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TAST > SEC Filings for TAST > Form 10-Q on 6-Nov-2013All Recent SEC Filings

Show all filings for CARROLS RESTAURANT GROUP, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for CARROLS RESTAURANT GROUP, INC.


6-Nov-2013

Quarterly Report


ITEM 2-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Throughout this Quarterly Report on Form 10-Q, we refer to Carrols Restaurant Group, Inc. as "Carrols Restaurant Group" and, together with its consolidated subsidiaries, as "we", "our" and "us" unless otherwise indicated or the context otherwise requires. Any reference to "Carrols" refers to our wholly-owned subsidiary, Carrols Corporation, a Delaware corporation, and its consolidated subsidiaries, unless otherwise indicated or the context otherwise requires. Any reference to "Carrols LLC" refers to Carrols' wholly-owned subsidiary, Carrols LLC, a Delaware limited liability company.
We use a 52-53 week fiscal year ending on the Sunday closest to December 31. The fiscal years ended December 30, 2012 and January 1, 2012 each contained 52 weeks and the three and nine months ended September 29, 2013 and September 30, 2012 each contained thirteen and 39 weeks, respectively. Introduction
We are a holding company and conduct all of our operations through our direct and indirect subsidiaries and have no assets other than the shares of capital stock of Carrols, our direct wholly-owned subsidiary. The following Management's Discussion and Analysis of Financial Condition and Results of Operations (or "MD&A") is written to help the reader understand our company. The MD&A is provided as a supplement to, and should be read in conjunction with our Consolidated Financial Statements and the accompanying financial statement notes appearing elsewhere in this report and our Annual Report on Form 10-K for the year ended December 30, 2012. The overview provides our perspective on the individual sections of MD&A, which include the following:
Company Overview-a general description of our business and our key financial measures.
Recent and Future Events Affecting Our Results of Operations-a description of recent events that affect, and future events that may affect, our results of operations.
Operating Results from Continuing Operations-an analysis of our results of operations for the three and nine months ended September 29, 2013 compared to the three and nine months ended September 30, 2012 including a review of material items and known trends and uncertainties.
Liquidity and Capital Resources-an analysis of historical information regarding our sources of cash and capital expenditures, the existence and timing of commitments and contingencies, changes in capital resources and a discussion of cash flow items affecting liquidity.
Application of Critical Accounting Policies-an overview of accounting policies requiring critical judgments and estimates.
Effects of New Accounting Standards-a discussion of new accounting standards and any implications related to our financial statements.
Forward Looking Statements-cautionary information about forward-looking statements and a description of certain risks and projections. Company Overview
We are one of the largest restaurant companies in the United States and have been operating restaurants for more than 50 years. We are the largest Burger King franchisee in the world and have operated Burger King restaurants since 1976. As of September 29, 2013, we operated 564 Burger King restaurants in 13 Northeastern, Midwestern and Southeastern states. On May 30, 2012, we acquired (the "acquisition") 278 restaurants from Burger King Corporation ("BKC"), which we refer to as the "acquired restaurants". Our restaurants operated prior to the acquisition are referred to as our "legacy restaurants". Our former indirect wholly-owned subsidiary, Fiesta Restaurant Group, Inc., which we refer to as "Fiesta", was spun off by us to our stockholders on May 7, 2012. The results of operations and cash flows of Fiesta are presented as discontinued operations in our consolidated financial statements for all periods presented. The discussion in our MD&A is focused on our continuing Burger King restaurant operations. The following is an overview of the key financial measures discussed in our results of operations:
Restaurant sales consist of food and beverage sales, net of discounts, at our restaurants. Restaurant sales are influenced by customer traffic, menu price increases, promotions, new restaurant openings and closures of restaurants. New restaurants are included in comparable restaurant sales after they have been open for 12 months. For comparative purposes, the calculation of the changes in comparable restaurant sales is based on a 52-week year.


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Cost of sales consists of food, paper and beverage costs including packaging costs, less purchase discounts. Cost of sales is generally influenced by changes in commodity costs, the mix of items sold and the effectiveness of our restaurant-level controls to manage food and paper costs.

Restaurant wages and related expenses include all restaurant management and hourly productive labor costs and related benefits, employer payroll taxes and restaurant-level bonuses. Payroll and related benefits are subject to inflation, including minimum wage increases and increased costs for health insurance, including changes from the comprehensive federal health care reform law, workers' compensation insurance and state unemployment insurance.

