrative expenses were approximately $800,000 of expenses incurred in connection with the restaurant acquisition, approximately $500,000 of incremental field and corporate overhead costs for the acquired restaurants, $700,000 of legal fees related to recent activity regarding our outstanding litigation with the EEOC, and about $700,000 increase in bonus expense.

Additionally because of the spin off of Fiesta, net G&A expenses increased somewhat due to the reduced allocation of certain corporate costs with Fiesta. Depreciation and amortization expense increased from $4 million to $6.3 million due to the addition of 278 Burger King Restaurant and from the investments earlier this year in new point of sales systems in new kitchen equipment.

Interest expense increased from $2.3 million to $2.6 million in the quarter, including about $300,000 related to the settlement of an interest rate swap in conjunction with the refinancing. Net loss from continuing operations for the second quarter of 2012 was $900,000, or $0.04 per diluted share, compared to net income from continuing operations of $300,000, or $0.01 per diluted share last year. The loss in the second quarter of 2012 included charges totaling $2.3 million or $0.06 per diluted share net of tax including a loss on the extinguishment of debt of $1.5 million or $0.04 per share due to refinancing, and acquisition related expenses of $800,000 or $0.02 per diluted share. Capital expenditures for the quarter totaled $9.9 million including $4.5 million for remodeling and $4.4 million for our new point of sales system rollout.

Total outstanding debt was $162.1 million at quarter end, mostly comprised of $150 million of 11.25% senior secured second lien notes and at the end of the quarter our cash balances totaled $78 million which included $20 million of restricted cash held as collateral for our revolving credit facility.

Finally, I’d like to provide you with our current guidance for 2012. Comparable restaurant sales for the full-year are expected to increase between 4% and 6%. Commodity cost is expected to increase 3% to 4%. General and administrative expenses excluding stock compensation for the second half of 2012 are expected to be approximately $14 million to $15 million. This excludes legal fees that we may incur in conjunction with the EEOC litigation where we’re recently seeing some activity.

The annual effective income tax rate is expected to be between 42% and 44% and lastly, capital expenditures are expected to be approximately $40 million to $45 million including $28 million to $33 million for remodeling more than 80 restaurants.

And with that, we’ll now open the line for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And our first question comes from the line of Bryan Elliott with Raymond James. Please go ahead.

Bryan Elliott - Raymond James & Associates, Inc

Drill down a little more on the comp result, obviously we saw the system as a whole slow through the quarter, that looks like you all did not do that and just wondered if you could elaborate a bit and help us understand that difference?

Paul R. Flanders

Well, as we said we were up 8.8% for the quarter. We maintained pretty good momentum through sequentially in each of the months. We we’re – I’d say we started out probably about 9.5% as we said in the last call, over 9% in May and about 7.5% in June. So, I think June was lower, but again it’s relative to where our run rate was.

Bryan Elliott - Raymond James & Associates, Inc

And just, I guess and sort of thinking about where you are versus them, I mean do you think your operational disciplines are already having an impact on execution at the store level or do you think the difference between the national results and (indiscernible) results maybe are a function of maybe better geography and economic conditions and your markets would be in a little bit better, just wondered what your – and I understand it’s somewhat guess work about what your perspective on – what the cause of the widening gap between you and the system as a whole might be in your minds?

Daniel T. Accordino

Bryan, this is Dan. I think generally its geographic, I think if you look at the Burger King same-store sales across the country you would find that the markets on the east-coast are tending to perform at a higher level than the markets on the mid-west and west.

Bryan Elliott - Raymond James & Associates, Inc

Okay, thanks. That’s helpful. Also on the, the product extensions, particularly the beverages and sort of the snack items which have driven a lot of shoulder period sales for some other folks in the industry. Are you seeing similar timing of sales for those items or are you starting to essentially be a player in the shoulder periods?

Daniel T. Accordino

We are – our sales are positive across all day parts and the snack period certainly has been a strong period for us ever since the products were rolled out in April. So yes, I think that we are seeing momentum in parts of the day that we weren’t necessarily as strong as others.

Bryan Elliott - Raymond James & Associates, Inc

And last question would be, the average check and the positive mix-shift actually of magnitude despite you’re calling out some discounting as pressuring the gross margin, where you could give us a lay of the land on what you see going on competitively out there with the slowing consumer environment, did it get worse through the quarter, what areas might be seeing competitive discounting be at its more extreme is it breakfast or et cetera, and in light of that and given the snacks and the beverage which are sort of somewhat below average, sales probably, what really drove that average ticket and mix – a positive mix-shift were you able to really drive traffic to the premium burgers or was there something else going on, help me with that a bit please?

