Carrols Restaurant Group, Inc.

Good morning. Welcome to the Carol's Restaurant Group Incorporated Third Quarter 2020 Earnings Conference Call. At this time, all participants are in listen-only mode. Following the presentation, we will conduct a question-and-answer session, and the instructions for registering for Q&A will be given at that time. I would like to remind everyone that this conference's call is being recorded today, Thursday, November 5, 2020, at 8.30 a.m. Eastern Time, and will be available for replay. I would now like to turn the conference over to Tony Hall, Chief Financial Officer. Please go ahead, sir.

Thank you, Jerry, and good morning, everyone. By now, you should have access to our earnings announcement released earlier this morning and an earnings review presentation that are both available on our website at www.carolls.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, or plans. These statements are not guarantees of future performance, and therefore, undue reliance should not be placed upon them. We also refer you to our filings with the SEC for more details, especially the risks that could impact our business and results, including the impact of COVID-19. 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 gap measures is available with our earnings release. With that, I will now turn the call over to our Chairman and CEO, Dan Accardino. Dan?

Thanks, Tony, and good morning, everyone. I want to get begin by expressing my appreciation to the entire Carol's team, whether they are in our restaurants, serving our customers while adhering to our strict safety and sanitation protocols in the field, overseeing operations and our support center, or even remotely helping our restaurants succeed. They are persevering and working very hard in the midst of this pandemic and enabling us to put our best foot forward. As I said last quarter, but it bears repeating today, we have done an exceptional job pivoting operations, and those adjustments have positively impacted our financial performance. Now let me provide a brief synopsis of the current state of our business. Number one, we were pleased to have increased comparable restaurant sales at both Burger King and Popeyes during the third quarter and improved our profitability as measured by our adjusted restaurant-level EBITDA, adjusted EBITDA, and net income compared to the year-ago period. Secondly, we generated $23 million of free cash flow during the third quarter, bringing free cash flow generation to $47 million year-to-date in 2020. Our liquidity position was already ample at the end of the second quarter at over $180 million, has improved since then with current available liquidity of nearly $205 million. And thirdly, we are in the process of negotiating and revising our area development agreement with our franchisor, Burger King Corporation. At a high level, we expect the requirements under the previous agreement relating to new restaurant development and restaurant remodeling provisions will be significantly modified. After considering restaurant development and remodeling, as well as other system-wide upgrades and initiatives, we remain committed to what we said last quarter in terms of annual CapEx spending of $40 to $50 million over the next three years. At this level of spend, we believe we should be able to continue generating positive free cash flow for the foreseeable future. Now let's discuss each of these points in some greater detail. Our service model is based upon convenience, given our limited and no-contact channels, such as drive-through at-the-counter takeout and recently implemented delivery business, where in aggregate we generated approximately 99% of our sales last quarter. We believe these attributes have positioned us well to navigate COVID since all of these channels have proven to be resilient sales platforms. We did, however, increase the number of our dining rooms open to 35% in the third quarter, which was up from 20% in the second quarter. We have also benefited from having a geographically diverse restaurant portfolio of more than 1,000 restaurants across 23 states. This is because the shifting impact of the pandemic has provided us somewhat of a cushion as short-term staffing or supply issues have been thankfully limited to only a few restaurants at any one time. From a regional perspective, we are performing relatively better in the Northeast, but worse in the South Central region, and Tony will discuss how we are faring by region in more specific terms. For the full quarter, comparable restaurant sales for our Burger King restaurants increased 0.8% against a tough 4.5% comparison from last year. This marked an impressive turnaround from the second quarter when comp sales fell 6.4%. However, it is clear that our trend softened as we moved through the third quarter and into October. We attribute this to several factors. Number one, first, we believe that customers exhausting their stimulus tax and constrained in their spending due to a weakening Main Street economy had a negative impact on sales in the latter part of the third quarter into October. Second, we think increased competitive pressures within the fast food segment during the third quarter affected our market share, including heightened promotional activity and discounting. Third, over the past two weeks, the increase in COVID cases, along with related renewed dining restrictions in many states, is likely to have at least temporarily dampened consumer demand. And lastly, we lapped the introduction of the Impossible Whopper last year, which made comparisons more onerous beginning in August. Impossible orders were averaging 50 per restaurant per day upon launch and are now less than half of that. Delivery comprised approximately 3% of total Burger King restaurant sales during the third quarter with an average order size of $17. This was approximately twice the overall average order size during the third quarter of 2020. We have partnered with four leading service providers, DoorDash, UberEats, Postmates, and Grubhub, who are now providing fully integrated delivery services at approximately 870 of our Burger King restaurants. up from 800 at the end of the second quarter. Looking ahead, we believe more of our Burger King restaurants could provide a delivery option as providers begin servicing their markets in a meaningful way. Comparable restaurant sales at Popeyes increased 5.5% versus a 5.8% increase last year. We view this outcome positively as we had not expected to see this level of resiliency given that we left the chicken sandwich launch from last August. Turning now to restaurant level and corporate expense management, we certainly made great progress. This is reflected in lower food waste, as we have adjusted our production requirements because of the shift away from breakfast to late night, and even more so in labor, where we have incurred higher wage rates but have been able to modify labor hours based on day part sales