Cracker Barrel Old Country Store, Inc Q2 FY2021 Earnings Call

Good morning, and welcome to the Cracker Barrel Fiscal 2021 Second Quarter Earnings Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Adam Hanan. Please go ahead.

Thank you. Good morning, and welcome to Cracker Barrel's Second Quarter Fiscal 2021 Conference Call and Webcast. This morning, we issued a press release announcing our second quarter results. In this press release and on this call, we will refer to non-GAAP financial measures for the second quarter ended January 29, 2021.

Thanks, Adam. Good morning, everyone. Thank you for joining us, and I hope everyone is continuing to stay safe and healthy. Before I begin, I'd like to take a moment to introduce Doug Couvillion, our Interim Chief Financial Officer. Doug has been with Cracker Barrel for over 20 years and has served in a number of executive positions, including Corporate Controller and Principal Accounting Officer; and most recently as Senior Vice President of Sourcing and Supply Chain. Doug has a deep knowledge of both Cracker Barrel and the restaurant industry, and I'm confident that his perspective and leadership will contribute to our success and help drive long-term value creation.

Thank you, Sandy, and good morning to all. I'm pleased to be on the call with you today. For the second quarter, we reported total revenue of $677.2 million, a decrease of 20% compared to the prior year quarter. Our restaurant revenue decreased 21.4%. And our retail revenue decreased 14.8%. In the second quarter, we experienced a significant increase in the number of dining room closures as well as more restrictive limits on capacity due to the resurgence of COVID-19. At the peak in December, approximately 120 stores were operating with closed dining rooms.

Thank you. We will now begin the question-and-answer session. Our first question is from Gregory Francfort from Bank of America. Please go ahead.

Hey, thanks for the question. Sandy, the first question, I guess, it's really a two-part question. And it seems like the way a lot of investors are looking at this group is a recovery sales and a recovery margin framework. And so I wonder if you could give your thoughts on maybe why— I don't know if it happens in 2022 or 2023 or late in 2021, why there might be an upside case for AUVs post-pandemic versus pre-pandemic? And then why on maybe even a 100% sales recovery rather than 105%, margins could be even higher. Just any thoughts on that would be great. Appreciate it.

Okay. Well, we're—I think, everyone is trying to think about what life will be like as we move past the pandemic. I'm excited that we have a number of sales-driving initiatives to start with. So beginning with the dine-in completion of our dinner initiative, which we started a couple of years ago. Our third phase will launch in April, which I think will provide guests with a reason to come back. We're making progress on beer and wine. I'm excited about that. We've made a lot of progress on our digital store, which I think will do a lot in terms of guest loyalty and facilitate our off-premise business. In terms of our off-premise business, we've seen explosive growth, and we believe that we will be able to maintain over 50% and we're hoping to keep about in excess of 50% of the growth in that category. So I think there's a lot of good news on the top line. Additionally, we've been working on productivity enhancements and cost savings initiatives. Doug spoke about the cost savings progress we're making. You heard about our menu simplification progress over the last few months, which I think really positions our field teams to deliver a more consistent experience, to improve productivity, and to allow room for future innovation. So I think we've got a lot of work on many areas that will position the company when our guests come back to experience the brand however they want to.

Thanks for the thought. I’ll hop back in the queue.

The next question is from Todd Brooks from C.L. King. Please go ahead.

Hey, good morning everybody. I just have a couple of questions. One, if we look at the Cracker Barrel footprint and the kind of obscene winter weather that we've had in a lot of the southern tier the Southeast, can you maybe talk about what percent of the store base has been impacted due to the storms here in February? And maybe if we can walk through whatever the projected impact from the storms caused on the thinking around the operating margin improvement guidance sequentially from fiscal Q2 to fiscal Q3?

I can start and then Doug I'll let you add more color. I don't know that Todd if I can give you exactly the percentage. We had stores—of course, Texas was impacted. I think at the peak we may have had 126 stores that were closed either because of the snow conditions or because our employees weren't able to get to the stores. Beyond that though we had a number of communities when the temperatures in the south reached the kind of places they were over the last week. Even when they weren't closed, it kept people from being out. So our business was broadly and dramatically impacted. It's also really disruptive in terms of production and many of those things. All of that though was baked into the guidance we provided for the third quarter.

