Carrols Restaurant Group's (TAST) CEO Dan Accordino on Q4 2016 Results - Earnings Call Transcript

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Carrols Restaurant Group, Inc. (NASDAQ:TAST) Q4 2016 Earnings Conference Call March 2, 2017 8:30 AM ET

Executive

Paul Flanders - CFO

Dan Accordino - President and CEO

Analyst

Fred Wightman - Citi

Jeremy Hamblin - Dougherty & Company

Will Slabaugh - Stephens

Brian Vaccaro - Raymond James

Operator

Welcome to the Carrols Restaurant Group’s Fourth Quarter 2016 Earnings Conference Call. Currently, 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. Today’s event is being recorded, Thursday March 2, 2017at 8:30 AM Eastern Time and will be available for replay.

Now 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. Reconciliation to comparable GAAP measures is available with our earnings release.

As a remainder, a Carrols Restaurant preferred those restaurants acquired from 2014 through 2016, while legacy restaurants include all of the company’s other restaurants, including the restaurants acquired prior to 2014.

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

Dan Accordino

Thanks, Paul and good morning, everyone. 2016 was a productive year at Carrols and we were pleased to have been generally in line with our outlook for restaurant sales comparable restaurant sales and adjusted EBITDA. We also improved margins at both our legacy and acquired restaurants, made considerable with our remodeling program and continued to effectively execute our expansion and acquisition strategy.

In 2016, we grew our restaurant sales by 9.8% to 243.6 million including 243.1 million of sales from the 234 restaurants acquired from 2014 to 2016. One additional operating week in 2015 contributed approximately 16 million through restaurant sales in the prior year period. Excluding the extra week restaurant sales increased 11.9% in 2016.

The QSR competitive environment continues to be characterized by aggressive price pointed offers and discounting to drive customer traffic. BURGER KING’s marketing initiatives continued to effectively provide customers a variety of value and premium offers in this very competitive environment. On a comparable 52 week basis, comparable restaurant sales increased 2.3% for the year against a strong 7.4% comparison from 2015.

For the fourth quarter, comparable restaurant sales grew 3.2% over a 5.1% increase in the prior year period on a comparable 13 week basis. The premium Bacon King Sandwich introduced in mid-October performed well throughout the quarter. This sandwich along with our two-for-$10 whopper meal deal resonated with customers and contributed to a solid increase in our average check. We also continued the two-for-$5 mix and match promotion featuring the extra-long cheese burger and the original chicken sandwich.

We posted another strong performance at breakfast with a double-digit comparable sales increase for that day-part, driven in part by our promotional offering of three pancakes for $0.89. In addition, a new Eggnormous Burrito offering and the two-for-$4 cross sandwich promotion both contributed to our strong breakfast sales.

In terms of profitability, we increased adjusted EBITDA 16.6% to 89.5 million for the full year from 76.7 million in 2015. Adjusted EBITDA margin improved 55 basis points for the year, due primarily to lower commodity cost namely ground beef and from ongoing improvements to margins at our acquired restaurants.

Lastly, adjusted net income was also higher for the year increasing 33% from 13.4 million in 2015 to 17.9 million. Although Paul will separately discuss fourth quarter results in greater detail in a moment, I want to point out that we did experience a decrease in adjusted EBITDA margin in the fourth quarter of 2016, when compared to the prior year period. This largely reflected the deleveraging from one less operating week compared to the prior year quarter, along with a higher level of promotional activity, the impact of ongoing labor cost pressures and higher advertising expense.

As I said a minute ago, we also continued to make progress with our remodeling activities and in executing our expansion strategy. In 2016, we completed 85 remodels and rebuild or relocated another eight restaurants. At the end of 2016, over 70% of our restaurants featured a 2020 design image.

Moving forward, we will continue remodeling restaurants in the normal course, however we anticipate that the pace of such activities will generally slow from the aggressive remodeling program undertaken over the past few years. In 2017, we anticipate remodeling 20 to 25 restaurants and rebuilding another five to seven restaurants.

We expect that with a lower level of ongoing capital expenditures that we should have free cash flow in 2017, which we anticipate will provide us with additional capital to fund our planned development of new restaurants and to selectively acquire additional restaurants.

