Carrols Restaurant Group (TAST) Q2 2019 Earnings Call Transcript

Carrols Restaurant Group (TAST)
Q2 2019 Earnings Call
Aug 08, 2019, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to the Carrols Restaurant Group second-quarter 2019 earnings conference call. [Operator instructions] I would now like to remind everyone that this conference is being recorded today, Thursday, August 8, 2019, at 8:30 a.m. 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 -- Chief Financial Officer

Good morning, everyone. 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 that 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.

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

Dan Accordino -- Chairman and Chief Executive Officer of Carrols Restaurant Group

Thanks, Paul, and good morning, everyone. Our second-quarter financial results were disappointing, and I want to address those directly this morning. Total restaurant sales were $368.6 million and grew by nearly 22% compared to the prior-year period due to our acquisition of 233 restaurants in the second quarter of 2019 and over 270 restaurants since the second quarter of last year. However, our comparable restaurant sales were flat compared to the second quarter of last year, with adjusted EBITDA decreasing $8.7 million and adjusted EBITDA margin declining over 400 basis points.

Let me address the more significant factors affecting our results. First, our restaurant-level profitability and adjusted EBITDA were challenged by a number of factors, most significantly by the deleveraging from flat comparable restaurant sales. Our comparable restaurant sales increased a modest 0.1% as we lapped a very strong 5% increase in the prior-year quarter. This was a disappointing result that prevented us from increasing our restaurant-level leverage to offset some of the significant cost and margin pressures that we experienced.

Of note, we experienced relatively softer sales in our southeast markets, which account for about a third of our restaurants. We also experienced underperformance in our breakfast and lunch day parts. Secondly, as we mentioned on prior calls, promotional levels have increased over the past year. And while the discounting levels have declined sequentially from the last couple of quarters, as we expected, the impact of higher promotions over the second quarter of last year continued to weigh in on our results.

As evidenced by our sales performance, these promotions were less effective in driving sales in the second quarter. The impact of the higher year-over-year promotional levels on restaurant margins at our core restaurants was approximately 60 basis points or approximately a $2 million decrease in EBITDA. Third, we experienced elevated commodity costs, including from beef prices that were 4.3% above our costs in the second quarter of last year. Increased commodity costs negatively impacted restaurant margins by over 100 basis points or approximately $3 million at our core restaurants.

Fourth, we experienced continued labor cost pressures as our average wage rate rose 5.2% in the second quarter. In tandem with a flat comparable sales performance, we deleveraged almost 90 basis points on restaurant labor. And finally, we were impacted by a lower contribution profile from the Cambridge restaurants, which we just recently acquired. The results from these restaurants do not yet reflect improvements in sales or margin efficiencies that we expect to achieve once our integration is complete.

In addition to the -- I'm sorry, it is clear that our second-quarter and first-half results were significantly impacted by the combined effect of these headwinds occurring at the same time. As a result of these near-term pressures, we have lowered our expectations for the full year. However, I am confident that these results do not reflect the shift in the fundamentals of our business model. With two world-class brands, a supportive franchisor partner, an experienced management team and growth opportunities across multiple attractive geographies, we believe that we are positioned to deliver strong growth and value creation to our investors going forward.

To that end, during the second quarter, we completed several key transactions, which position us to build long-term value across the business for the next number of years and beyond. In late April, we closed our acquisition of Cambridge Franchise Holdings, which added 165 Burger King restaurants and 55 Popeyes restaurants to our portfolio in a number of southern states. This transaction significantly expands our growth opportunities across attractive new markets, enhances our growth potential by adding a strong second brand that provides a long runway to continue expanding our business with increasing diversity and scale. It is early in our integration of Cambridge, and it will take some time to see the benefit of this acquisition flow through to our financial results.

However, we are confident based on our experience and track record that we can improve the sales and overall financial performance of these restaurants over time as we assimilate them into our platform and implement our financial and operating systems. In conjunction with the Cambridge transaction, we also finalized a new development agreement with Burger King, which expands our ability to acquire an additional 500 restaurants and assigns us Burger King's right of first refusal, or ROFR, in 17 states. This agreement extends our ROFR territory to Arkansas, Louisiana, Mississippi and Tennessee. This agreement, along with a Popeyes development and two state ROFR agreement acquired with the Cambridge transaction provides us substantial runway for growth and long-term value creation through both acquisitions and new unit development across two great brands.