Sandy, thanks. I think that as far as the regional perspective and from the weather, you've nailed it. And just to reiterate what Sandy said, our expectations for February from a sales and operating perspective were included in our margins. I think it might help if I talk to you a little bit more about what we're expecting with the 50 to 100 basis points range that we gave related to the improvements expected sequentially. When we look at things, the largest driver is a favorability in our cost of goods sold because of significant changes on our channel shift. We expect seasonally to have lower retail cost of goods sold. Some of that is a continuation of the effective sell-throughs our team were having and reduced promotional activity we expect to carry through the quarter. We also expect as our off-premise business continues to shift back into the dining room, we will have lower restaurant cost of goods, reflecting a change from the second quarter when they were higher because of Heat 'n Serve. We also have a bit of menu leverage. We took menu pricing late in January. So we'll see the benefit of that for the full third quarter. So that pretty much kind of takes you through our expectations on the margins as we move through Q3.

That's very helpful, Doug. Thanks. And then just my follow-up question, if we knowing that there's too much variability to talk about quarter-to-date trends. If we look back to the fiscal second quarter and across the store base, could you maybe talk about spread and performance maybe some of the earlier to reopen markets or more liberal capacity markets versus some of the more restricted markets so that we can get an idea of maybe in a reopening scenario what some of the base might recover to as we see capacity restrictions lift? Thank you.

We're monitoring closely the individual stores and regions. And not surprisingly, the business is better in those markets and communities where there are the fewest restrictions. However, it's a little more complicated because you could say Florida would potentially be a strong zone. We're pleased with the progress we're making, particularly in the Southeast where the restrictions have gone. But if a store is dependent on tourism, it might not feel it. So we are not necessarily seeing travel to some of our destination stores yet that we are hoping to see certainly in the summer and as we move through the spring and vaccinations open up and people get comfortable moving around a bit more.

The only thing I would add to that is I think we've talked previously about on-interstate versus off-interstate stores. With the softness in travel, we see a little bit less recovery in our on-interstate stores, but we're picking up in the off-interstates, which is a good sign.

The next question is from Jeff Farmer from Gordon Haskett. Please go ahead.

Thank you. I have a couple of questions and a follow-up. So I will start with the follow-up. Your F2Q off-premise sales were, I think, in the range of $17,000 to $18,000 per week. Pre-COVID I think you guys were $7,000 to $8,000 per week. I think you just said that you were looking to keep in excess of 50% of that sort of increase in off-premise. But 50% of what I guess is the question. What number are you referring to? Because you did see that seasonality—seasonally high sort of F2Q off-premise number, so 50% of what is the follow-up question?

I'll take that Jeff. It's probably good that I clarify. What we're trying to model here as we look further out is how sticky our off-premise business is. It varies by channel in terms of our view about it. Individual continues to be the largest channel, which we think some of that is going to convert back to the dining rooms when they open. We think our catering channel is going to grow when people start doing gatherings. We believe our Heat n' Serve will remain solid. We've been doing a lot of work on the assortment there; it's an interesting place for the brand. In general though, what I meant by my comment is that long-term, we’d like to believe that we can retain in excess of 50% of the growth we experienced in our off-premise business over the last year.

Okay. And then on the questions, the fiscal third quarter same-store sales guidance I think that implies average weekly sales of roughly $62,000 a week if my math is somewhere close. Is that the run rate you're seeing now, or is that a run rate you anticipate growing to as you move throughout the quarter?

Yes. That's—it's a good question and I'll clarify a couple of different ways. No, that's not what we're seeing right now. We certainly were encouraged by the trends we saw in January coming into February. We think that will grow into the sales expectations we provided over the remainder of the quarter. Just to add clarification, we guided versus 2019 and provided a range of 11% to 14%. When you convert that into what we think comps look like versus 2020, that gets you around 50% on the restaurant side. For retail, it's in the range of 65% to 70%.

Right. Okay. And then the final question. You did touch on this in the prepared remarks, but as it relates to the $50 million in cost savings that you're pursuing this year and the offsets, I think you gave a little bit of color here, but there's obviously the rent offset. I think there's roughly $8 million in incremental G&A expense. I might have missed some stuff. But just some additional clarity in terms of what that gross $50 million of cost savings could look like on a net basis in fiscal 2021?

