Carrols Restaurant Group, Inc.

Welcome to Carol's Restaurant Group, Inc.' 's third quarter 2023 earnings conference call. At this time, all participants are on a listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions on how to ask a question will be given at that time. I would like to remind everyone that this conference call is being recorded today, Thursday, November 9th, 2023 at 830 a.m. Eastern Time and will be available for replay. I will now turn the conference over to Greta Miles, Carol's Controller and Assistant Treasurer. Thank you. Please go ahead.

Thank you, Operator, and good morning, everyone. By now, you should have access to our earnings announcement released earlier today and our earnings presentation that are both available on our website at www.carols.com under the Investor Relations section. Before we begin our remarks, I would like to remind everyone that our discussion, including answers to questions posed to management, may include forward-looking statements or comments with respect to our strategies, intentions, or plans, and the future direction of revenues, input costs, or other aspects pertaining to our business. These statements are not guarantees of future performance, and therefore, undue reliance should not be placed on them. We also refer you to our filings with the SEC for more details, both with respect to forward-looking statements as well as 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, and a reconciliation to comparable GAAP measures is available with our earnings release. With that, I will now turn the call over to our President and CEO, Deborah Derby.

Thank you, Greta, and good morning, everyone. We're thrilled with our results for the third quarter, as we not only achieved comparable sales growth of 8.1% at our Burger King restaurants, we also saw positive traffic growth earlier than anticipated this year. In addition, we had great traction with recent product launches, such as the BK Royal Crispy Wraps, which significantly outperformed expectations. Our strong top line growth drove a 530 basis point expansion in restaurant-level EBITDA margins compared to a prior year period, and was the basis for free cash flow generation of over $30 million in the quarter, and the reduction in our net leverage ratio to 2.8 times. Equally important, our team members continue to remain focused on providing our new and returning guests with an excellent customer experience, as we saw improvements in all KPIs measured by our franchisor, including a 33% increase in guest satisfaction. As a result, we are on the cusp of achieving A-level operator status under our franchisor scoring system in less than 12 months. To see such progress across our portfolio of 1,020 Burger King restaurants in such a short period of time is a real testament to the talent and hard work of our field and restaurant team members. Together, our operational improvements allowed us to increase our hours of operation by over 3% while reducing labor hours by about 2% compared to the prior year period. We continue to see productivity efficiencies in labor, with wage inflation decelerating to approximately 4%, manager and hourly turnover remaining stable, and enhanced operational efficiency from our team members. Our success in the quarter also extended to our Popeyes restaurants, which are now part of the second largest chicken fast food chain in the U.S. The introduction of sweet and spicy wings helped drive both comparable sales growth and improved profitability. Similar to our Burger King restaurants, we are seeing continued progress in our customer satisfaction scores at our Popeyes restaurants as well. These strong quarterly results and operational improvements would not have been possible without the hard work and dedication of our more than 24,000 Carol's team members, and I want to thank them personally for their continuing efforts and commitment. Our digital business, including delivery and mobile, has also seen substantial growth and is now approaching 10% of our overall sales, a year-over-year increase of 300 basis points. There are two major areas which we believe are contributing to this increase. First, the successful marketing and product launches by our franchisor, including the BK Royal Crispy Wraps, have amplified Burger King's relevance across demographic groups, including the younger consumer, which is generally more tech-savvy. We've seen across-the-board improvements to both mobile and delivery in terms of comp sales, traffic, and average check. Second, delivery continues to benefit from a relatively strong dinner and late-night performance. with the latter continuing to be aided by our increased hours of operation that I referenced earlier. To further drive the momentum we are seeing in our digital business, we are in the process of rolling out self-order kiosks at approximately 250 of our restaurants over the next four months, with the vast majority of this investment being funded by Burger King's Royal Reset Program. While Burger King is still early in the testing and adoption process, we're encouraged by the results that they have seen thus far. In addition, we recently expanded our local value initiatives that I talked about last quarter, now reaching approximately 60% of our Burger King restaurants. These promotions continue to drive incremental traffic and increase the average check in day parts where we see an opportunity for increased business. I would also like to touch on our capital spending plans as we look towards 2024. We are still in the process of finalizing our strategy, but we continue to remain focused on organically driving sales and profitable growth in the near term. primarily through reinvestment in our restaurants. In order to accelerate that organic growth, in 2024, we plan to remodel about 45 Burger King restaurants. While this will increase our overall capital expenditure somewhat from 2023 levels, we will continue to only invest in remodels that we believe cumulatively will meet our mid-teen return hurdle rate threshold. Similar to the benefits we are leveraging with our 2023 remodels, we will be able to avail ourselves of meaningful contributions from our franchisor for our 2024 remodels through their Reclaim the Flame program. We believe that such economic assistance, along with our robust earnings profile, makes it an opportune time to accelerate the modernization of our portfolio and reap the benefits of our investment. Burger King's latest restaurant format, named Fizzle, was unveiled in October at the Burger King Franchisee Convention. The new Fizzle image will meaningfully enhance the guest experience through digital improvements, updated drive-thru and pickup, as well as signature design elements. We are excited to have the first ground-up sizzle restaurant in the entire Burger King system, which just opened a couple of weeks ago in Marion, North Carolina. For 2024, we are planning for approximately half of our Burger King remodels to be in this new and improved image. We are delighted to add another great quarter to a string of excellent quarters since the beginning of 2023. For the fourth quarter, we expect a strong finish to the year with comparable sales at our Burger King restaurants in the mid-single digits. aided by accelerating traffic growth. Finally, based on the board's confidence in the outlook for our business and strong cash flow profile, they have declared an initial $0.02 per share regular quarterly dividend. As we look to 2024 and beyond, we remain focused on maintaining the momentum we achieved this year while continuing to drive positive traffic growth and incremental EBITDA. As I have said in each of the previous quarters, Carroll's is a great company with talented and committed team members. We believe we have only scratched the surface of our immense potential and look forward to building on these achievements going forward. With that, I will now pass the call over to our Chief Financial Officer and Treasurer, Tony Hall, for a more detailed discussion of our financial results.