Restaurant rent expense includes base rent and contingent rent on our leases characterized as operating leases, reduced by the amortization of deferred gains on sale-leaseback transactions.

Other restaurant operating expenses include all other restaurant-level operating costs, the major components of which are royalty expenses paid to BKC, utilities, repairs and maintenance, real estate taxes and credit card fees.

Advertising expense includes all marketing and promotional expenses including advertising payments to BKC based on a percentage of sales as required under our franchise agreements.

General and administrative expenses are comprised primarily of
(1) salaries and expenses associated with corporate and administrative functions that support the development and operations of our restaurants,
(2) legal, auditing and other professional fees and (3) stock-based compensation expense. Historical general and administrative expenses exclude all amounts associated with Fiesta as those amounts are included in loss from discontinued operations and include a reduction to general and administrative expenses as if the transition services agreement with Fiesta was in place for all periods presented.

EBITDA and Adjusted EBITDA. EBITDA and Adjusted EBITDA are non-GAAP financial measures. EBITDA represents net income or loss from continuing operations before income taxes, interest expense and depreciation and amortization. Adjusted EBITDA represents EBITDA as adjusted to exclude impairment and other lease charges, acquisition and integration costs, EEOC litigation and settlement costs, stock compensation expense and loss on extinguishment of debt. We exclude these items from EBITDA when evaluating our operating performance and believe that Adjusted EBITDA provides a more meaningful comparison than EBITDA of our core business operating results, as well as with those of other similar companies that may have different capital structures. Management believes that EBITDA and Adjusted EBITDA, when viewed with our results of operations calculated in accordance with GAAP and our reconciliation of Adjusted EBITDA to net loss from continuing operations, provide useful information about our operating performance and period-over-period growth, and provide additional information that is useful for evaluating the operating performance of our core business without regard to potential distortions. Additionally, management believes that EBITDA and Adjusted EBITDA permit investors to gain an understanding of the factors and trends affecting our ongoing cash earnings, from which capital investments are made and debt is serviced. However, EBITDA and Adjusted EBITDA are not measures of financial performance or liquidity under GAAP and, accordingly, should not be considered as alternatives to net loss from continuing operations or cash flow from operating activities as indicators of operating performance or liquidity. Also, these measures may not be comparable to similarly titled captions of other companies. For a reconciliation between net loss from continuing operations and EBITDA and Adjusted EBITDA see page 23.

EBITDA and Adjusted EBITDA have important limitations as analytical tools. These limitations include the following:

         EBITDA and Adjusted EBITDA do not reflect our capital expenditures,
          future requirements for capital expenditures or contractual commitments
          to purchase capital equipment;


         EBITDA and Adjusted EBITDA do not reflect the interest expense or the
          cash requirements necessary to service principal or interest payments
          on our debt;


         Although depreciation and amortization are non-cash charges, the assets
          that we currently depreciate and amortize will likely have to be
          replaced in the future, and EBITDA and Adjusted EBITDA do not reflect
          the cash required to fund such replacements; and


         EBITDA and Adjusted EBITDA do not reflect the effect of earnings or
          charges resulting from matters that our management does not consider to
          be indicative of our ongoing operations.  However, some of these
          charges (such as impairment and other lease charges) have recurred and
          may reoccur.


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Depreciation and amortization primarily includes the depreciation of fixed assets, including equipment, owned buildings and leasehold improvements utilized in our restaurants and the amortization of franchise rights from our acquisitions of restaurants and franchise fees paid to BKC.

Impairment and other lease charges are determined through our assessment of the recoverability of property and equipment and intangible assets by determining whether the carrying value of these assets can be recovered over their respective remaining lives through undiscounted future operating cash flows. A potential impairment charge is evaluated whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be fully recoverable. Lease charges are recorded for our obligations under the related leases for closed locations net of estimated sublease recoveries.

Interest expense consists primarily of interest expense associated with our 11.25% Senior Secured Second Lien Notes due 2018 (the "Notes"), borrowings under our prior Carrols LLC senior secured credit facility and the amortization of deferred financing costs. There have been no borrowings under our existing senior credit facility in 2013.