In 2016, we continued to expand our ownership of BURGER KING Restaurants with the acquisition of 56 restaurants. On Tuesday of this week, we also completed a previously announced acquisition of 43 restaurants in the Cincinnati market, giving us a good start on our 2017 expansion.

In summary, we accomplished a great deal in 2016 in a challenging operating environment, and we look forward to continued enhancing long term shareholder value in 2017 and beyond through the strategies that we have already laid out.

With that I will now turn the call over to Paul for our financial review.

Paul Flanders

Thanks Dan. I will begin by covering our fourth quarter 2016 results, and then provide our annual guidance for 2017. Restaurant sales in the fourth quarter increased 5.1% to 240.8 million from 229.1 million in the prior year period. Restaurants acquired since the beginning of 2014 contributed sales of 66.5 million compared to 46.7 million in the fourth quarter of last year.

Excluding the effect of the additional week in 2015, which contributed 16 million of sales, total restaurant sales in the fourth quarter increased 13% over the fourth quarter of 2015. Comparable restaurant sales increase 3.2% on a 13 week basis over a solid 5.1% increase in the fourth quarter of 2015. Comparable restaurant sales increased 3.1% on legacy restaurants and 3.9% in our comparable acquired restaurants, the latter primarily consisting of the restaurants that we acquired in 2014.

Overall, comparable restaurant sales reflected a 3% increase in average check and a 0.2% increase in customer traffic. Restaurant level EBITDA was 33.6 million in the fourth quarter of 2016, compared to restaurant level EBITDA of 36.8 million in the fourth quarter of 2015. Additional operating week in 2015 contributed an estimated 4.4 million to restaurant level EBITDA.

Restaurant level EBITDA margin was 14% of restaurant sales and decreased 210 basis points from the prior year period including 87 basis points from the deleveraging from one last operating week. Restaurant level EBITDA margins were also impacted by the higher level of promotional activity, continued pressure on labor cost and higher advertising expense.

Adjusted EBITDA was 20.4 million in the fourth quarter compared to 23.7 million in the prior year period. Excluding the additional operating week in 2015 which we estimate contributed approximately 4 million in EBITDA, adjusted EBITDA would have increased approximately 3.4% over the prior year quarter. Adjusted EBITDA margin decreased to 188 basis points to 8.5% of restaurant sales including a 109 basis points impact from one less operating week.

Cost of sales of as a percentage to restaurant sales was 15 basis points lower in the fourth quarter compared to the prior year period. This includes the impact for more favorable commodity cost including ground beef which at a $1.85 per pound was 3.6% below the fourth quarter of 2015. Effective menu pricing was 1.6% in the fourth quarter and helped offset some of the impact from our higher promotional discounting.

Restaurant labor expense increased 83 basis points to 31.7% of restaurant sales, compared to the prior year quarter due primarily to a 6% increase in our average hourly rate. The advertising expense increased to 4.4% of restaurant sales from 3.8% in the fourth quarter of 2015, due to increased spending on local advertising and the 2015 exploration of advertising credits that we have been receiving from BURGER KING for 2012 restaurant equipment investments.

General and administrative expenses were 14.4 million in the fourth quarter, compared to 14.3 million in the prior year period, and improved 24 basis points to 6% as a percentage of restaurant sales. General and administrative expense in the fourth quarter included 426,000 stock compensation expense and 762,000 of acquisition related cost.

Income from operations was 6.1 million in the fourth quarter of 2016, compared to 11.6 million in the prior year period. This decrease primarily reflected one less operating week and an increase in depreciation and amortization expense from the remodeling and acquisition of restaurants over the past two years.

Net income was 29.5 million in the fourth quarter of 2016 or $0.65 per diluted share, compared to net income of 7 million or $0.16 per diluted share in the prior year period. This increase was primarily due to the $30.4 million reversal of the valuation allowance previously established against net deferred income tax assets.

Adjusted net income in the fourth quarter of 2016 was 2.0 million or $0.04 per diluted share, compared to adjusted net income of 6.5 million or $0.14 per diluted share in the prior year period which included the additional operating week, which was 2.5 million or $0.06 per diluted share after taxes. Excluding the 30.4 million in our tax benefit from the reversal of the valuation allowance, the provision for income taxes was 2.3 million for all of 2016. For comparability, adjusted net income is presented for 2016 and 2015 to reflect a normalized provision for income taxes as if the valuation allowance had been reversed prior to 2015.

