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Edited Transcript of SAUC earnings conference call or presentation 8-Mar-19 3:00pm GMT

Q4 2018 Diversified Restaurant Holdings Inc Earnings Call

Southfield Mar 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Diversified Restaurant Holdings Inc earnings conference call or presentation Friday, March 8, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Gregory Burke

Diversified Restaurant Holdings, Inc. - President, CEO & Director

* Phyllis A. Knight

Diversified Restaurant Holdings, Inc. - CFO & Treasurer

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Conference Call Participants

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* Jeremy Scott Hamblin

Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail

* Michael Scott Wallace

White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager

* Will Hamilton

* Craig Mychajluk

Kei Advisors LLC - SVP of Operations

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Presentation

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Operator [1]

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Greetings, and welcome to the Diversified Restaurant Holdings' Fourth Quarter and Full Year 2018 Finance Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Craig Mychajluk, Investor Relations. Thank you, sir. You may begin.

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Craig Mychajluk, Kei Advisors LLC - SVP of Operations [2]

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Thank you, and good morning, everyone. We appreciate your time today and your interest in Diversified Restaurant Holdings.

Joining me on the call is David Burke, our President and Chief Executive Officer; and Phyllis Knight, our Chief Financial Officer and Treasurer. You should have a copy of the financial results that were released after markets closed yesterday, and if not, you can access it at our website, diversifiedrestaurantholdings.com. There's also a slide presentation posted on our website that we will refer to during today's call.

If you would, please refer to Slide 2. As you are aware, we may make some forward-looking statements on this call during the formal discussion as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated on today's call. These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. These documents can be found on the company's website or at sec.gov. During today's call, we will discuss non-GAAP measures, which we believe will 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 GAAP. Reconciliations of non-GAAP to comparable GAAP measures are provided with the tables accompanying the earnings release. So with that, let me turn it over to David to begin. David?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [3]

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Thank you, Craig. And good morning to everyone. So we continue to be energized and excited by the initial changes that are being implemented by our franchisor and, as noted in our preliminary release last week, we're starting to really reap its early benefits of the new marketing, media and promotional initiatives, combined with our steadfast focus on guest experience, loyalty attachment and development of the delivery channel.

For the first time since 2015, we achieved positive same-store sales of 2.2% in the fourth quarter. Importantly, that moment has carried into 2019, with positive same-store trends continuing to the first 9-week for the first quarter despite severe weather that impacted a significant portion of our footprint. Excluding those weather-related delays, same-store sales growth has been over 3%, and traffic continues to be the leading driver, a positive 4.5%. What's more telling is that the recent performance was accomplished with little promotional impact as most of the fall football campaigns were phased out in January. I'll touch on the litany of new teams that are upcoming after Phyllis runs through the financials. But beforehand, I'd like to comment on last week's announcement, regarding an agreement to acquired 9 Buffalo Wild Wings restaurants in the Chicago area for $22.5 million. But there are a number of reasons this transaction is attractive to us. And while it stands up well on its own merits, we view it as an important catalyst to broaden our debt refinance options with the ultimate goal to strengthen and stabilize the balance sheet, increase our free cash flow to drive future value creation.

These sports bars are located with one of our existing footprints in the Chicago market where we currently have 9 other locations. Healthy AUVs of about $3.6 million are attributable to strong demographics. However, we do believe there is room to improve on these levels with additional emphasis on loyalty, attachment rate, and delivery. There's a margin opportunity as well, as we expect to leverage our scale and infrastructure. They're currently generating a restaurant-level EBITDA margin in the 13% range. And the seller has done a great job in maintaining the facility, that's really without need for any significant capital investment at this time. The acquisition is subject to franchisor consent, waiver of a right of first refusal and customary closing conditions. We anticipate closing in the second or early part of the third quarter. We are evaluating various alternatives to finance this transaction and everything is on the table. While there are a variety of debt options and a consideration, equity will likely have to be part of the financing structure as we aim to ameliorate our leverage ratios and eliminate the immediate refinancing risks as our debt goes current in June. The added EBITDA from the acquired sports bars plays a significant role in this risk-reducing initiative. With that, I'll pass it over to Phyllis, and then I'll come back and touch on the upcoming changes.