trends. Our current team size for Burger King Restaurant averaged 20 employees during the third quarter, up from 19 in the second quarter. This increase was due to the normalization of certain labor elements depending on geography and local conditions related to expansion of hours. In the third quarter of last year, we averaged 23 employees. Briefly on the Cambridge integration, we continue to see a meaningful sequential improvement in labor costs. Comparing the third quarter of 2019 to the third quarter of 2020, restaurant labor expense is a percentage of net sales of the Burger King restaurants improved by about 250 basis points, and at the Popeyes restaurants by 640 basis points. Certainly, some of this improvement relates to the current environment, but it also reflects the successful implementation of our labor scheduling process. As it relates to cost of sales, we have made progress in managing these costs, but still have more systems integration work to complete, particularly at our Popeyes restaurants. In addition to favorable expense trends at the restaurant level, we've also benefited from reduced regional and corporate overhead by having streamlined our regional management structure earlier this year while improving our training process. In total, we increased our adjusted restaurant level EBITDA margin by 225 basis points and adjusted EBITDA margin by 200 basis points during the third quarter compared to the prior year period. These are both positive outcomes and in line with what we said during our second quarter call, as we had not expected the more substantial margin gains that we had realized in the second quarter to repeat. Year-to-date, we have opened six new restaurants with two additional locations to open by year-end. We have also permanently closed 19 underperforming restaurants, while we had earlier planned to close A total of 22 restaurants in 2020. We now expect to close approximately 35 to 37. So an additional 16 to 18 locations are expected to close by year end. These restaurants were losing money in a post-COVID environment, and the closures will benefit our EBITDA next year. Turning to our balance sheet and related metrics, we were already in a very strong position financially as we exited the second quarter and built upon that further during the third quarter. We ended the quarter with $67.8 million in cash and cash equivalents, up from $46 million at the end of the second quarter, and $136.2 million under our revolving credit facility available for borrowing. We also believe we have a very manageable debt level of $496 million with no near-term maturities, and we have no outstanding borrowings under our revolving credit facility. As you know, we have been committed to keeping our expenditures in check, which we said repeatedly throughout 2020, and continue to expect operational capital expenditures to total about $40 million this year net of sale leaseback proceeds. As I referenced earlier, we generated $23.3 million in free cash flow during the third quarter and $46.7 million through the first three quarters of the year. Recall that before the pandemic, we had targeted up to $25 million in free cash flow in 2020, so we've obviously surpassed that amount considerably. Lastly, we are in the process of negotiating a revision to our area development agreement with Burger King Corporation as it relates to our new restaurants and remodeling requirements. We anticipate that our proposed revised agreement will reduce the minimum new restaurant development requirements down to a total of 50 units over the next five years. and removes annual remodel commitments that were part of the current agreement. We expect that we would also give up our right of first refusal that we believe has diminished in value in the current QSR business environment. We believe that this new arrangement, when entered into, will allow Carroll's to ramp up its organic growth on a balanced basis. It should be noted that while we expect to enter into this new agreement, at this stage the parties have agreed to a term sheet and there is no assurance that such new arrangement will be entered into on such terms or at all. As we committed to last quarter, we intend to spend $40 to $50 million per year for capital expenditures over the next three years. Within that total amount, we intend to build 8 to 12 new restaurants per year beginning in 2021, with fewer being completed next year before accelerating thereafter, given the time needed to identify real estate, secure permits, and commence construction. A large portion of our newly constructed restaurants will be built using third-party capital to finance all but the equipment costs related to those new restaurants. We plan on remodeling 20 to 25 restaurants per year, commencing in 2021, over a three-year timeframe. We believe that the combination of our share of investment towards new restaurant development, along with remodeling, maintenance capex, and other system-wide upgrades, and initiatives such as upgrading our outdoor digital menu boards, our capex spend should remain within our committed amount per year through 2024. As it relates to acquisitions, we are still holding off on these until our adjusted leverage ratio, as defined in our credit agreement, drops below four times, which we expect to occur early next year. At that point, we will consider pursuing opportunistic bolt-on restaurant transactions as long as we remain below four times leverage ratio target on a pro forma basis. Given our size, capital structure, and operational track record, we believe to be able to complete transactions. We expect to be able to complete transactions without needing a roofer. To conclude, we believe our third quarter performance is demonstrative of our business strength through the pandemic and positioned us well when eventually all of this is behind us. We are benefiting from our reliance on drive-through carryout and delivery channels with only minimal reliance on our dining rooms, although we are aware that consumer spending has softened in the near term. We have improved our margins and increased our adjusted restaurant level EBITDA and adjusted EBITDA. We have enhanced our liquidity. We are generating more free cash flow than we originally anticipated this year, even under pre-COVID conditions, and we are reaffirming our intention with respect to our CapEx spend outlook, this expected annual expenditure level, of 40 to 50 million will be sufficient to maintain the quality of our current portfolio of restaurants and grow our footprint longer term. We believe we are positioned to execute on our stated goals and will soon be poised to step up our organic and non-organic growth levers in a balanced way while keeping our leverage in check. Our game plan is to continue generating a significant and growing level of free cash flow, and we are confident in our ability to execute on that objective. With that, let me turn the call over to Tony to review our financials.