Total capital expenditures for 2016 were 94.1 million including 74 million for remodeling 85 restaurants, rebuilding four restaurants and relocating four restaurants. Total capital expenditures were 28.7 million in the fourth quarter and included 22.8 million for remodeling and relocating restaurants.

We also acquired 56 restaurants in 2016 including 27 in the fourth quarter. Our total investment for the year of 48.1 million included approximately 19.4 million for fee-owned real estate. We’ve completed the sale lease-back of most of the [three] properties that we acquired in late 2015 and in 2016. Proceeds from sale lease-backs totaled 53.6 million for 2016 including 24.2 million in the fourth quarter.

At the end of the year, total outstanding debt was 223.6 million including 13.5 million drawn under our revolver. We also recently amended our revolving credit facility to increase maximum available borrowings to 73 million which will provide additional capital for potential acquisitions.

With that, let me provide you the following guidance for 2017. I point out that other than the 43 restaurant acquisition completed Tuesday; our guidance does not include any impact from other potential transactions that we might complete during the year. We expect total restaurant sales to be 1.02 billion to 1.07 billion. This projection includes an estimated 2% to 4% growth in comparable restaurant sales.

Commodity costs are expected to increase approximately 0% to 2% including a modest decrease in beef cost. General and administrative expenses are expected to be 54 million to 56 million excluding stock compensation costs and potential acquisition related costs. Adjusted EBITDA is expected to be 90 million to a 100 million; our effective income tax rate is anticipated to be 20% to 25%.

Total capital expenditures excluding acquisitions are expected to 55 million to 75 million. This includes the remodeling of approximately 20 to 25 restaurants, the rebuilding of 5 to 7 restaurants and the construction of 7 to 15 new restaurants including relocations of two to three existing restaurants.

Our capital expenditures also include 10 million to 12 million for non-recurring investment and new kitchen production and holding systems, new training systems and certain POS system upgrades. And lastly we anticipate opening 7 to 15 new restaurants including two relocations and the closing 20 to 25 existing restaurants.

Although we don’t provide specific quarterly guidance, I do want to provide some directional comments regarding the first quarter of 2017. I point that we experienced the strongest quarterly sales performance of 2016 in the first quarter, favorable restaurants sales increased 5.7% in the first quarter of last year, reflecting among other things the launch of grilled hotdogs and the introduction of our five-for-$4 meal promotion.

Based on trends earlier in the quarter, our guidance for 2017 takes in to consideration the comparable restaurant sales for the first quarter and likely to be flat to slightly negative.

And with that, that concludes our prepared remarks. So operator you can go ahead and open the line for questions now.

Question-and-Answer Session

Operator

[Operator Instructions] We’ll go first to Bryan Hunt of Wells Fargo.

Unidentified Analyst

It’s actually Dave [Cook] on for Bryan. First I wanted to touch on your forward guidance. Just to clarify, you mentioned opening 7 to 15 restaurants. Is that net of the expected 20 to 25 closures?

Dan Accordino

No.

Unidentified Analyst

And what sort of wage inflation are you expecting in 2017?

Paul Flanders

Our plans are built around assumption of about 5% to 6% increase in wages. So it continues to still run about the levels that we’ve seen in 2016.

Unidentified Analyst

And we’ve seen some headlines recently, some of your QDR competitors testing out some self-ordering kiosks. Can you remind us is that something you’re going to offer today or are looking in to?

Dan Accordino

This is Dan. No, we are not looking into it, and to the best of my knowledge BURGER KING is not testing any kiosks, they are testing some ordering - mobile ordering and delivery of protocols but I don’t know of any self-service kiosks that are being tested.

Unidentified Analyst

And then you alluded to the increased cash flow in 2017, given the lower CapEx. Can you just give us an update on the M&A environment, are there any more or less opportunities out there relative to recent years.

Dan Accordino

I would say that the deal was always approximately the same as what we’ve been experiencing in the past couple of years.

Operator

[Operator Instructions] We’ll go next to Greg Badishkanian of Citi.

Fred Wightman

This is actually Fred Wightman on for Greg. Just quickly within that 2% to 4% comp growth, how much pricing are you assuming for the full year?

Paul Flanders

Right now we’re working with a little under 1.5%, and we need to anticipate trying to work that up a little bit as we go through this. I think we like to get it to 2 to 2.5.