Lastly, we completed a $550 million refinancing in the second quarter that provides us with a covenant-light capital structure and significantly enhanced our liquidity and flexibility to support the execution of these attractive growth opportunities going forward. We believe that we are better positioned than most operators and that this is an opportune time to pursue additional acquisitions within both the Burger King and Popeyes systems. We are confident that we can improve overall financial performance at restaurants that we acquire, including the Cambridge restaurants, while opportunistically executing our acquisition strategy. We believe that this strategy will enable us to build an even stronger foundation to drive our growth going forward and are currently evaluating a number of acquisition targets.

Our capital allocation strategy will continue to favor investments that enhance our EBITDA growth, namely acquisitions and new restaurant growth, which generate attractive long-term returns for our investors. Today's announcement of our $25 million share repurchase authorization reflects the board's continued confidence in our strategy and value-creation potential and provides us with added flexibility to opportunistically reinvest in our company over time. To conclude, while we fell short of our goals for the second quarter, the confidence we have in our business model, our brands and the new growth opportunities that lie ahead is as strong as ever. We also have a very exciting new product being launched at Burger King this week with the Impossible Whopper, which we believe will attract many new guests to our restaurants and drive incremental sales.

And overall, we are confident that the marketing calendar, including the Impossible Whopper and more effective promotions will help us generate stronger sales performance and better restaurant-level margins through the remainder of the year. Paul will now go into greater detail with our second-quarter financial review and updated annual guidance.

Paul Flanders -- Chief Financial Officer

Thanks, Dan. As I think Dan has made clear, we were disappointed by our second-quarter results, which I will drill down in a little bit more in a second. However, there's much for us to be positive about as we look at how we've positioned the company for growth with attractive alternatives to employ capital and effective ways to build value for investors longer term. We operate two strong brands that we believe are well-positioned beyond these near-term challenges.

Restaurant sales for the second quarter increased 21.6% over the prior-year period to $368.6 million, including $50.7 million in sales from the Cambridge acquisition, which closed on April 30, along with sales from 56 additional restaurants acquired over the past year. Comparable restaurant sales for our core Burger King restaurants, which excludes Cambridge and the other restaurants operated less than one year, increased a modest 0.1%, consisting of 0.4% increase in average check and a 0.3% decrease in customer traffic. Our average check increase reflected 0.9% menu pricing, offset by higher promotions and mix changes compared to the second quarter of 2018. The Cambridge restaurants will not be included in our comparable restaurant sales base for the first 12 months.

Directionally, however, I will say that the Cambridge Burger Kings were mid single-digit negative in the quarter, while the Popeyes restaurants performed better with moderately positive sales. Adjusted EBITDA declined $9 million in the quarter to $23.8 million from $32.8 million in the second quarter last year, and restaurant-level EBITDA decreased to $41 million from $47.4 million. To reiterate some of what Dan said, flat comparable restaurant sales for the quarter challenged us to offset the cost increases that we've experienced in our key input cost and resulted in deleveraging across a number of expenses. While promotional activity was higher compared to the second quarter of 2018, it was simply not sufficiently effective in driving sales.

Cost of sales increased 259 basis points as a percentage of restaurant sales compared to the prior-year period, reflecting higher promotional levels and higher commodity costs. Ground beef was $2.16 a pound, which had increased 4.3% from $2.08 per pound in the second quarter last year. Restaurant labor expense increased 88 basis points as a percentage of sales compared to the prior-year quarter and included a 5.2% increase in the hourly wage rate at our core Carrols Restaurants, which I know was a little lower than the prior year. In addition, we were impacted by the lower margin profile of the Cambridge restaurants just recently acquired and their relatively low EBITDA contribution, given the short period included in our results.

We are still very early in our integration of these restaurants, and our results do not yet reflect the improvement in sales, operations and margin efficiencies that we are confident that we will make as we move forward. Our net loss was $3.7 million in the second quarter of 2019 or $0.09 per diluted share, compared to net income of $7.8 million or $0.17 per diluted share in the prior year. The net loss included a $7.4 million loss on extinguishment of debt due to the write-off of previously deferred financing costs in conjunction with our refinancing in the second quarter. Adjusted net income was $4.3 million or $0.07 per diluted share, compared to adjusted net income of $10 million or $0.22 per diluted share in the prior-year quarter.

A summary of the adjustments in arriving at adjusted net income, including loss on debt extinguishment, acquisition and integration costs and other items are detailed in the tables accompanying this morning's release. Total capital expenditures were $24.9 million in the second quarter of '19 and $43.1 million for the first six months. At the end of the second quarter, our cash balances were $3.4 million and total outstanding debt was $454.9 million. Now let me turn to our outlook for 2019, which we have updated in view of our performance to date and our projections for the balance of the year.