Recent and Future Events Affecting our Results of Operations Acquisition of Burger King Restaurants
On May 30, 2012, we acquired 278 restaurants from BKC, for a purchase price consisting of (i) a 28.9% equity ownership interest, (ii) a net cash purchase price of $12.1 million and (iii) additional consideration of $4.3 million including $3.6 million for BKC's assignment of its right of first refusal ("ROFR") on franchisee restaurant transfers in 20 states pursuant to an operating agreement dated May 30, 2012 (the "operating agreement"). The amount for the ROFR is payable in quarterly payments over five years. We also entered into new franchise agreements pursuant to the purchase and operating agreements and entered into leases with BKC for all of the acquired restaurants, including leases for 81 restaurants owned in fee by BKC and subleases for 197 restaurants under terms substantially the same as BKC's underlying leases for those properties. Pursuant to the operating agreement, we also agreed to remodel 455 Burger King restaurants to BKC's 20/20 restaurant image by 2015. As of September 29, 2013, we had completed remodeling a total of 183 restaurants to the 20/20 restaurant image, including 93 restaurants in the first nine months of 2013. We currently anticipate remodeling an additional 17 to 22 restaurants in the fourth quarter of 2013.
In the fourth quarter of 2012, the Company finalized its allocation of the purchase price for this acquisition to the tangible and identifiable intangible assets acquired and liabilities assumed in the transaction. The prior year periods presented in the accompanying unaudited consolidated financial statements have been recast to reflect the impact of the fair value adjustments for the acquisition as if they had originally been recorded on May 30, 2012. The impact of these adjustments for the three and nine months ended September 30, 2012 included a reduction of rent expense of $0.1 million and $0.2 million, respectively, and a reduction of depreciation expense of $0.5 million and $0.7 million, respectively.
Refinancing of Outstanding Indebtedness
On May 30, 2012, we issued $150.0 million of 11.25% Senior Secured Second Lien Notes due 2018 and entered into a new senior credit facility that provides for up to $20.0 million of revolving credit borrowings (which was undrawn at closing). The net proceeds from the issuance of the Notes were used to (i) repay all outstanding borrowings under the prior Carrols LLC senior credit facility of $64.8 million (ii) pay $12.1 million related to the acquisition of the acquired restaurants from BKC and (iii) fees and expenses related to the offering of the Notes. Interest expense associated with the Notes, including the amortization of deferred financing costs, will be approximately $17.8 million in 2013. Spin-off of Fiesta Restaurant Group, Inc. On April 16, 2012, our board of directors approved the spin-off of Fiesta (the "Spin-off"), which through its subsidiaries, owns, operates and franchises the Pollo Tropical and Taco Cabana restaurant brands. In connection with the Spin-off, on April 24, 2012, we and Carrols entered into several agreements that govern our post Spin-off relationship with Fiesta, including a Separation and Distribution Agreement, Tax Matters Agreement, Employee Matters Agreement and Transition Services Agreement ("TSA").
Fiesta filed with the Securities and Exchange Commission (the "SEC") a Form 10 registration statement, File No. 001-35373, as amended, which included as an exhibit an information statement which describes the Spin-off. The Form 10 registration statement, which registered the common stock of Fiesta under the Securities Exchange Act of 1934, as amended, was declared effective by the SEC on April 25, 2012.
On May 7, 2012, we completed the Spin-off of Fiesta in the form of a pro rata dividend of all of the issued and outstanding common stock of Fiesta to Carrols Restaurant Group's stockholders whereby each stockholder of Carrols Restaurant Group's common stock of record on April 26, 2012 received one share of Fiesta common stock for every one share of Carrols Restaurant