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [4]

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Thanks, David, and good morning. Before we get started, just a quick reminder that 2017 was a 53-week year, so the fourth quarter and full-year comparisons were impacted by that extra week, typically, the largest sales week of the year. In the slides that we've posted to our website, we've broken that out. So you can see a more relevant comparison of the period.

Sales in the fourth quarter totaled $39.1 million, an increase of $700,000 or 1.8% compared with the comparable 13 weeks in the fourth quarter of 2017. Same-store sales increased 2.2%, with traffic up 4%, and average check down 1.8%. It's worth noting that we didn't take much price in 2018. The decline in average check was a result of the $5 football promotion that ran throughout the quarter. We do have an approximately 1.5% price increase coming with the new menu rollout next week which David will talk about later in the call. For the year, sales totaled $153.1 million compared with $165.5 million in 2017, or $162 million for the comparable 52-week period. Adjusted EBITDA for the quarter totaled $3.8 million, and restaurant-level EBITDA totaled $5.6 million. Absent the extra week in 2017, both metrics performed relatively well compared with last year, as higher sales and lower G&A expenses helped to offset increased labor costs. For the full year, adjusted and restaurant-level EBITDA margins were down 1.7 and 1.9 points, respectively, and were impacted by the significant negative traffic we experienced during the first 3 quarters of the year.

Slides 5 through 10 provide further details on traffic and average ticket trends, as well as the bridge of period-to-period sales and adjusted EBITDA.

Cost of sales benefited again in the fourth quarter from lower traditional chicken wing costs coming in at 29.2% of sales, down 10 basis points. For the year, cost of sales improved 90 basis points to 28.6% of sales. The impact of lower traditional wing costs in the fourth quarter was largely offset by the $5 football promotion that was implemented in the fall. And as David mentioned, those promotions were largely dialed back in January. Traditional wings as a percentage of total cost of sales held in the 20% to 21% range for most of the past year, a significant change from the mid-20% range in 2017. More recently, the wing cost environment has been relatively stable other than the typical seasonal increases around the Super Bowl. This history is shown on Slides 13 and 22.

Productivity initiatives have helped to offset some wage inflation, but like everyone, we continue to contend with a tight labor market, which is driving higher average wages. Hourly and total labor costs as a percent of sales increased 160 basis points in both the fourth quarter and full-year periods. However, we estimate that about 60 basis points of this increase was attributable to the 14th week in the fourth quarter of last year, where fixed labor costs are spread over the additional week and hourly wages are efficient relative to the average due to the high sales volume that week.

We break the components out on Slides 14 and 15. Our G&A costs were in line with expectations as a percentage of sales and adjusted for some incentive accrual timing differences between the years, G&A decreased 20 basis points to 5% of sales for 2018.

G&A totaled $8.2 million, so approximately $700,000 of that consisted of nonrecurring items, primarily fees around the first quarter bank amendment and the July equity offering. As we look forward, we're targeting maintaining G&A expenses in the range of 5% of sales.

During the quarter, we recognized an impairment loss of $2.8 million, resulting from the write-down of fixed assets at 4 locations. For the year, we've now recorded $3.8 million in impairment charges related to 5 locations. These are restaurants with a somewhat limited market that experienced slightly negative restaurant-level EBITDA in 2018. We do not currently anticipate closing any of these sports bars and we remain optimistic about the brand level changes that are beginning to take hold and they expect the continuation of positive sales trends.

We fully expect to return to profitability for each of these 5 locations. The impairment charge is a result of a strict application of the accounting rules, not our view around future profitability.