Our updated guidance is detailed in this morning's release, so I'll try to limit my comments here to the more relevant changes. Our overall sales guidance has not changed significantly, but we've tightened our comparable restaurant sales estimates somewhat to 2% to 3% for the year. We are increasingly confident at the Burger King marketing calendar, including the Impossible Whopper launch this week to generate improved sales performance and better margins through the remainder of the year. Our outlook on commodity cost reflects our expectation that commodity inflation will be higher than anticipated due to higher beef costs in the second half of the year.

Commodity costs are now expected to increase 3% to 4%, with beef costs up 7% to 9% versus our prior guidance of a 2% to 3% overall increase in costs. Adjusted EBITDA is now expected to be $100 million to $105 million for the year, including $10 million to $12 million from the Cambridge acquisition for approximately eight months. Our revised guidance does not include a full-year contribution from either the Cambridge or the Baltimore acquisitions. On a full-year basis, these will add another $7 million to $8 million of EBITDA before any operating improvements that are likely as we move forward with our integration, making our run rate EBITDA approximately $110 million for the year at the midpoint of our guidance.

And that concludes our prepared remarks. And with that, operator, let's go ahead and open the lines.

Questions & Answers:

Operator

Thank you. [Operator instructions] And our first question, we'll hear from Jake Bartlett with SunTrust.

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

Great. Thanks. Thanks for taking the question. Paul, I'm wondering, your same-store sales guidance for the year implies about a 2.8% to 4.8% for the back half of the year.

Can you give us some help in figuring out whether we should be toward the high end or the lower end of that range, kind of a wide range? And also, maybe in that context, how your sales have trended so far in the third quarter.

Paul Flanders -- Chief Financial Officer

Yes. I think as we look at the guidance, I think we're obviously thinking the back half of the year should be around where the midpoint implies in the guidance. And our comparisons ease up a little bit in the back half compared to the first half of the year. So we're optimistic as we look forward.

In terms of where we saw our quarter to date, July is obviously in the book at this point. We're up about 1.5% in July.

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

Got it. And then when we think about the impact of promotions and discounting, it's been a headwind in the first half of the year here. Do you expect it to actually flip and become a positive tailwind toward the back half?

Dan Accordino -- Chairman and Chief Executive Officer of Carrols Restaurant Group

Jake, this is Dan. With the Impossible Whopper, our assumption is, number one, that our same-store sales in the second half are going to be much more robust than what they were in the first half, certainly, and that there will be a lower level of discounting by virtue of the fact that much of the promotional activity is going to be behind the Impossible Whopper. The discount, I'm not as concerned about the discounting as I am about the fact that if you have discounting, it needs to drive same-store sales. And that really was the challenge in the first half.

I think the focus on discounting really isn't the issue. The issue is, if you're going to discount, you better generate positive same-store sales, and that didn't happen in the first half. In the second half, again, with the launch of the Impossible Whopper today, we're very optimistic about our sales performance and our margin improvement in the second half.

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

Got it. And then lastly, just on the stores that you acquired from Cambridge. I was on the impression that the restaurant-level margin profile was similar to your core stores. And it sounds like they're actually much worse.

And then I'm looking at the negative mid-single-digit same-store sales. Can you attribute that to kind of transition, just to kind of issues as you transition and kind of change of operations? Or what's happening there in terms of the margins in the same-store sales? And how confident are you that both of those can start to improve?

Dan Accordino -- Chairman and Chief Executive Officer of Carrols Restaurant Group

This is Dan again. The Cambridge same-store sales were negative when we did the acquisition. So we expected that over time, they would generate some positive same-store sales, at least it'd result in a -- by the end of the year to be flat to slightly positive. So that's not a surprise.

And no, their margins were never anywhere near where Carrols' margins are. We always said that there was a 250 basis point delta that we would improve upon, and we still expect we will. We also said, however, that we wouldn't have our POS devices and our back office and all of that installed until the fourth quarter. So we're still on track with that.

And everything that we thought we would accomplish with Cambridge, we still are confident we will.

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

Thank you very much.

Operator

And next, we move to Will Slabaugh with Stephens Inc.

Will Slabaugh -- Stephens Inc. -- Analyst

Hi, guys. Can you talk a little bit more around your confidence in the Burger King marketing calendar that you mentioned? And what you're most excited about? I realize it's extremely early given the nationwide Impossible launch was just this week. But can you help us out there in how you're thinking about the potential impact of the Impossible itself, just given what you've heard or seen from tests or any of your stores as well?

