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Edited Transcript of TAST earnings conference call or presentation 8-May-19 12:30pm GMT

Q1 2019 Carrols Restaurant Group Inc Earnings Call

Syracuse May 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Carrols Holdco Inc earnings conference call or presentation Wednesday, May 8, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel T. Accordino

Carrols Restaurant Group, Inc. - President, CEO & Chairman of the Board

* Paul R. Flanders

Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer

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Conference Call Participants

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* Brian Michae Vaccaro

Raymond James & Associates, Inc., Research Division - VP

* Jeremy Scott Hamblin

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

* Wayne J. Archambo

Monarch Partners Asset Management, LLC - General Partner, Portfolio Manager & Equity Analyst

* William Everett Slabaugh

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Good morning, welcome to the Carrols Restaurant Group First Quarter 2019 Earnings Conference Call. (Operator Instructions).

I'd like to remind everyone that this call is being recorded today, Wednesday, May 8, 2019, at 8:30 a.m. Eastern time, and will be available for replay. I will now turn the conference over to Paul Flanders, Chief Financial Officer. Please go ahead, sir.

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [2]

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Good morning. By now you should have access to our earnings announcement released earlier this morning, which is available on our website at www.carrols.com, under the Investor Relations section. Before we begin our remarks, I would like to remind everyone that our discussion will include forward-looking statements, which may consist of comments regarding our strategies, intentions, guidance and plans. These statements are not guarantees of future performance, and therefore, undue reliance should not we placed on them. We also refer you to our filings with the SEC for more details, especially the risks that could impact our business and results. During today's call, we will discuss certain non-GAAP measures that we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with generally accepted accounting principles. A reconciliation to comparable GAAP measures is available with our earnings release.

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

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Daniel T. Accordino, Carrols Restaurant Group, Inc. - President, CEO & Chairman of the Board [3]

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Thanks, Paul, and good morning, everyone. Before discussing the first quarter, let me start by saying how excited we are to have closed the Cambridge deal on April 30, a transaction that we believe will prove to be transformational for us. To summarize, we acquired 165 Burger King and 55 Popeyes restaurants across 10 Southeastern states, and a tax-free merger with Cambridge Franchise Holdings. We now operate 1,010 Burger King and 55 Popeyes restaurants in the 23 states. Along with an expanded and more diversified restaurant footprint, we believe this transaction positions us well to continue with executing our acquisition and expansion strategy and provide several avenues for future growth.

We significantly expanded our Right of First Refusal on our ROFR and are preapproved for the acquisition of 500 additional Burger King Restaurants under a new area development and remodeling agreement with Burger King Corporation. This agreement extends our ROFR territory to Arkansas, Louisiana, Mississippi and Tennessee. As previously disclosed, we relinquished our ROFR rights in the 7 states where we are not actively expanding. We also agreed to develop 200 new Burger King Restaurants over the next 6 years and to remodel or upgrade a number of our existing restaurants, more restaurants to be acquired for the Burger King of Tomorrow image.

Lastly, we now have a complementary growth platform in Popeyes through the merger, we assume Cambridge's development agreement with Popeyes, which includes the ROFR for acquisitions in Tennessee and Kentucky as well as a development agreement for approximately 70 new Popeyes restaurants over the next 6 years.

This is an exciting time at Carrols, and we are well along in developing our plans to integrate Cambridge over the next several months. We believe as we assimilate these restaurants with our operating systems that there is a good potential for us to improve sales and overall financial performance. We also plan to leverage Cambridge's development capabilities to support our expansion and are confident that we can achieve overhead synergies as we move forward.

Finally, we would like -- also like to officially welcome Matt Perelman and Alex Sloane to the Carol's Board of Directors.

With that said, let's turn to our quarterly results. For the first quarter, we grew our top line by 7.1% to $290.8 million and delivered a 2.4% increase in comparable restaurant sales. Note that we left our toughest comparison from the prior year, 6.2%, as we rolled over several impactful offerings from last year, such as the Double Quarter Pound King and the launch of the Spicy Crispy Chicken Sandwich. The 2.4% comparable restaurant sales gain included a 2.3% increase in traffic and was about 200 basis points better than the overall U.S. Burger King system.