Cash and cash equivalents of $5.4 million, were up from $4.4 million at the end of 2017. 2018 capital expenditures were $1.6 million and were for minor facility upgrades and general maintenance type investments. We do not expect to build any new restaurants, nor do we anticipate completing any major remodels in 2019. However, the company is planning to invest in some corporate initiatives and point of sales system upgrades in 2019. As a result, we expect CapEx to be approximately $2 million in 2019.

Total debt at quarter end was $102.4 million, down $11.6 million for the year. And we remain in compliance with all loan covenants. With that, I'll turn the call back over to you, David.

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [5]

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Thanks, Phyllis. As I mentioned, we are about 2/3 of the way to the first quarter and are seeing early success from the creative measured approach being taken by our franchisor to re-energize and rebuild Buffalo Wild Wings brand. Given the marketing plans and other forthcoming brand enhancing initiatives, we believe there is a significant opportunity to continue to build on this momentum through 2019 and well into the future.

Starting next week, there will be a significant strategic media and marketing push around March Madness, leveraging TV, radio and social media to drive traffic. This will be the first campaign with the brand's new creative ad agency and media buyer.

Concurrently, we're rolling out a number of new brand in elements that will enhance our image and our guest experience.

Next time you walk in one of our sports bars, I'm confident that you will see and feel the difference. The first thing customers will notice is the new menu. Beyond featuring some new items, which I'll talk about in a moment, the menu design itself has matured, with a wood-back clipboard-style format.

On the food front, there's a new, fresh twin patty All-American cheeseburger that will illustrate the level of food quality we seek to obtain for all menu items going forward. We're also introducing a significant upgrade to a few of our most popular shareables, including our new ultimate nachos, our new Hatch Chile con Queso and our new salsa with house-made tostada chips. Along with these new menu items, the food presentation will also be greatly enhanced. No more paper bowls and plastic cups. We have all new plating kit which include aluminum trays, craft paper liners and stainless steel cups for staff.

Team members' uniforms are also new, with hip B-Dubs T-shirts and jeans. Lastly, we're also working on the bar, introducing among other things, classic cocktails like the old-fashioned, Moscow mule and mojito served in new proper glasswork. Each of these items are truly a step-change from our legacy. And importantly, we will have superior products without materially higher costs. For example, the platewear upgrades payback in just a few months, given all the elimination of many disposable paper products. We anticipate new menu items to be added throughout the year, and current plans are still focused on a complete relaunch of the brand this fall. With all of these exciting initiatives ongoing, we have continued to run a best in class operation and focus on the controllable assets of our business.

Guest experience scores are strong, and out pushed to improve penetration of the Blazin' Rewards loyalty program remain a success, with attachment rates jumping north to 27% last month, still far outpacing the Buffalo Wild Wings franchise system. Our goal is to reach 35% loyalty attachment this year, though we remain focused on continuing to push growth in loyalty to increase the frequency of guest visits to our sports bars. Read Slides 19 and 20 for additional details. We are uniquely positioned to benefit from softer brand plans to take Buffalo Wild Wings to the next model. With the building resurgence of the brand combined with our operating expertise, we believe, we can achieve strong long-term growth and market performance.

Operator, we can now open the line for any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Jeremy Hamblin with Dougherty.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [2]

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Congratulations on the improved trends and results. I wanted to start by asking a question on Q4 results. And your Other operating expenses saw, I think, about a 90 basis points uptick. And just wanted to get a sense of how much of that was maybe due to higher delivery costs and how we should be thinking about that line item, I think, maybe as delivery and digital ordering become a higher percentage of total rev. Can you provide some color on that?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [3]

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Sure, Jeremy. Yes, you're right. I mean, the bulk of that increase was driven by delivery fees. We did see delivery sales ramp up quite a bit in the fourth quarter, and we expect that to really continue through 2019. Having said that, we're certainly looking for ways to work with our key delivery partners to try to be more efficient in the way that expense hits us and I think we've got some opportunity there, but that was the main driver. We saw a little bit of increase in our repairs in maintenance expense in the quarter, but nothing too material.