To remind you, as we've talked about those cost savings, we have several offsets. A lot of the offsets were related to our sales-driving activities. The largest piece was related to our beer and wine expenses. We are also making investments in our digital business and have some offsets related to health and safety measures, which have been in the numbers. As we think about our business model post-COVID, we believe those health and safety measures will come out of the expenses. We're really not prepared to talk about exactly what that looks like until we get into the fall when we have a little better perspective from our planning and give guidance for 2022.

Okay. Thank you.

The next question is from Jake Bartlett from Truist. Please go ahead.

Great. Thanks for taking the questions. My first is about your expectations for the third quarter. This goes back to the February results. I know you're not sharing them, but can you just talk broadly about how close to fully recovered you think you'll be by April? It seems like within this guidance, there's a scenario where you're actually very close. If you can speak to your confidence about the speed of the recovery that you're expecting?

Hey, Jake. We thought we were going to make you happy by giving you third quarter guidance on that.

I am. I love it.

No. Month-over-month, it improves as vaccines, stimulus money, and feelings improve, restrictions loosen. We're hoping that it just continues to improve as we continue through the third and into the fourth. But we're not prepared to break it down month-by-month at this time.

Okay. And the comment on margins, I think the comment was that you'd expect flat operating margins in 2022, which I think sales were at 2019 level. Maybe if you can kind of repeat that. But I wanted to make sure I understood the moving pieces in light of the margin savings, the $50 million in savings you've gotten. It seems like you could be at a higher margin in 2022 than you were in 2019. But maybe if you could just clarify that comment?

Let me give you a little perspective on that. First off, we really haven't given any details related to 2022 yet. A couple of things you have to keep in mind as we guide for 2022 is that we have changes related to the sale-leaseback, which will change our operating margins compared to 2019. So, there will be some step down for that, which will then be offset by some of the cost savings initiatives we have and the rollout of some of the ongoing costs we've discussed in a few things. But it’s really not going to be a flat number.

Got it. So maybe to put it another way: would you expect margins to be higher or lower than 2019 at the same sales levels if 2022 was the same sales level as 2019?

We're not providing guidance on margins right now for 2022.

Okay. I was just trying to understand the moving pieces. But just lastly Doug, if you can clarify where we are in the $50 million of savings. I think you mentioned what was saved in G&A. But maybe I missed it, the impact in labor. So maybe just trying to make sure we understand what's left to come of that in the third quarter. And then on pricing, I just want to make sure I understand; I think what it implies is a 3% pricing in the back half of the year. And if that is the case, what is driving the kind of much more aggressive pricing outlook?

Well, I'll start on general pricing and then Doug can give additional detail on cost savings. So first of all, we mentioned that we were going to be conservative in the first half. We guided for the year at about 2% but being conservative in our initial pricing actions for the first half. At the end of January, we took another pricing change, and I’m trying not to disclose too much that Doug wishes I didn’t. Then we plan some additional pricing actions over the course of the year selectively. All that getting to the guidance for the year of about 3%.

Yes, that is correct.

In terms of our cost savings, Doug what else do you want to add?

Yes. The largest part, I think we've provided this on the September call; the larger part of it was coming out of the store operating area. We achieved about $20 million of cost savings in the prior year. That left the balance to be earned this fiscal year, and about half of that was in Q1 and the other half in Q2 and Q3 over the course of this fiscal year. We've wrapped up the cost savings with this fiscal quarter, and there’s a little bit left that will carry over for the remainder of the year but it's pretty small.

Great. I appreciate it. Thank you.

The next question is from Brett Levy from MKM. Please go ahead.

Great. Thanks. You started to talk a little bit about some of the progress you're making at Maple Street. How should we think about what you can do from a development standpoint and not just throughout this year and into next year, but also what can we see longer term out of it when it starts to become a more meaningful needle mover from a profit contribution? And how are you thinking about what you may have learned over this course of the last year for the traditional Barrel locations?

Let me start and I'll hit the Maple Street, then touch on the Cracker Barrel. First, as I said in the prepared remarks, we're really pleased with the performance; they've exceeded our expectations both in the comps and in the progress they're making on their operating income margins. We've been really focused on ensuring we had the best sites as we opened new locations and that we understood what the best site looks like, which is why we've gone a little slower than we had originally planned. I'm excited about the sites we identified. As I mentioned, there will be three opening this year – the first in Louisville, and the second one today in Murfreesboro. We will be entering new markets as well looking for additional locations around existing markets. I'd like to say that in the next fiscal year, we’ll be looking at growth in the double digits back to where we originally thought, in the sort of 15% to 20% range. So then it starts to become meaningful on both certainly the top-line numbers for us.