Thank you, Deb, and good morning, everyone. Restaurant sales in the third quarter increased 7% to $475.8 million, compared to $444 million in the third quarter of 2022. For the quarter, comparable restaurant sales at our Burger King restaurants increased 8.1%, comprised of a 7.7% increase in average check and a 0.3% increase in traffic. As we anticipated, we saw a sequential step down in our comparable restaurant sales in the third quarter as our average check moderated with reduced benefit from pricing and lower discounting that began in 2022. This was partially offset by the improvements that we saw in traffic. Comparable restaurant sales at our Popeye's restaurants increased 11.7%, comprised of an 8.6% increase in average check and a 2.8% increase in traffic. Turning to expenses, our cost of food, beverage, and packaging improved 380 basis points to 27.3% of restaurant sales, as commodity inflation fell to approximately 0.7%. It is important to point out that in the quarter, we benefited from a new vendor agreement that improved product rebates, which was retroactive to the beginning of 2023. This was responsible for about 70 basis points of the 380 basis point margin improvement in the third quarter. This will continue to benefit us in the fourth quarter of 2023 and thereafter by about 20 basis points per quarter for a number of years. Beef was $2.84 per pound during the quarter, which was a 4.8% increase from the same period last year. As we normally see in Q4, beef costs currently are on the decline and hovering around $2.65 per pound. From where we stand today, we expect commodity inflation to be in the low single digits for the remainder of 2023. Restaurant labor expense decreased 120 basis points to 32.3% of restaurant sales as labor inflation was more than offset by labor efficiencies and higher average check. Hourly wage rates for our team members increased by 3.8% during the quarter compared to the prior year period. As we look ahead, we expect wage inflation in the mid-single digits for the remainder of 2023. Our restaurant operating expense decreased 10 basis points to 15.7% of sales. Rent expense decreased 20 basis points year-over-year as a percentage of sales compared to the prior year period. General and administrative expenses as a percentage of sales increased 40 basis points year-over-year due to incentive compensation accruals that were absent in the prior year period. Adjusted EBITDA increased to $41.9 million in the third quarter of 2023 compared to $17.7 million in the prior year period, an increase of 137% on a sales increase of 7%. Adjusted EBITDA margin came in at 8.8%, more than double the prior year period. As we near the end of the year, we anticipate achieving adjusted EBITDA between $145 million and $149 million for 2023. This equates to adjusted EBITDA between $28 million and $32 million in the fourth quarter. For the third quarter, our net income was $12.6 million, or $0.20 for diluted share, compared to the net loss of $8.7 million, or $0.17 for share, for diluted share in the prior year period. On an adjusted basis, third quarter net income was $10 million, or $0.16 for diluted share, compared to an adjusted net loss of $7.3 million, or $0.14 for diluted share in the prior year period. Free cash flow in the third quarter was $33.9 million, a significant improvement compared to free cash flow of $14 million in the same period last year. Over the past 12 months, we've generated free cash flow of over $80 million. This indicates a robust free cash flow yield given our current stock price. At the end of the third quarter, cash and cash equivalents totaled $73 million in long-term debt, including the current portion and finance lease liabilities was $475 million. Our overall interest rate on our debt this past quarter was 5.7%, as approximately 90% of our debt remains fixed. As of quarter end, there were no revolver borrowings and $11 million of outstanding letters of credit, leaving us with $205 million of availability under our revolver. We currently have no covenants applicable on our senior credit facility at this time. In addition, Deb mentioned a few minutes ago, our board of directors has authorized and declared an initial quarterly dividend of two cents per share. This dividend will be paid on December 15th, 2023 to shareholders of record as of November 21st, 2023. This concludes our prepared remarks. We'd like to thank you again for your interest in Carol. Deb, Greta, and I are now happy to answer any questions that you may have. Operator, please open the line for questions.

Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. Again, that's star 1 to register a question at this time. Today's first question is coming from Joshua Long of Stevens. Please go ahead.

Great. Thank you for taking my question. I was curious if you could talk a little bit about, you know, kind of the overall competitive environment and what you saw through the quarter. I know that there's been this ongoing trend of normalization versus, you know, pre-COVID periods or coming out of COVID rather. But, you know, when you think about your core consumer, all the work that the Burger King brand has put together and all the great operational efforts that you've done at the store level, just curious how those two, you know, those dynamics come together in what otherwise could be seen as somewhat of a still challenging operating environment.

Yeah, I would say, Joshua, that I guess a couple of things. As you mentioned, the operational improvements we think are a key part to what we're seeing with the customer satisfaction. And we continue to believe that guest satisfaction is a key driver of repeat visits and incremental traffic growth. And so that's one of the reasons we believe we've had, we got to see positive traffic sooner than we otherwise expected to. Also think that our friend Troy Zor has done a really good job with the promotions and marketing that they've done earlier in the year, and that has continued to support the brand overall, as well as our performance.

Great. Thank you for that. And when we think about the guide for the mid-single digits, same for sales at Burger King, supported by traffic growth, can you talk about some of the pushes and pulls there as we go through the rest of the year? Obviously, great results this quarter. It seems like there's a lot of momentum, but maybe still some pushes and pulls for your core consumer, just in terms of inflation, affordability broadly. Obviously your brand is well positioned for this, but just curious, as you see there, as you, as your team sees it, kind of any pushes and pulls kind of that could, you know, influence that mid single digit comp either way.

Well, I said that, you know, yin and the yang of the, of the comp is that we continue to expect positive traffic in the fourth quarter. We think that's gonna be bolstered by the additional incremental spending that Burger King is planning on doing, that they've sort of been saving up for for the fourth quarter. And they announced on their call it'd be about a $35 million incremental, so I think that would really bolster, that'll help bolster traffic. The other side of it is, as we said last quarter, the average check piece of it is coming down because we're lapping lower discounting and our ability to raise prices, we're not pushing the envelope on that. So those are the two things that are kind of driving the mid-single-digit comp growth in the fourth quarter.