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [4]

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Jeremy, this is David. Just to add a little bit more to that, we are -- I like to look at this from a recent casual diner. We really started this about almost 2 years ago now to really ramp up the delivery. I have a -- I'm a firm believer in it, that it is incremental business to us. And you had to do it despite that these, but now we're working -- as we're building that business, really working diligently with our vendors to reduce this as much as possible and make the entire process more efficient, so we get a better contribution in the end.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [5]

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Okay. And on a longer-term basis, you view that business as being a margin-accretive or a margin-dilutive business, that portion of the business?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [6]

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Well, I mean, I think if you take that portion of the business standing alone, it's certainly going to be at a lower margin than either carry-out or dine-in. But because -- it's just -- I think our view is it's a game we have to be in and our product actually traveled very well and it's a popular product. It's kind of interesting. If you look at the dynamics, we have a very favorable mix because we see a lot of our boneless wings get delivered, which has a very attractive cost of sales. And so if you look at the food mix compared to dine in, even though you're absent the alcohol, you are at a slightly favorable cost of sales. You give up a little bit on paper costs, which is something that we're working hard on as a total system. And then, obviously, you have the delivery fees. So I guess I would say, standalone, kind of channel-by-channel, it is certainly at a lesser margin. But I think -- a lot of this is going to develop over time. If you view a high percentage of that business as incremental, then, I think, overall, because of the leverage we get on the sales that it will be positive to margins.

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [7]

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True.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [8]

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Got it. And then a couple of items here early on. Just in terms of the: one, wing prices look like they're tracking a little bit higher year-over-year. How should we be thinking about kind of delivered cost of Q1 wing prices? And then the second thing would be, just Easter is almost a month later this year, can you just talk us through how we should be thinking about the impact of that hold on Q1 but then also in Q2?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [9]

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Yes. Sure, I mean, that's a great point. Both the timing in Easter and actually the NCAA tournament have an unfavorable calendar shift for us in Q1. So March Madness, the Final Four, the full last week of the tournament, it moves into Q2 because everything's back a week compared to last year. Hard to say how that's going to impact Q1, probably that is in and of itself favorable and then the shift back in Easter could be -- between the 2 quarters, it all evens out. So we'll just have to see how that plays out. On wing prices, they're kind of back to following a pretty normal pattern. So we saw a big runup, not too unusual highs right around Super Bowl, and then we've seen them to come kind of sharply back down here over the last couple of weeks. So a little bit higher year-over-year than they were last year, but not materially so. And then I want to just point out, if you're going to look sequentially Q4 had such big impact on cost of sales as a result of the $5 football menu, which we're very supportive of. We really do think it was a traffic driver and we think the pitchers are very popular. But it came at a cost on average check and impact on cost of sales. We're not going to have that for the most part in Q1 because that promotion really wound down after January, so that will be a favorable offset.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [10]

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Great. And then just one more and I'll hop out of the queue. But in terms of the transaction in the 9 restaurants you're looking to acquire, as you compare your restaurants already in that market with the restaurants being acquired, can you give us a sense for what the gap is on margins, that they are currently running in those locations on a restaurant-level basis versus yours? And kind of the time frame that you think you'll be able to get those restaurants in a similar operating performance as what you're seeing in your location?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [11]

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Yes. Got it. Sure, Jeremy. As we stated in the prepared notes that are -- the acquired -- or the to-be-acquired restaurants are operating around $3.6 million of AUVs and 13% EBIT margins. Our 9, which are in different markets, they're South Chicago, northwest Indiana, so different demographics; population density is much, much lower -- are -- we're running right around $3 million AUVs and we probably have about a 3-point advantage on the margins. So we do believe there's a lot opportunity for us, not just to grow the top line with leverage and delivery in our loyalty program, et cetera, but also the profitability side of it as well. Previously, it was running at $3.6 million on up, we should be doing significantly better. I think the timing of that, some of it's low-hanging fruit. Some of it can happen pretty quickly. It's -- certain things are very mechanical like contracts. So we can leverage our existing contracts from -- anywhere from insurance to credit card fees. And then some will take a little more time by making adjustments, for instance, on labor and cost of sales and waste, and a lot of about is just cultural and training. And you want to be able to be careful and you want to do it as quick as possible, but not too fast because you have to -- you want to retain the culture and there is some training involved to get that done. So I -- honestly, I believe within the 12-month period, we can have that pretty much set up.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [12]