Comparable sales were positive across all day-parts. The $1 10-piece Chicken Nuggets deal supported our value offerings early in the quarter, followed by Spicy Nuggets at a $1.49, which performed well despite the transition of our nuggets deal up from the dollar price point. The new Big King XL sandwich also supported our premium platform. Other offerings included the $3.49 King Meal Deal, the $6 King Box deal and our popular 2 for $6 Mix or Match featuring Crispy Chicken, Spicy Crispy Chicken and WHOPPER sandwiches.

Lastly, the new BK café platform was launched in late March, designed to provide a foundation to driving sales and breakfast day-part going forward.

Burger King continues to focus on a balanced menu approach with quality, core and premium offerings balanced by value-oriented products and deals to provide everyday value. This barbell strategy continues to resonate with customers. However, as we've previously discussed, discounting and promotional activity increasingly reached elevated levels over the past 18 months, and accelerated during the second half of 2018. While still high by historical standards, this discounting finally began to taper off midway through the first quarter, resulting in modestly lower discount sequentially from the fourth quarter of 2018. We expect the impact from discounting to subside as we move further into the year. The effect in the first quarter, however, was still significantly higher than on a year-over-year basis compared to the prior year quarter, which leads us to our first quarter profitability.

Restaurant level EBITDA declined from $33.4 million in the first quarter of last year to $28.6 million and restaurant-level EBITDA margin decreased 244 basis points from the prior year quarter. These lower margins were almost solely reflective of 152 basis point increase in cost of sales from the higher discounts compared to the first quarter last year, and by 90 basis points of deleveraging on labor cost due to ongoing tightness in the labor market. Margins in our core restaurants have obviously been under some pressure over the past couple of quarters during the elevated promotional levels and persistent labor pressures that we've experienced. However, we have a track record of effectively leveraging operations and achieving better-than-average sales trends, which we believe positions us better than many other operators. This should enable us to opportunistically execute our acquisition strategy, while improving overall financial performance at restaurants that we acquired, including the Cambridge restaurants. The recent merger with Cambridge and the new development agreements with Burger King and Popeyes provide us a number of alternatives for future expansion and a long runway for both brands. We believe that we can leverage these growth opportunities, and we grow shareholder value longer term as we expand. We have much work ahead of us this year as we integrate this most recent acquisitions and are excited as we launch the new phase of our growth. Paul will now go into greater detail with our first quarter financial review and updated annual guidance.

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [4]

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Thanks, Dan. Before I discuss the quarter, let me first touch on some recent changes to our capital structure. Concurrent with the Cambridge merger, we refinanced all of our Cambridge -- all of our and Cambridge's indebtedness and entered into a new $550 million secured senior credit facility. The proceeds from a $425 million Term Loan B were used to refinance our existing 8% notes, to pay off Cambridge's indebtedness and to pay various fees and expenses related to the financing. The facility also included a $125 million undrawn 5-year revolving credit facility that will be used to execute our growth initiatives moving forward. We were very pleased with the execution of the financing led by Wells Fargo, who helped to subside the deal while tightening pricing along the way. In the end, we were able to considerably reduce our cost of funds from 8% to below 6%, while expanding the capital available to fund our growth strategy.

Total consideration to Cambridge related to the merger included approximately 7.36 million shares of Carrols common stock, a 16.6% equity interest. And shares of 9% PIK Series C Convertible Preferred Stock, that will be convertible into approximately 7.4 million shares of Carrols common stock. The conversion of the preferred stock will be subject to a vote of stockholders at the next annual meeting and will automatically convert into common stock upon approval of such conversion. On a fully diluted, as-if converted basis after giving effect to the conversion of both the Cambridge and the Burger King Corporation convertible preferred stocks. Cambridge would hold an approximately 24% equity interest in the company. There was no cash consideration as part of the transaction.

Turning now to the first quarter. Restaurant sales increased 7.1% over the prior year period to $290.8 million. Comparable restaurant sales increased 2.4%, consisting of a 2.3% increase in customer traffic and a 0.1% increase in average check. The average check increase reflected 1.3% in menu pricing offset by higher discounting and mix changes compared to the first quarter of 2018.

Adjusted EBITDA decreased from $18.9 million to $13.1 million, and restaurant-level EBITDA decreased from $33.4 million to $28.6 million compared to the first quarter of last year.

Adjusted EBITDA margin decreased 245 basis points and restaurant-level EBITDA margins decreased 244 basis points, due mostly to the deleveraging cost of sales and labor. As a percentage of restaurant sales, cost of sales increased to 152 basis points, reflecting higher discounts and modestly higher commodity cost.