Fred Wightman

And then you highlighted promotions and discounting a few times in the script. You’re guiding for commodities to be flat to up for this year. Obviously that’s a little bit different in the tailwind we’ve seen past couple of years. Just how do you think the categories going to respond as we sort of pivot from a tailwind from commodities to maybe a bit of a headwind?

Dan Accordino

This is Dan. My sense is that the competitive environment will continue to be just that, very competitive. And I think you’re going to continue to see a level of balanced approach throughout the year of some new products as well as a continued focus on value offerings.

Fred Wightman

And then just one more, any thoughts on the Popeyes acquisition from restaurants brands?

Dan Accordino

No.

Operator

We’ll go next to Jeremy Hamblin, Dougherty & Company.

Jeremy Hamblin

Wanted to just make sure that I understand, the EBITDA margin guide for this year implies about 8.8% to 9.35% of 15 to 70 basis points decline year-over-year from what you just did in ’16. Is that almost exclusively coming from labor? It kind of sounds like you’re expecting labor to deleverage may be 75 to 80 basis points or are there other line items where you’re expecting potential deleverage year-over-year?

Paul Flanders

That’s exactly what’s driving it Jeremy. As I said, we expect wage rates to be up 5% to 6% at least that’s our current thinking. And obviously our sales guide doesn’t quite cover that, and there’s some deleveraging areas, but no there’s nothing else and the P&L is really worthy of any, no.

Jeremy Hamblin

And then not to get too granular on the Q1 commentary, but has there been any noticeable difference here in the last couple of weeks versus what you saw? We know that the five-for-$4 launch last year is pretty successful. We think January is big. Are trends improving in the last couple of weeks versus where they stood earlier in the quarter?

Paul Flanders

Certainly the weather has been outstanding, at least in the North East for the last week. So yes, we’ve seen some improvements in those sales. But again we’re lapping against some perfect numbers last year, which is really the issue.

Jeremy Hamblin

And then just want to come to the acquisitions pipeline and you just closed on a really nice large deal 43 units. What should we be thinking in terms of the potential opportunity for additional acquisitions? How does the pipeline look today, and then when do you think it’s feasible given that that’s a pretty healthy acquisition to absorb for the year. Something where we should be thinking nothing could really happen until the back-half of the year or how are you guys viewing that?

Dan Accordino

Jeremy this is Dan. And yes, you are absolutely correct; I don’t anticipate that we’re going to lay in any meaningful acquisitions until at least the third quarter.

Jeremy Hamblin

And then last thing, just regarding the closure of locations. In terms of thinking about those 20 to 25 existing restaurants, are those just leases that are coming up from 2014 or ’15 deals that now make sense to close or just in terms of that level’s a little bit higher than what you’ve seen in terms of the last year certainly in closures. Is that just kind of addition by subtraction or just making the groups of stores that you’ve acquired a little bit healthier by taking away some of the weaker ones.

Paul Flanders

Well as you’re aware we didn’t really close too many in 2016, so some of this is a catch up I think to some degree. But generally the units we’re closing that we’ve acquired recently maybe a couple. There are a few from the 2014 acquisitions that we knew we would close when the leases came up and we’re approaching those, and then beyond that there’s still some from the legacy group which includes the 2012 acquisition, obviously at this point. So there’s a fair number of restaurants.

I’ll tell you the impact of these is probably about 20 million on sales and I think the EBITDA impact from the closure and this includes the ones we closed right at the end of 2016 is probably less than $600,000 or $700,000. And that’s not having much impact.

Jeremy Hamblin

In terms of the new construction, what are the construction costs running on those new restaurants, the total?

Paul Flanders

We’re running about 1.03 million excluding rent.

Operator

[Operator Instructions] We’ll take our next question from Will Slabaugh of Stephens.

Will Slabaugh

Question on trends, you guys showed a pretty nice acceleration this quarter on one and two year basis, while the rest of the industry was really benign. So within that I was a little surprised to hear how much of that was ticket driven, with the success of the Bacon King also being the biggest piece of that. So wondered if you can talk about what you think the consumer is responding to in this environment that seems pretty value-driven where you guys are successful on the outset end of that. And kind of what that tells you about the average ticket opportunity at BURGER KING, and if you’re expecting a similar premium pushes in the coming quarters?