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Right. It sounds like an exciting transaction.

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Operator [13]

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(Operator Instructions) Our next question comes from the line of Mike Wallace with White Pine Capital.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [14]

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Got a couple of questions, still some around what Jeremy was discussing. The -- can you give us some sense to why the seller is selling?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [15]

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I don't think it's appropriate to have those discussions. These are -- release them in a public forum, frankly. I'll give you some color, I mean, franchises -- we've been around for over 20 years. And I think, there are some others and just depending on when you get in. Typically, in the past, it's been a result of either a retirement or just wanting to move on as you run out of territory, because it was a lot of entrepreneurs that started these from scratch and once you build in you're out of territory, you want to move on and do something else oftentimes when you have that entrepreneurial spirit. So that's really all I'm comfortable expressing on that topic.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [16]

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All right, we can -- is -- there are something discussions regarding the seller possibly taking some equity? Or are they completely going to go?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [17]

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No. They'll go completely out.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [18]

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Okay. And then can you give us some sense of the type of financing you're considering? Maybe some sense of the ranges of mix between debt equity? And some of the preliminary terms you're getting back from the lenders?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [19]

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Sure. Mike, it's Phyllis. There is -- you kind of start with the debt side. I mean, the big advantage for us with this transaction, frankly, is the ability to add a minimum, get a term extension. There's some kind of refinance around the current senior debt that's on our balance sheet that goes current in June. So that's, obviously, a huge priority for us. To the extent that we decide on the debt side to stay in that market, I don't think you can really look at having a lot of upside in terms of additional debt you can take on. Should we choose to go outside the bank market, I think there is additional debt that we can take on that could, I don't know, soften the blow or kind of reduce the amount of equity that needs to be raised to complete the deal. And so I don't really want to put percentage on it right now, but we're looking at both things. That obviously there are trade-offs in the bank market. We don't necessarily love having cash flow go to mandatory amortization. But we like the better interest profile, and we don't love the idea of trading interest for principal necessarily. Having said that, there is a lot of merit to the conversation going outside the bank market, maybe trading a little bit higher interest rate for the ability to take on some incremental debt. And not have the aggressive, mandatory amortization that pulls cash flow toward debt as opposed to other opportunities. So kind of all those things that we're looking at. We've kind of model everything out. We're having pretty active discussions. And we'll no more over the coming weeks, but that's really all we can comment on at this point.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [20]

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Is it possible you'll do a mix of bank and outside, non-bank financing? Do a mix of it or would it be one or the other?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [21]

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To be honest with you, I think it's more unlikely that it's one or the other, but it doesn't mean it's not possible to do some kind of combination. I don't think it's the most likely outcome.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [22]

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Okay. And then what kind of equity mix are you really thinking about, range of equity mix?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [23]

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What do you mean in terms of...