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Group common stock held. As a result of the Spin-off, Fiesta is an independent public company whose common stock is traded on The NASDAQ Global Select Market under the symbol "FRGI."
The historical operating results of Fiesta are included in our operating results as discontinued operations.
Amounts earned by Carrols under the TSA were $0.6 million and $3.0 million in the three and nine months ended September 29, 2013, respectively, and $1.5 million and $2.6 million in the three and nine months ended September 30, 2012. Amounts earned under the TSA are currently expected to range from $3.4 million to $3.6 million for all of 2013. Fiesta has terminated certain administrative services provided by us under the TSA during 2013. We currently anticipate the amounts to be earned under the TSA in 2014 to be minimal. Future Restaurant Closures
We evaluate the performance of our restaurants on an ongoing basis including an assessment of the current and future operating results of the restaurant in relation to its cash flow and future occupancy costs, and with regard to franchise agreement renewals, the cost of required capital improvements. We may elect to close restaurants based on these evaluations.
In 2012, we closed four restaurants. In the first nine months of 2013 we have closed eight restaurants, including two in the third quarter of 2013 and four underperforming restaurants in the second quarter of 2013 prior to the expiration of their contractual lease term. We reserved $1.6 million for estimated future rent payments and other lease related expenses for these four locations. We may incur lease charges in the future from additional closures of underperforming restaurants, however we believe the impact of these closures will likely be accretive to our future EBITDA.
We currently anticipate that we will close two additional restaurants in 2013, excluding any restaurants relocated within their market area. We also currently anticipate closing approximately 18 to 20 additional restaurants in 2014. Our determination of whether to close restaurants in the future is subject to further evaluation and may change.
We do not believe that the future impact on our consolidated results of operations due to restaurant closures at the end of their respective franchise agreements will be material, although there can be no assurance in this regard. Valuation of Deferred Income Tax Assets
We are expecting we will have a federal net operating loss carryforward of approximately $23 million for 2013, which will expire in 2033. In addition, we have federal tax credit carryforwards of $3.4 million which expire beginning in 2031.
We are required to perform an assessment of positive and negative evidence regarding the realization of the net deferred income tax assets in accordance with ASC 740. As part of this process, we consider all available positive and negative evidence, including future reversals of existing temporary differences, projected future taxable income and recent financial operations, to determine whether, based on the weight of that evidence, a valuation allowance is needed for some portion or all of a net deferred income tax asset. Judgment is used in considering the relative impact of negative and positive evidence. In arriving at these judgments, the weight given to the potential effect of negative and positive evidence is commensurate with the extent to which such evidence can be objectively verified. In evaluating the objective evidence provided by historical results, we consider (among other things) whether the past three years of pre-tax income from continuing operations would yield a cumulative loss position, as well as forecasts of expected operating results for the future years over the carryforward period. We have incurred losses in the past two fiscal years and expect to incur a loss for the 2013 fiscal year. This will be considered in the assessment of the realization of the federal net deferred tax assets that we expect to complete in the fourth quarter 2013. Health Care Reform
The Patient Protection and Affordable Care Act (the "Act") requires businesses employing fifty or more full-time equivalent employees to offer health care benefits to those full-time employees beginning in January 2015, or be subject to an annual penalty. Those benefits must be provided under a health care plan which provides a certain minimum scope of health care services. The Act also limits the portion of the cost of the benefits which we can require employees to pay.
We are continuing to assess the financial impact of the Act including the provision beginning in 2015 to offer health insurance to our hourly employees who work an average of 30 hours or more per week. Based on our analyses to date and our current activities addressing aspects of this provision operationally, we currently estimate that our cost for the health care coverage for our qualifying hourly employees would not exceed $3.0 million on an annual basis if all our eligible hourly employees elect coverage. Given the estimated annual premium cost our eligible hourly employees would incur in comparison to the annual financial penalty they would pay if they do not elect our health care coverage, we estimate our additional annual health care costs could range from $0.5 million to $1.0 million due solely to this provision; however there can be no assurance in this regard. For 2014, we currently anticipate additional fees due to the Act of $0.5 million associated with our current health care coverage of our employees.


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Operating Results from Continuing Operations
Three Months Ended September 29, 2013 Compared to Three Months Ended
September 30, 2012
The following table sets forth, for the three months ended September 29, 2013
and September 30, 2012, selected operating results from continuing operations as
a percentage of restaurant sales for all of our restaurants and our legacy
restaurants and, for the three months ended September 29, 2013, the acquired
restaurants:
                                                                    Three Months Ended
                                                        September 29, 2013      September 30, 2012
Costs and expenses (all restaurants):
Cost of sales                                                     30.4 %                   32.1 %
Restaurant wages and related expenses                             31.1 %                   31.6 %
Restaurant rent expense                                            7.0 %                    7.2 %
Other restaurant operating expenses                               16.0 %                   17.0 %
Advertising expense                                                4.4 %                    4.6 %
General and administrative                                         5.2 %                    5.5 %

Costs and expenses (legacy restaurants):
Cost of sales                                                     29.7 %                   30.0 %
Restaurant wages and related expenses                             29.9 %                   29.5 %
Restaurant rent expense                                            6.0 %                    6.2 %
Other restaurant operating expenses                               14.9 %                   14.7 %
Advertising expense                                                4.3 %                    4.4 %

Costs and expenses (acquired restaurants):
Cost of sales                                                     31.2 %                   34.8 %
Restaurant wages and related expenses                             32.6 %                   34.2 %
Restaurant rent expense                                            8.2 %                    8.5 %
Other restaurant operating expenses                               17.4 %                   19.9 %
Advertising expense                                                4.7 %                    5.0 %