Beef was a $1.99 per pound and decreased about 2% from the $2.03 a pound in the first quarter of last year. The impact from higher promotions and discounts alone resulted in a 130 basis point increase in cost of sales compared to the first quarter of 2018. As Dan mentioned, we've seen the impact of this discounting start to taper off, which is very encouraging. To put it in perspective, the impact from January and March 2019, improved by approximately 130 to 140 basis points.

Restaurant labor expense increased 90 basis points to 34.5% compared to the prior year quarter due to a 4.6% increase in our hourly wage rate. As a percentage of sales, other restaurant operating expenses decreased slightly by 9 basis points to 15.7%, and general and administrative expenses were flat at 5.9%, excluding acquisition costs.

Our net loss in the first quarter of 2019 was $11.5 million or $0.32 per diluted share compared to a net loss of $3.1 million or $0.09 per diluted share in the prior year period. So net loss included $0.9 million in impairment and other lease charges and $2.7 million of acquisition expenses. We also had a $2.1 million in other income, primarily related to $1.9 million cash settlement with Burger King Corporation related to new restaurant development permitted for other franchisees has negatively impacted about 15 Carrols restaurants, dating back to 2015.

For the same period last year, net income included $0.3 million in impairment and other lease charges and $0.1 million of acquisition expenses. Excluding these items, our adjusted net loss was $10.4 million or $0.29 per diluted share compared to an adjusted net loss of $2.8 million or $0.08 per diluted share in the prior year period. A reconciliation to net loss under GAAP to an adjusted net loss of non-GAAP measure is provided in the supplemental tables with today's release.

Total capital expenditures were $18.2 million in the first quarter. At the end of the quarter, our cash balances were $1.7 million and total outstanding debt was about $286 million.

With that, let me provide some updates to our outlook. I do not intend to go through all the detailed guidance here this morning. So I refer you to this morning's press release for more specific information. With the recently completed merger with Cambridge, we have updated our 2019 guidance to include the newly acquired restaurants that will be included in our full year results in approximately 8 months.

At this point, our guidance excludes any other potential acquisitions that we may complete. On an annualized basis, adjusted for the pro forma effect of its acquisitions over the past year, Cambridge generates approximately $300 million of sales and $40 million in adjusted restaurant level EBITDA. We expect Cambridge's contribution to adjusted EBITDA to be $25 million to $30 million, following our integration of their corporate support functions over the balance of this year.

In terms of input cost, we have recently experienced unexpected increases in ground beef cost, due in part to the impact on protein prices brought about by the breakout of hard fever in China. We have updated our guidance to reflect our current expectations, the commodity costs will likely be higher than we originally anticipated. We've raised our adjusted EBITDA guidance to $114 million to $121 million to reflect the addition of Cambridge's results in 2019.

Lastly, we have updated our capital spending estimates to reflect Cambridge's development plan, which includes the addition of 8 to 10 new Popeyes and 3 to 4 Burger King's for the balance of the year as well as their development of new Burger King restaurants and our anticipated remodeling projects.

Our total capital expenditure is expected to increase to $120 million to $130 million. I will also point out that these CapEx amounts are before an estimated $8 million of landlord contribution for the upgrade of a number of units owned by Burger King, and are before sale/leasebacks that are estimated to be $15 million to $25 million. That concludes our prepared remarks.

So with that, operator, we can go ahead and open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Brian Vaccaro, Raymond James.

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Brian Michae Vaccaro, Raymond James & Associates, Inc., Research Division - VP [2]

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I want to start out with the comp guidance and ask -- I think Burger King Brand is planning to roll out the impossible burger to additional markets soon after a pretty successful test in St. Louis and a national rollout by year-end. And I'm curious when that product will begin to be offered in your markets, if you have any visibility there? And if you've baked in any anticipated benefit from the rollout in your comp outlook later this year?

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Daniel T. Accordino, Carrols Restaurant Group, Inc. - President, CEO & Chairman of the Board [3]

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Brian, this is Dan. And we do not have any visibility in terms of how that product is going to be rolled out. And no, we have not baked in any guidance relative to the rollout of that product.