Dan Accordino -- Chairman and Chief Executive Officer of Carrols Restaurant Group

Again, this is Dan. Well, we have been -- we're forecasting for the second half, as Paul said, same-store sales that are in the 4% kind of numbers. We think that that's conservative relative to what we've seen in the test markets for the Impossible Whopper. So we are very optimistic about the Impossible Whopper for the entire balance of this year.

And because of that, we've confidence in the marketing calendar as well. There's really a couple of things that Jose Cil said on his call that you got to have a balanced approach, and the sense was, if there was a value component that was missing in the first half, don't confuse value with discounting. The taco, which was introduced about three weeks ago, is a very compelling value component and actually is doing quite nicely in terms of number of units sold and incremental traffic. So between the launch of the Impossible Whopper and the increased focus on a value component, as well as increased marketing against breakfast, we're very confident in the calendar and the second-half forecast.

Will Slabaugh -- Stephens Inc. -- Analyst

That's helpful. And on the margin front, 2Q is traditionally a little bit better on the margin side than the back half of the year though I realize some of the Cambridge noise and the things you walked through, Dan, that threw that off a little bit. Your guide implies an acceleration in margins in the back half. I realize some of that's tied to same-store sales improvements.

I don't know if there's anything else that we should be thinking about from a cost perspective in the back half that might get a little bit better as well to help out.

Paul Flanders -- Chief Financial Officer

No, I think that's accurate as well. We do we anticipate margins to improve, slightly somewhat certainly from where we were in the second quarter. I think the only thing I would call out in the second half is the commodity costs. Beef costs are, as I said, anticipated to be a fair amount higher than we originally anticipated.

Our guidance implies about a 15% return on beef costs versus last year, where we were at pretty attractive price levels, below $2 a pound.

Will Slabaugh -- Stephens Inc. -- Analyst

Got it. And can you give us a more recent update on what you've been seeing with beef? Is that above the inflation rate that you're seeing right now?

Paul Flanders -- Chief Financial Officer

Yes. I think -- I mean, quarter to date, I think we averaged about $2.20 a pound. So far, it's come down in the last couple, three weeks. We're actually running about $2.17 a pound right now.

Will Slabaugh -- Stephens Inc. -- Analyst

OK. And then the last thing is just on Cambridge in general. Are the Cambridge stores performing worse than you would have expected at this point? Or they're just early, and we're simply going to see some noise in the numbers until we get further along in this integration and really everything still on track in your mind?

Dan Accordino -- Chairman and Chief Executive Officer of Carrols Restaurant Group

Yes. Well, this is Dan, again. Yes, listen, we bought 620 restaurants, I think, in the past seven years. And what we've always said we would do in terms of margin improvement and sales increases, we've always done.

And I'm absolutely confident that we'll do the same with Cambridge. So I wouldn't say that they are any worse than what we had expected. And again, until we get all of our systems in place, we're really not going to see a lot of improvement in terms of the margin enhancement. However, we have put an infrastructure in place with region directors and district managers, some of whom have come from the Carrols' portfolio, so that we can be ready to move this thing along at a more rapid rate.

And I'm absolutely confident that we will realize the objectives that we established for Cambridge.

Will Slabaugh -- Stephens Inc. -- Analyst

Good to hear. Thanks, guys.

Operator

[Operator instructions] Next, we move to Dan Docherty with Raymond James.

Dan Docherty -- Raymond James -- Analyst

Hi, guys. It's Dan Docherty on for Brian Vaccaro this morning. I got a question on 2Q store margin performance. You guys disclosed the onetime R&M, but the integration seems to have been quite a bit more disruptive to the P&L as you integrated Cambridge, besides a couple of million you stripped out of G&A.

Could you perhaps provide store-level EBITDA for legacy Carrols versus Cambridge in 2Q? And then one follow-up.

Paul Flanders -- Chief Financial Officer

Yes, we didn't break that out. But what I can say, I think, directionally is Cambridge contributed about $4 million of restaurant-level EBITDA, plus, as you alluded to, there's about $400,000 to $500,000 of integration costs that are included in there that -- so call it, $4.5 million adjusted. And those integration costs were primarily unusually high and excessive repairs maintenance that we needed to spend when we first got in, in the restaurants.

Dan Docherty -- Raymond James -- Analyst

OK, gotcha. And then your 2019 guidance seems to imply a pretty marked improvement and much more normal margin dynamics in the second half compared to the second quarter. Could you provide a little more color on what you expect to improve?