Daniel T. Accordino

I think there are two things essentially that, many of the snack items are being purchased as incremental sales add on, so that helps our average check and as Paul indicated in his financial review, our average ticket is up about a 0.5 higher than our price increases. So, that is part of it. The other part of it is, there’s less reliance on the value menu. Some of the value menu items, the prices they’ve been taken off the – at a $1 price point and been raised to a higher level of $1.19 or $1.29 or something of that nature. So, I think there is, you got some higher price points around the value menu which is also true for the competition and there’s less reliance on the value menu than has been historically the case.

Bryan Elliott - Raymond James & Associates, Inc

Excellent, great. Thanks so much.

Operator

Thank you. And your next question comes from the line of Andrew Gadlin with CJS Securities. Please go ahead.

Andrew Gadlin - CJS Securities, Inc.

Good morning. Just following up on the previous question; could you comment on how the same-store sales growth has continued into this quarter?

Paul R. Flanders

Yeah, I mean, we were continually very robust, I mean, July our comparable stores were up over 8.5%.

Andrew Gadlin - CJS Securities, Inc.

One of the things that came out is that the new restaurants have a lower sales level -- about 13.5% lower sales level than your legacy stores. Is there an opportunity to boost those sales levels as well?

Daniel T. Accordino

Oh, absolutely. That is one of the – we’ve got two pieces to the opportunity that we saw when we purchased these restaurants. The first piece was the restaurants that are performing at a lower AUV than our legacy stores, in many cases are in the same geography that our legacy stores exist, which certainly lends itself to the fact that we can improve the sales of those restaurants by imposing certainly operating disciplines. The second piece is obviously the huge P&L leverage opportunities which we’re starting to realize already.

Andrew Gadlin - CJS Securities, Inc.

Great. Do you have any sense on the timing that changed it all?

Daniel T. Accordino

We are – from a sales standpoint we will expect to see that slope starting to get better in the end of third and fourth quarters. There’s no reason not to, as we impose our operating disciplines. From a P&L standpoint the labor numbers will be on our formula by the fourth quarter of this year, and we would expect to realize a 50 basis point improvement in cost of sales in terms of the inefficiency between now and the end of 2012 and another 100 to 150 basis point improvement in cost of sales due to limiting inefficiencies in 2013.

Andrew Gadlin – CJS Securities, Inc.

Great.

Daniel T. Accordino

We would also expect to see some improvement in terms of these sales increases by virtue of accelerating this remodeling program. Originally we had said that we were going to do 55 remodels in 2012. We have now upped that number to north of 80.

Andrew Gadlin - CJS Securities, Inc.

Safe to say that you’re still getting the type of returns on the 2020 remodels that you were getting earlier?

Daniel T. Accordino

Yes.

Andrew Gadlin - CJS Securities, Inc.

Okay. There has been some concern’s that with the rise in corn prices that could cycle through to higher ground beef prices going forward. What’s your sense of that?

Daniel T. Accordino

I think going forward it’s true that in 2013 – for the first half of 2013, we think the price of ground beef is going to be very problematic. For the balance of 2012 it will have quite the opposite effect that more cattle are being slaughtered and therefore the price of ground beef now is lower than what we had forecasted.

Andrew Gadlin - CJS Securities, Inc.

Is the price of ground beef in Q3, are you sensing that it’s going to be lower than it was in Q2?

Daniel T. Accordino

It will be equal to or below where it was in Q2.

Andrew Gadlin - CJS Securities, Inc.

Okay. And then when would you start to see that in 2013, you’ll see it in the first quarter?

Daniel T. Accordino

Yes.

Andrew Gadlin - CJS Securities, Inc.

Okay. All right. Thank you very much.

Operator

Thank you. And our next question comes from the line of Karen Eltrich with Goldman Sachs. Please go ahead.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Thank you. As we look at the EBITDA performance you did outline obviously some one-time costs, but given the comp-store performance, I guess, I’d have expected more of an EBITDA pull from your legacy stores. What kind of were some of the drags on that given the strong comp store sales?

Paul R. Flanders

Well, they really were any other than cost of sales. As I said cost of sales were up about 120 basis points in the legacy restaurant. The impact is that we did expand margins and leverage just everything else in the P&L in the legacy restaurant. And as I said the discounting affected it a little bit, but that maybe with 50 basis points.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

And the discounting was attributable to the couponing that took place?

Daniel T. Accordino

Yeah. There was some retail activity Karen around the introduction of all of these new game changer products.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Right. And can you maybe give an update in terms of the conversion to systems for the newly acquired stores and how that’s going and how quickly you’ll start to see some benefits from that?