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [24]

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50/50, 50 equity, 50 debt, is it going to be 35 equity, 65 debt? Is there a range of 20 to 40 debt equity and balance being debt?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [25]

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Yes. I mean, obviously, that's an important question and it's not one I really want to comment on specifically at this point. What I will say is that when we model this thing out, I'm highly confident that it's value accretive over the next couple of years, regardless if you do 20%, 50% or 100% equity. And so we're going to be careful how we structure it and do the best thing we can for the equity side. But I think the deal has very strong merit regardless of where that percentage kind of falls.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [26]

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With the addition of the additional Chicago restaurants, you guys are going to be, I think, you already were, but now at the largest franchisee in the system, correct?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [27]

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That's right.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [28]

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Yes. And are you getting any guidance or help from Inspire regarding the transaction?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [29]

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I mean, we're -- I'm pretty reluctant to comment too much on that. They're in the process now of going through their traditional due diligence and (inaudible) the waiver process and consent process, so really not inclined to comment on that at this time.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [30]

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Okay. So when do you expect to close?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [31]

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Yes. I think we said we'd love to get it closed by the end of the second quarter. It could certainly move into early part of third quarter, July.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [32]

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Would Inspire be a lender to you or is that not part of their business model?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [33]

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I don't -- we're not assuming that at all. I don't think that's really part of it. There's no precedence set for that. I wouldn't make that assumption.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [34]

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Okay, that's good. Just changing topics, then it -- you did a $19 million tax true-up in '18. Did that have any impact on the NOLs? And what are the NOLs, could you just remind us of that?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [35]

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Yes, I mean, the NOLs today, when we look at it, it shelters about $75 million of pretax income in the NOL and tax credits together. So it went up a little bit, I mean, obviously, we reported negative pretax income for the year.

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Michael Scott Wallace, White Pine Capital, LLC - CIO, Managing Partner, Principal and Portfolio Manager [36]

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Okay. And then -- so there was no impact from the true-up of the $19 million?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [37]

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No.

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Operator [38]

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Our next question is a follow-up question from Jeremy Hamblin with Dougherty.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [39]

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I had a follow-up on the transaction as well. And just in thinking about, as we model out the potential impact of the deal, and you have roughly $4.5 million of EBITDA, currently, being spit out by those restaurants. As you mention that kind of 300 basis point GAAP on lower AUV that your restaurants are doing, I think, theoretically, it could be even a little bit higher than that. But just working with the 300 basis points, should we read that to think that $4.5 million could quite easily become a $5.5 million run rate, just simply by closing that gap on margin performance? And then in addition to that, can you speak to whether or not there are cost synergies simply because you got a nice overlap in markets because you're already in that market. So is this something where essentially this could be like a $6 million restaurant-level EBITDA transaction over, let's say, an 18-month period?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [40]

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Yes, from a restaurant-level perspective, first I would say that your first -- the first thought is pretty accurate. We do believe we can achieve those types of numbers in a reasonable amount of time. In terms of other synergies, just because we're in -- within market, a lot of the costs are going to be associated on a restaurant level. So I'm not going to try to pretend there's synergies just because we're in that market already. The synergies, a lot of it comes from the above store side of it. And there definitely are some and then just the sales leveraging from our (inaudible) G&A, that's where you really see a lot of the pickup.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [41]

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Right, okay. And then just to Phyllis, this point, even at a -- even if I run the gamut of equity versus debt mix upon closing the transaction, even just with the assumption of $4.5 million, by my math you still see this accretive even if there was a 100% equity? Is that consistent with your remodeling?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [42]

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Yes, exactly, right, yes.

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Operator [43]

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Our next question comes from the line of Will Hamilton with Manatuck Hill Partners.

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Will Hamilton, [44]

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David, I just wanted -- you expressed some enthusiasm, obviously, about the initiatives coming out, I guess, next week in terms of marketing and menu and whatnot, and obviously, you're already expressing some comp momentum. You don't like to give guidance, I know, but can you give us a framework of where you think, sort of, traffic comps could go? I mean, could we -- are we talking mid-single-digits or in a good scenario, you've -- could it -- can increase to high single-digits? The comparison's obviously easier. And then as a follow-on on that, are labor costs starting to stabilize at least for you a little bit? And then, what would be the flow-through through the income statement if we do achieve something like the mid-single digits?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [45]