Since the beginning of the third quarter of 2012 through the end of the third quarter of 2013, we have closed ten restaurants.
Restaurant Sales. Total restaurant sales in the third quarter of 2013 decreased to $168.3 million from $169.5 million in the third quarter of 2012. Comparable restaurant sales for our legacy restaurants increased 0.6% due to a 1.6% increase in customer traffic partially offset by a decrease in average check, due primarily to a shift in sales mix compared to the prior year. Comparable restaurant sales at our acquired restaurants increased 0.2% from an increase in average check of 1.0% due to menu price increases, offset by a decrease in customer traffic. The comparable restaurant sales increases were offset by the closure of ten restaurants since the beginning of the third quarter of 2012. Operating Costs and Expenses (percentages stated as a percentage of restaurant sales for the restaurants being discussed). Cost of sales for all restaurants decreased to 30.4% in the third quarter of 2013 from 32.1% in the third quarter of 2012. Cost of sales at our legacy restaurants decreased to 29.7% in the third quarter of 2013 from 30.0% in the third quarter of 2012 due primarily to a favorable sales mix and the effect of menu price increases, partially offset by higher promotional sales discounts (1.5%), higher beef costs and lower vendor rebates (0.4%). Cost of sales at our acquired restaurants decreased to 31.2% in the third quarter of 2013 from 34.8% in the third quarter of 2012 due to improvement in restaurant-level food and cash controls, the effect of menu price increases and a favorable sales mix, partially offset by higher promotional discounts and higher beef costs.
Restaurant wages and related expenses for all restaurants decreased to 31.1% in the third quarter of 2013 from 31.6% in the third quarter of 2012. Restaurant wages and related expenses for our legacy restaurants increased to 29.9% in the third quarter of 2013 from 29.5% in the third quarter of 2012 due primarily to higher workers compensation claims (0.4%). Restaurant wages and related expenses for our acquired restaurants decreased to 32.6% in the third quarter of 2013 from 34.2% in the third quarter of 2012, due to increased productive labor efficiencies (2.4%) partially offset by higher workers compensation claims (0.5%).


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Other restaurant operating expenses for all restaurants decreased to 16.0% in the third quarter of 2013 from 17.0% in the third quarter of 2012 due primarily to lower repairs and maintenance expenses at our acquired restaurants (0.4%), lower utility costs (0.2%), lower cash handling costs (0.2%) and lower operating supplies.
Advertising expense for all restaurants decreased to 4.4% in the third quarter of 2013 from 4.6% in the third quarter of 2012 due primarily to lower spending for additional local advertising in certain markets and incentives received from BKC's ITP program related to certain restaurant remodels. Advertising expense as a percentage of sales is lower at our legacy restaurants compared to our acquired restaurants due to advertising credits being received from BKC that are associated with 2012 menu enhancement initiatives and our installation of digital menu boards at our legacy restaurants. These expenditures at the acquired restaurants were made prior to the acquisition.
Restaurant rent expense for all restaurants decreased to 7.0% in the third quarter of 2013 from 7.2% in the third quarter of 2012 due in part to the closure of underperforming restaurants since the beginning of the third quarter of 2012 and lower contingent rental expense at our legacy restaurants. General and Administrative Expenses. General and administrative expenses decreased $0.6 million in the third quarter of 2013 to $8.7 million and, as a percentage of total restaurant sales, decreased to 5.2% compared to 5.5% in the third quarter of 2012. The decrease in general and administrative expenses was due primarily to costs incurred in the third quarter of 2012 in connection with our litigation with the EEOC which was settled in the first quarter of 2013 partially offset by higher administrative bonus accruals and lower amounts earned under the TSA with Fiesta.
Adjusted EBITDA. As a result of the factors above, Adjusted EBITDA increased to $10.1 million in the third quarter of 2013 from $9.2 million in the third quarter of 2012. For a reconciliation between net loss from continuing operations and EBITDA and Adjusted EBITDA see page 23.
Depreciation and Amortization Expense. Depreciation and amortization expense increased to $8.5 million in the third quarter of 2013 from $7.7 million in the third quarter of 2012 due primarily to the addition of the acquired restaurants and our remodeling initiatives in late 2012 and 2013.
Impairment and Other Lease Charges. Impairment and other lease charges were $1.1 . . .

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