Daniel T. Accordino

We’ll start to see some labor benefits in reasonably short order. We’ve got a meeting next week with all of the newly acquired restaurants to walk them through our labor scheduler and how we calculate labor at the legacy restaurants and that will be put into effect by September 4th.

From a cost of sales standpoint, those initiatives are already in place and the [disturbance] now are around the operators in understanding what their obligations are to take inventories and accept the food deliveries appropriately and that sort of things. So the technology is there, right now we’re coaching around what they’re supposed to be doing.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Great. And the final question, as you mentioned there’s been a lot of change on the menu. How does the pipeline look and how are you finding that your labor is adjusting to all of the changes?

Daniel T. Accordino

The pipeline is robust. There are a whole new series of products that will be coming out shortly, after new LTO barbecue items are now being phased out and it’s going to be a new line of LTO products. All of these products increased operational complexity, there’s no question and whereas we used to be favorable to our labor formula by [0.4%, 0.5%]. Right now we’re favorable to our labor formula about half that amount. So, we’re not making as much labor as we used to and we don’t want to, because of the operational complexity around these new products.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Thank you very much.

Operator

Thank you. And our next question comes from the line of Bryan Hunt with Wells Fargo Securities. Please go ahead.

Bryan Hunt - Wells Fargo Securities

Good morning.

Paul R. Flanders

Good morning, Bryan.

Bryan Hunt - Wells Fargo Securities

Paul and Dan, can you remind us the sales list that you’re targeting on a remodel and tell us maybe what you’ve experienced in the most recent remodels that you’ve completed?

Paul R. Flanders

As you know we’re just sort of getting started on these 2020 remodels, so I wouldn’t say we have a lot of data points. So far we’ve completed about 21 units. Burger King is – the list about 10% to 15%. I think they’ve probably got more data points than we do at this point. So, jury is out for us, but I would say we would expect minimally to be seeing 8% to 10%.

Bryan Hunt - Wells Fargo Securities

Okay. And, you’ve accelerated your remodel program. Are you likely to do the same thing for 2013 as well, do you think you’ll pull forward some remodels into 2013 or is this going to reduce the number of 2013 remodels?

Daniel T. Accordino

What I would like to do Bryan is, we’ve hired a project management firm to oversee this activity for us because of the magnitude. So, we’re trying to get a head-start on 2013 and depending upon how well that goes, there’s no reason why we would slow that momentum. The cash is on the balance sheet. We are getting a positive return from these remodels and therefore to the extent that we can accelerate these remodels and complete the entire DMA’s we think the synergistic effect of doing that actually should help leverage there the sales increase.

Bryan Hunt - Wells Fargo Securities

Okay. And granted given your success, I mean you’ve seen – at least we’ve seen some of your peer group maybe same-store sales momentum slow, do you feel like you’re gaining share and have you seen any specific response to the Company’s success?

Paul R. Flanders

I think, clearly we’re taking, gaining share certainly in the markets that we’re operating given the strong same-store sales that we’re seeing. I’m not sure we’re seeing any competitive response rather than what I would consider relatively normal.

Bryan Hunt - Wells Fargo Securities

Okay. And then lastly, you gave us an inflation number this year and you talked about potential inflation fees early next year. Have you started to circle up any type of inflation number for 2013, because it would be safe to assume in my opinion that you’re going to see inflation across all (indiscernible) in 2013?

Daniel T. Accordino

I think that’s fair. We don’t have enough insight at this point. I think that to comment on that hopefully as we get a little bit layer into the year, we would be able to provide some guidance.

Bryan Hunt - Wells Fargo Securities

Are you seeing any labor inflation pressure anymore?

Paul R. Flanders

No

Bryan Hunt - Wells Fargo Securities

Okay. That’s it for my questions. Thank you for your time.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Howard Penney with Hedgeye Risk Management. Please go ahead. Mr. Penney, your line is open.

Howard Penney - Hedgeye Risk Management

Sorry, thanks very much. I was wondering if you could comment on the 8% number that you alluded to July, the magnitude of the discounting in July year-over-year or promotional activity increased or how do you compare the discounting year-over-year for the [comp]?

Paul R. Flanders

It’s actually a little bit lower in July than it was last year. It wasn’t significant last year either.

Howard Penney - Hedgeye Risk Management

Thank you.

Operator

And I’m showing there are no further questions, I’d like to turn the call back to management for closing remarks.

Paul R. Flanders

All right. That concludes our call today. We appreciate your attendance and we will speak with you next quarter. Thank you.

Operator

Ladies and gentlemen this concludes the conference call for today. Thank you for your participation. You may now disconnect.

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