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Brian Michae Vaccaro, Raymond James & Associates, Inc., Research Division - VP [4]

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Okay. And on the gross margin outlook. So I appreciate the comment around the discounts coming down and the benefit that you saw starting in March there. But I guess in light of the slightly raised commodity inflation outlook that you detailed, how are you thinking about menu pricing versus the one in change you had in place during Q1 of '19?

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Daniel T. Accordino, Carrols Restaurant Group, Inc. - President, CEO & Chairman of the Board [5]

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We -- this is Dan again. We're currently looking at our menu pricing strategy in each of our markets. I wanted to wait until we closed on the acquisition of Cambridge to evaluate their prices -- menu prices as well, so that I could make an adjustment across the entire portfolio. That adjustment will be made in June. And my guess in the overall portfolio, the price increase would be roughly 1%.

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Brian Michae Vaccaro, Raymond James & Associates, Inc., Research Division - VP [6]

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Okay. And then last one for me, just on the acquired units. You highlighted $300 million in sales and $40 million of store-level EBIDTA on an annual basis. So I just wanted to clarify the $40 million. Is that net of incremental sale/leaseback rent after you complete the sale/leasebacks? And also does that reflect the anticipated savings and margin benefit in the -- in that $40 million?

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [7]

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No. This is Paul. The run number is based on the LTM, it doesn't exclude any sale/leasebacks that we might do. As you recall, we had indicated, we would do maybe $25 million of sale/leasebacks of some of the Cambridge properties after we completed the acquisition. Not really rushing to do that right now, given the fact that we've got -- we upsized the Term Loan B by about $25 million. So that -- so we're going to hold off on that at the moment. So the sale/leasebacks, I referred to earlier, are primarily some new units that we're building this year. In terms of the -- any assumptions relative to P&L improvements following the acquisition, no, that's not -- the net that's not reflected in the $40 million.

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Operator [8]

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The next question is from Jeremy Hamblin, Dougherty & Company.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [9]

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First one to start with ground beef prices, and thanks for the color on the changes there -- the impact from swine fever. Paul, where are you seeing ground beef prices tracking today, let's say, in the last -- in a week or 2 on your delivery cost per pound?

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [10]

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Yes. As I said, we were about -- we averaged about $1.99 for the whole first quarter and that obviously increased in the back end of the quarter. Our current prices on beef are about $2.17 a pound. So as you can see, it's jumped up a fair amount here. And now it's been at this level for several weeks. So it seems they'd be stable at that level, which is a positive, I think.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [11]

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Okay. And then what about in terms of just some color on your quarter-to-date comp trends? Obviously, some products I think the people might be excited about in the rollout later this year. But as you pull back on the discounting, have you seen any negative impact or how are your current trends tracking?

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [12]

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The April was basically flat over the prior year and our comparison in the month of April was about 6.5%. So the 2-year trend still is about 6.5%, obviously, which was -- about where we were in the first -- a little bit lower than where we were in the first quarter.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [13]

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Okay. And then translating that into May, you would expect May results to improve as you see a little bit easier compared to the remainder of the quarter?

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [14]

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No. May was a good month last year. I think that -- I think your comment may hold when we get to June for sure.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [15]

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Okay. Understood. Coming to the Cambridge deal and the change in your capital structure. Where -- I might've missed this, but where is the kind of post-deal cash level after the refinancing and so forth?

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [16]

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Well, when we closed the deal, I think that we -- there was probably $10 million roughly of cash between Cambridge and us on a combined basis left. We also -- we had the interest payment due the day after the closing. So that was essentially funded out of the closing. So we actually -- we're in the process -- we're building cash, now as we speak obviously.

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Jeremy Scott Hamblin, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst of Consumer & Retail [17]

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Okay. And then just embedded within your guidance here, on the Cambridge aspect. So it looks like about $15 million of expect contribution this year, is there any -- can we extrapolate that to assume something closer to $20 million on an annualized run-rate basis? And looking forward with $40 million in restaurant-level EBIDTA, how do we start thinking about this in terms of 2020 from contributions, from that deal?

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [18]

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Yes. I think when you look at the incremental guidance that we've provided for Cambridge, I think the -- we have not really assumed any synergies on the G&A side at this point because we're going to spend a good part of it -- the rest of this year integrating their corporate functions and so forth. So that -- so the synergy number really isn't benefiting this year, and we anticipate that's probably another $5 million or $6 million going forward. So I think, you deduced about $20 million EBITDA. I think you're low there, I think that number is going to be closer to $28 million, $30 million.