Dan Accordino

This is Dan. It’s a combination of, as we said in our commentary, the Bacon King has done very well which has driven tickets that’s for sure, and the two-for-$10 whopper promotion as well as the continuation of the two-for-$5 has still been very well in terms of driving incremental traffic. And the breakfast we’ve had a significant increase in traffic in the breakfast day part. So I think that those three items have really contributed to the fourth quarter. For the balance of this year, I see a continued emphasis on both of the value component as well as premium products some of which will be a variation of the Bacon King and some will be a reinforcement or re-advertising or re-promotion of our existing full premium products.

Will Slabaugh

Got it. And then I wondered if you could talk also about the comment you made around higher advertising expenses. Was this something planned by corporate or is this more of your local advertising that you did on your own?

Paul Flanders

Well the increase was two-fold, one was we spend more local advertising, that’s really driven by a market-to-market decisions. And then another component was the fact that we had some simple credits for the last three or four years while in (inaudible) in 2015 when we were receiving credits from BURGER KING and it effectively funded some equipment investments back in 2012.

Will Slabaugh

And last thing I had was any sort of color you could give us around the tax rate for 2017 or any taxes at all in 2017?

Paul Flanders

Yeah, as I said the effective tax rate valued was 20% to 25%, the reason its low is it has to do with the impact of the worker opportunity tax credit and the impact that that has. In terms of cash taxes, as you know we have still a better [wells] which will run for some time. So we won’t be in a position where you have to pay cash to excess in ’17.

Operator

We’ll go next to Brian Vaccaro of Raymond James.

Brian Vaccaro

Paul I wanted to ask about the acquired unit margins, are there certain investments in labor or repaired maintenance perhaps that might be impacting the margins there in the near term. And can you just talk about the sales and margin profile of the 43 units you recently acquired?

Paul Flanders

Yeah, I think clearly when we bring these restaurants on board, the acquired restaurants, we certainly see a high level of R&Ms right out of the gates and it’s not surprising, given the sellers are not necessarily replacing everything they should. So that’s unusual and I expect we’ll see some of that in Cincinnati as well.

In terms of the profile, those stores are averaging in terms of revenue between 1 million; I’d say around 1.250 million so a little lower than the ones we brought in 2016 with the margins commensurate with those sales levels.

Brian Vaccaro

Okay, but no change in your expectations or several hundred basis points of margin improvement going forward?

Paul Flanders

No I would say that this group of stores, they will run pretty well. So I wouldn’t - we certainly see that we believe we’ll improvement to the P&L. 200 basis points and they might be in the segment.

Brian Vaccaro

With that said, you’re talking about there’s others to come. Sure.

Paul Flanders

I think one way we’ve tried to quantify historically is that the improvement in the P&L resulted about a multiple improvement in terms of purchase price multiple. I would say that this deal we’re probably looking at about half a term improvement.

Brian Vaccaro

That’s helpful. Wanted to ask about the margin outlook and understand your [COGs] outlook is flat up to with ground beef down slightly. Can you provide some color on what are some of the offsets there where you’re seeing a little bit of pressure?

Paul Flanders

There are a lot of other items in the basket. But they are not huge increases, they are just - the middle of that guidance is 1%. So generally we’re seeing small increases on a lot of different items, pork is an example, chicken, those are the big items.

Brian Vaccaro

And in terms of your advertising cost outlook, can you help us with that in 2017? Are you expecting continued de-leverage or should that flatten out?

Paul Flanders

We should actually get a little leverage there. We will back-off, not much spending a little bit this year. So I think when you think about that line item, you should be able to think about 25-30 basis points of leverage.

Brian Vaccaro

And appreciate the color on the impact of the closures. What’s the cadence on those closures? Should we spread those through the year or is that sort of a first half timing?

Paul Flanders

Well the 2017 closures those are 20 to 25. And we also closed nine units’ right and last day of fiscal year which was January 1. So we got the impact of those as well. So those are already closed obviously. I would say that the bulk of these will be closed by the end of the second quarter.

Operator

And Mr. Flanders, I’d like to turn the conference back to you for any additional or closing remarks.

Paul Flanders

The only closing we’ll make is we appreciate your attendance today and appreciate your ongoing support, and look forward to talking to you in a couple of months. Thank you.

Operator

That does conclude today’s conference call. Thank you for your participation. You may now disconnect.

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