Thank you. That was helpful.

The next question is from Alton Stump from Longbow Research. Please go ahead.

Thank you. Hey, good morning. I just wanted to ask first about the off-premise margin front; obviously being lower which is understandable. As you think about long term, given that it will probably be a bigger piece of your business even after COVID, how do you think about ways to close that gap on margin? Whether it's targeting more pricing on off-premise or getting scale to cut that cost? Which of the moving pieces do you think could potentially close the gap on your off-premise margin versus on-premise?

Sure. So I'll take that. We're doing a lot across the brand in many areas about how to improve our margins, but specifically in off-prem. So individual to-go probably is the biggest thing we're working on is how to increase the check. If you look at the rate on individual to-go, it’s actually pretty well in line with dine-in. We'd like to get more of an attachment either beverage, an add-on, or a retail item to get the check up. We're working on our supply costs, which is a big part of our off-prem business, and looking to reduce labor; that's a technology play whether that's getting more guests to go through our digital app so they order and pay that way which reduces the labor required. We think in some of our offers like Heat n' Serve, we have pricing power. We're working on new offers that will appeal. These individual box meals we've launched in the last week as a catering offer respond to both the pandemic interest in having individual meals versus buffet but also a lot of guests need an individual offer that fits their occasion. So our teams; culinary, technology, and our operators are working to improve the off-premise experience, which is why we believe we will be able to make progress on our off-premise margins.

Great. Very helpful. And then a quick follow-up; I'll hop back in the queue. Doug, I think I heard you correctly that you said the tax rate will be 100% in 3Q and 5% in 4Q. Just what are the moving pieces driving that big volatility in the tax rate from 3Q to 4Q?

Yes. When you think about taxes, the large gain from the sale-leaseback caused a relatively high tax rate compared to the rest of the year. We had the carryback recorded in Q2, both of which impact cash taxes paid. Taxes are kind of a solve when recording them on an interim basis. As we look at our effective rate for the year and apply that against our earnings for the next two quarters, that's just the rate that it takes to solve. So really those—happenings in the prior periods are driving it as opposed to activities in the next two quarters.

Got it. Thank you.

You get the prize Alton for discussing the tax question. I have to tell you nobody here was really excited about it.

The next question is from Bob Derrington from Telsey.

Yes, thanks. Doug, if you could clarify that last point on the tax. If we think about it, I assume you're talking about the GAAP tax during the quarter. Would you be reporting the third quarter on an adjusted basis?

I was talking about the GAAP tax rates and the guidance we gave. When we report the third quarter it would be on a GAAP and adjusted basis so you have visibility.

Okay. All right. That's terrific. I assume that, but I hate to make any assumptions. And also as it relates to menu pricing could you clarify for us. As I look around the industry, most of your peers are generally taking menu pricing a little bit more in markets where minimum wage rates are going up. Is that generally the thought here as far as the incremental menu pricing you’ve taken and are anticipating?

Yes. We introduced pricing tiers four or five years ago largely as we started moving out west; our growth was in areas where there were significant minimum wage increases. We’re already positioned to do it. As we think about our pricing increases, we look to take more price in areas where we need to offset minimum wage increases.

Got you. Okay. And Doug, I appreciate the clarification on the same-store sales converted to adjusted for this year versus last. As I look at some of the numbers, it appears that's in line with current expectations. However, looking out to the fourth quarter, last year travel trends were significantly impacted by COVID spread. National surveys show pent-up demand for travel, suggesting aggressive expectations from consumers to get out on the road for the beaches or elsewhere. Sandy, how do you find enough people to staff the stores, if this trend continues into the strong summer travel season?

Well, first, let's all hope that once we’re through this, America wants to get out on the road. While they're out, we will be ready to feed them. Our operators are focused on ensuring we are both staffed and trained as we head into that. One benefit from the actions we took from the very beginning of the pandemic is that we've focused on employee retention. Our operating teams have done a phenomenal job ensuring employee retention through various programs and the flexibility we've provided. We are focused on what the right level of staffing is and how to achieve that in coordination with our HR team so we are ready.