Dan Accordino -- Chairman and Chief Executive Officer of Carrols Restaurant Group

Well, this is Dan again. The margin improvement, to a larger degree, is a function of generating 4-plus percent same-store sales in the second half. When you get sales, obviously, we can leverage these other costs, which we couldn't do in the first half. So with the Impossible Whopper, which is a good margin product, and the value offerings, as well as positive same-store sales and positive traffic, historically, we've always generated a significant leverage off the sales increase.

This isn't complicated, really. This business needs a 3% to 4% same-store sales increase year over year in order to leverage your operating expenses, and we didn't get that in the first half.

Dan Docherty -- Raymond James -- Analyst

OK, great. And then just one last question on discounting. I think it was down sequentially, but could you disclose the percentage of sales on discount in 2Q and how that compared to the first quarter?

Paul Flanders -- Chief Financial Officer

Yes. We were -- I guess the way I would characterize it, as a percentage of sales, the discounts were about 200 basis points better sequentially from the first quarter. An issue with the discount more a function of the -- you're still up against lower levels from the prior year.

Dan Docherty -- Raymond James -- Analyst

OK, great. Thank you.

Operator

And next we move to Jake Bartlett with SunTrust.

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

I just had a follow-up on the margins at the acquired stores. I'm just looking at the fourth-quarter earnings call. And I think, Paul, you indicated that the restaurant-level margins were similar for the acquired stores and your stores. Is that not true? And maybe just from the last question, was it that you inserted some costs that you typically do kind of in the earlier stages of acquisitions? Is that what's driven the Cambridge level margins down much lower?

Paul Flanders -- Chief Financial Officer

Well, I wouldn't make too much of where we are in the second quarter because we don't own them for nine weeks in the quarter. I think the difference you're referring to is our comments really refer to where we see the margins ending up for the full year this year. Obviously, the Cambridge restaurants, as we said, the Burger Kings, have been negative in terms of same-store sales. So they've deleveraged, and so you're comparing where we think they're going to be at the end of this year versus, perhaps, what you're referring to is an LTM view from six or nine months ago.

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

Got it. So that was true at that time, but it's diverse because the sales had fallen at those stores?

Paul Flanders -- Chief Financial Officer

Yes. And as well as -- I mean, you see what's happened to the core Carrols margins when we moved. The Cambridge is impacted by the same factors that are impacting our results, the Carrols' results.

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

OK. Got it. And then just to -- if you could give us what the overall commodity inflation was in the second quarter, as well as the first quarter, just so we can see what that implies for the back half?

Paul Flanders -- Chief Financial Officer

I don't have the overall here handy. I mean, the biggest item that's driven commodities this year has been beef and pork, and beef is obviously the primary driver of our inflation. I think we were up about 4.5% on beef, and the overall inflation will be a little bit lower. That's, I'm just guessing, maybe 2% or 3%.

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

OK. Thank you very much.

Operator

And we'll take a follow-up question from Dan Docherty with Raymond James.

Dan Docherty -- Raymond James -- Analyst

Hi, guys. Just a question on delivery. I believe BK is up to about 3,500 units in the U.S. offering third-party delivery.

Has that reached any of your units at this point? And if so, could you discuss what you're seeing from a sales and profitability perspective?

Dan Accordino -- Chairman and Chief Executive Officer of Carrols Restaurant Group

Yes, Dan, this is Dan again. No, we have not. We don't have delivery in any of our Burger King restaurants yet. We do deliver in our Popeyes portfolio.

But we are looking at delivery, and we're looking at the various aggregators, and we're looking at how delivery will impact our restaurants, certain restaurants from a geographic standpoint. It looks like they'll make -- it'll make some sense than other restaurants, so we probably wouldn't be doing it. But I would expect that given the POS integration and everything else that we're working on, we probably will have some restaurants in a delivery mode by the fourth quarter.

Dan Docherty -- Raymond James -- Analyst

OK, great. Thanks, guys.

Operator

And that will conclude the question-and-answer session. At this time, I would like to turn the call back over to Mr. Flanders for any additional or closing remarks.

Paul Flanders -- Chief Financial Officer

Thank you. We don't really have anything else to add today, but certainly, as you can tell, it was a challenging quarter. We're looking forward to reporting better news as we move through the year, and appreciate your time this morning. Thanks.

Operator

[Operator signoff]

Duration: 32 minutes

Call participants:

Paul Flanders -- Chief Financial Officer

Dan Accordino -- Chairman and Chief Executive Officer of Carrols Restaurant Group

Jake Bartlett -- SunTrust Robinson Humphrey -- Analyst

Will Slabaugh -- Stephens Inc. -- Analyst

Dan Docherty -- Raymond James -- Analyst

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