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Yes, okay. I mean, as you know, it's very difficult to predict, particularly, when we're reinventing the brand right now. Quite a lot of initiatives, but we are very optimistic in what we can achieve. And you -- we've already hedges about what we're doing so far this year, and that's really without a lot of weight behind it. You saw the momentum in Q4, so and then we're adding -- we're taking prices with the new menu rollout starting next week, we know right around on 1.5%. So you stack that up, you're pushing to that mid-single-digit as it is, right? So I don't think that's out of reasonableness to make that assumption. We will -- and I'm not going to be overly optimistic and try to pitch that we're going to do double digits or anything like that. But I feel very comfortable with that kind of momentum. In terms of the labor market, yes, it's starting to level out. We really -- it was really rough last with the inflationary side of things on the wages, and I think that slowed down a little bit. And we're working really hard on retention to try to reduce our turnover, get that in check, but that's a very expensive piece of it. That really played into the competition side of the labor. So despite the inflationary side, as you're getting higher turnover because it's so competitive, that actually costs more in the long run, monetarily and just from a guest-experience standpoint because you have a lot of training to do, et cetera, so. But we feel much better about that this year. So we'll continue to work through that.

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [46]

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I do think, well, look, on the labor front, so we came in 2018 at 26.8% and if you -- let's say you want to model up 5% on sales, I guess I'd still say I think from our perspective, we're going to be cautious on assuming that labor leverage kind of outstrips potential increases in wages, but they'll continue. And I guess, what I'm trying to say about that is, I would -- I think the safe assumption is that labor in this environment still maybe just kind of remains flattish as a percentage of sales as opposed to seeing improvement. I think the sales leverage we'll get won't be great for offsetting what may continue to be pressure. Hopefully, as David said, I do think it's abated some, but I just think it's a line we need to be cautious on right now. So we're not forecasting a big improvement in the labor line for 2019.

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Operator [47]

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Our next question comes from the line of [Jeremy Bloom], a private investor.

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Unidentified Participant, [48]

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I just had a question about the marketing with your new franchisor. What's the scale of the budget? Is it a lot bigger? And where are they spending it? Are they changing where they are spending a lot at this point?

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [49]

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There is quite a few changes with it. I mean, the overall budget for the year really isn't -- didn't change significantly because it's -- a lot of it's dependent upon our contribution as a franchisee. So they're working with that budget, but I can say that the efficiency is going to be much greater, right? So taking advantage of efficiencies and the media buys, we're part of a much larger company now, with Arby's and then just most recently Sonic. So the buying power is much better, and then the efficiency of just the organization as a whole. There's also the allocation of the overall advertising spend. So from a media perspective, how you allocate towards TV, little more weight on social media, which was really nonexistent a few years ago with the old regime. And I think you can see that now if you're following Twitter or Instagram and what we've done in the past for Super Bowl and even before that, a lot more activity. And I think that's starting to show in the numbers as well because it's always a contributor. So everything is looking in a much better from an efficiency standpoint, which is really where you're going to get you biggest gains.

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Unidentified Participant, [50]

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And then just a follow-up. With adding 9 new restaurants, how much more in overhead are you going to need to support that additional 9 new restaurants?

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Phyllis A. Knight, Diversified Restaurant Holdings, Inc. - CFO & Treasurer [51]

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Yes, we're assuming about $300,000. So -- but really what that is, we've got the 9 restaurants in the market right now. We'll go to 18 in that market and we'll probably run it with, kind of, 3 regional managers as opposed to 1 today, just to be a little bit closer to the operations, at least in the near term. So estimating about $300,000.

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Operator [52]

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We have no further questions this time. I would now like to turn the floor back over to management for closing comments.

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David Gregory Burke, Diversified Restaurant Holdings, Inc. - President, CEO & Director [53]

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I'd like to thank everyone for joining us on today's call and your interest in Diversified Restaurant Holdings. And please feel free to reach out to us at any time. And we look forward to talking to you again after the first quarter results.

Again, thanks for participating, and have a great day.

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Operator [54]

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Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.