Got you. Thank you for that. Then last question, you previously talked about a store in which you were testing different ideas regarding virtual brands. Can you share anything else about that testing process at this point?

Yes. The test you're referring to is our CB Kitchen. What we tested in the Indianapolis market is converting a Cracker Barrel box to an off-premise only facility. I'm pleased with what it's done; it’s only been in operation for a few months. I believe its ability to provide Heat n' Serve offerings during holidays was beneficial, and we’re continuing to test and understand opportunities there, especially when catering returns to that market. We’re excited to be launching a virtual brand test on Friday that offers chicken and biscuits, provided delivery-only. It's a unique opportunity to see how an offer for something Cracker Barrel is known for resonates as a delivery-only offering. We'll keep you posted.

That's exciting. You mentioned the Heat n' Serve prime rib meal would be available during this coming Easter?

That's correct.

The next question is from Jon Tower from Wells Fargo. Please go ahead.

Hey. Thanks for taking the call and question. I have a few if I may. Just kind of following up on the wage question earlier. Can you help us understand the structure of wages at the store today? It differs by state, but perhaps the minimum wage or the percentage of employees at the store that are subject to the minimum wage levels? And then how much of that is tip credit? From a higher level, your thoughts on longer-term wage rate inflation? There's uncertainty about what's going to happen from a government level, but you're seeing retailers bumping up their wage rates right now, which could help your top line but also lead to pressures in retaining or bringing in new talent.

In a Cracker Barrel restaurant, we have tipped and non-tipped employees. Depending on the rules in each market, the minimum wage is more important in terms of the tip credit. The tip credit change can have a bigger financial impact on us. We're monitoring both. The tipped versus non-tipped mix, Doug, I don't know if you know that off the top of your head. An issue has been that, in an environment where we've shifted from the dining rooms to off-premise business, that has changed the mix into more non-tipped employees, which tend to be more expensive at a higher wage rate. We're watching how this unfolds in the states and communities we're in; it will take a while to work through. However, we believe we can offset some of these pressures through pricing increases. We're also focused on offsetting our labor needs through productivity improvements and technology.

Yeah, if you have that split potentially at the store level, I'd like to follow-up later, but that's fine if you don’t have it right now. I can move on to another question.

You probably want a normalized one; let's follow-up later.

Right, exactly. I appreciate that. As you talked about porches being a possible part of the prototype going forward, what's your thinking about spring and summer this year? Are those going to be options again in fiscal 2021 and into 2022, or are those going to be taken off the table?

Actually, we’re discussing that right now in the store. We have about 125 official front porch dining stores, meaning stores with outdoor furniture. There are probably 200 unofficial front porch dining rooms where stores have moved dining room furniture outside to service guests. Front porch dining will be part of Q3 and Q4, and we’re evaluating how it might become permanent. Guests love it, although our field teams find it challenging to take care of guests in that setup. We need to consider access to the front porch, weather concerns, etc. Our operators are working on where we should continue to have front porch dining and what that would look like.

Got it. Thank you. Lastly, on the beer and wine test, you mentioned expansion to a few more stores and that it was meeting expectations. Can you talk about the sales impact to those stores? I assume much of it is consumed at dinner, but would you be willing to break out the mix between lunch and dinner? Any surprises with the program as it's rolled out?

The mix—we mentioned last call it’s about 1% of sales. We believe we can double it, and I still believe that. One thing we've seen is that since Florida launched beer and wine, the COVID restrictions have significantly reduced. We've enhanced our marketing and training effort there, and I'm seeing positive results in Florida. Surprisingly, the number one seller remains mimosas. It's not just dinner; people drink mimosas with pancakes too. We’ve tested new items like Sangria and Blue Moon, which we believe we might add to the lineup. Our culinary team is working on assortment. The field operators are focused on delivering the new beverage program effectively, and our marketing team is really working hard on how to tell our guests about it, especially as we cannot have much point-of-sale information on the table.

Got it. I appreciate all the color. Best of luck. Thank you.

There are no more questions in the queue. This concludes our question-and-answer session. I would like to turn the conference back over to Sandy Cochran for any closing remarks.

Thank you all for joining us today. Cracker Barrel continues to be one of the strongest and most differentiated brands in the industry. I remain confident in our strategy and initiatives. I believe we're well positioned to drive strong performance when the industry normalizes. We appreciate your support and look forward to speaking to you in a few months.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.