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Operator [19]

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Your next question is from Wayne Archambo, Monarch partners.

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Wayne J. Archambo, Monarch Partners Asset Management, LLC - General Partner, Portfolio Manager & Equity Analyst [20]

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Just on the outlook. You talked about the discounting subsiding for the remaining. You saw some tapering in the middle of the first quarter. What gives you a reason to believe that the discounting is going to subside the rest of the year?

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Daniel T. Accordino, Carrols Restaurant Group, Inc. - President, CEO & Chairman of the Board [21]

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This is Dan. I've seen the marketing calendar for the balance of the year. And if that marketing calendar stays as is, then I'm quite confident that their discounting will be much lower than it was for the latter part of 2018 and certainly into January 2019.

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Wayne J. Archambo, Monarch Partners Asset Management, LLC - General Partner, Portfolio Manager & Equity Analyst [22]

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Do you have any concrete thoughts behind that? Or is that just your experience in the industry, based on that?

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Daniel T. Accordino, Carrols Restaurant Group, Inc. - President, CEO & Chairman of the Board [23]

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No. Actually, the marketing calendar, which -- that's up to Burger King to take care, not me.

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Wayne J. Archambo, Monarch Partners Asset Management, LLC - General Partner, Portfolio Manager & Equity Analyst [24]

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And on the labor cost side, are you finding any problem, finding labor? Or just the labor cost itself are a problem? Is there any shortage at any markets that you're seeing out there?

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Daniel T. Accordino, Carrols Restaurant Group, Inc. - President, CEO & Chairman of the Board [25]

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Well, labor has been a challenge for some period of time now. And it is a direct relationship between the difficulty that in certain markets that you have attracting labor and the rate that you have to pay. So we stamp our restaurants correctly, which is why our sales increases 200-plus basis points higher than the balance of the system. So we pay what we have to pay in order to adequately staff the restaurants.

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Operator [26]

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(Operator Instructions) We have a question from Will Slabaugh, Stephens Company.

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William Everett Slabaugh, Stephens Inc., Research Division - MD [27]

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On the discounting commentary, I had a follow up there. Can you compare 1Q's level of discounting and however you want to compare that or promotional activity to 4Q? And then when you think about what you consider normal over the past few years? And maybe the past few years isn't normal, or -- but however you want to characterize that? Just to give us a sense of where you think we are in that whole, sort of, discounting cycle, if you will? And what the rest of this year might mean for that?

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [28]

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This is Paul. Yes, the discounts, as you know, have continued to escalate over -- it was probably 24 months at this point. I think if you go back just sort of as a point of reference, if you go back to 2016, I think when probably this escalation started late in '16. From that point, our discounting levels have gone up about -- what you're going to need is a point of reference. If you go to the fourth quarter of this past year, which certainly was the peak level of the discounting, it was up -- the discounts were about 10% of sales, higher than they were in 2016, which is huge. We've reverted in the first quarter sequentially, and discounts have come down about 300 basis points between Q4 and Q1. So it's a pretty significant change, sequentially, we've seen just in the last 3 or 4 months.

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William Everett Slabaugh, Stephens Inc., Research Division - MD [29]

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Got it. That's helpful. And then second question is on the pipeline of the recent acquisition. I wonder if you could give us an update there in both the BK and the Popeye side. And if you could give any color as well, just about how initial conversations have gone with Popeye's franchisees that'd be helpful as well.

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Daniel T. Accordino, Carrols Restaurant Group, Inc. - President, CEO & Chairman of the Board [30]

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Yes. This is Dan. We have another deal, it's 11 or 12 restaurant that we're going to close on May 29 in the Baltimore area, we've a very high AUV. And we have had several discussions with both Burger King and Popeye's franchisees in terms of deal flow. And I would submit that the deal flow right now is as great as I have seen it in the past couple of years, both because of opportunities that have existed and because our refinancing was publicly known, so people realize that we're in the market to buy and there's a significant deal flow in both brands.

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Operator [31]

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There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

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Paul R. Flanders, Carrols Restaurant Group, Inc. - VP, CFO, & Treasurer [32]

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All right. We have nothing of any importance to add today, no guest today. But we appreciate your time. And we look forward to updating you in about 3 months. Have a good day. Bye.