I guess the only thing I would add to what Tony just said is that we continue to see the same trends we talked about in the earlier quarters with some of that what we believe to be trade-down occurrence. as we continue to potentially have some more challenging economic environments, we, you know, believe that will absolutely, you know, sustain our business.

Great. Thank you. And then one more, I think there was discussion that maybe 50% of the remodels would be under the new store format. And that's certainly exciting in terms of driving brand image and just the overall strength of the system. Curious if there's flexibility in that number, just how you think about arriving at 50% of the system. Maybe there's just, you know, certain, you know, elements or trade areas that just don't make sense, but just try to contextualize the opportunity on the kind of bringing that new store format into the, into the system.

Right. So a lot of it depends obviously on the site and the existing building that's there in some cases with remodels. So if, you know, if it makes sense economically to be able to put it into the sizzle format, we're absolutely going to want to do that because they're pretty excited with, uh, you know, some of the features that, that, you know, most more modern image offers. But unfortunately, not all of the sites will allow us to take advantage of that. So, it's very much a site-by-site determination and the number, you know, we give out approximately half, you know, at this point, you know, where we sit in 2023, that's kind of where we would put it.

But that's always going to be our preference if we can do it.

Thank you.

Thank you. The next question is coming from Jeremy Hablin of Craig Hallam.

Please go ahead.

Thanks and congratulations on the strong momentum in the business. I wanted to follow up here on menu pricing. And as we look forward, just a reminder of where menu pricing stands here in Q4. And then kind of the break points as we enter 2024 and thoughts around just how to think about competitive set and the backdrop of the macro, how you might think about pricing overall. for 2024?

The Q4 is sort of a mid-single-digit pricing, which is just accumulation of what we've done over the previous 12 months and net of what's dropping off. We had a big price increase drop off in September. So that gets us to this year. I think for next year, we're very cautious about it, and we're going to you know, I think we'll move at a more normal cadence, sort of pre-COVID type of cadence on price increases. That's what we're, you know, in terms of frequency of price increases and levels, you know, percentage increases, which were pretty modest, obviously, pre-COVID. So our expectation is that's the way, you know, that's how we're going to do it next year.

Got it. So I think historically that's been more like in the 2% to 3% range, correct? Yeah. Got it. And then, you know, congrats on the success here of the Royal Crispy wraps. Wanted to see, oftentimes you guys have a little bit of visibility on new product pipeline, but, you know, it hadn't really been a part of the BK turnaround story until, you know, until that, you know, kind of August timeframe, but wanted to just get a sense for are there kind of expectations on additional new products that could be big traffic drivers here as we think ahead to 2024?

I guess what I'd say on that one, Jeremy, is that what I thought was awesome about the wraps is that it almost wasn't a new product. I mean, they were taking a sandwich that already exists, the Royal Crispy sandwich, and were basically chopping it up and putting it in a wrap. So the beauty of that is, well, yes, you're using something that you already have and putting it in kind of a new format from an operational standpoint that was a significant help with the launch of that. I think going forward, I think our franchisor BK continues to work on new opportunities and they'll unveil them at the appropriate times.

Got it. And then I wanted to ask one on the dividend. Congrats on the initial dividend here. In terms of how the board and management is thinking about you know, the capital allocation plan and having a dividend, which, you know, should kind of open you up to a broader set of potential investors. Is there, you know, kind of a payout ratio that the company is thinking about for rule of thumb? I mean, the free cash flow generation, you know, is tremendous this year, I think well over a dollar a share. by our math, but wanted to just get a sense if there's, you know, kind of a ratio that's, you know, being targeted. And then, you know, kind of coupled with that, in terms of whether or not the company is going to, you know, would consider, you know, additional, you know, share buybacks down the road, how do we balance the tension of those two?

I guess I would just say, you know, obviously the dividend is an expression of the board's confidence overall, just in the you know, momentum and strength of the business. And that's really what drove that. And I think from a, you know, capital allocation perspective, as we go into, you know, next year, we kind of continue to look at it with kind of a three-pronged approach, which is, you know, continue obviously to pay down debt, organic growth within the business, and then finding a way to return capital to shareholders.

And those are kind of our three guiding principles as we move forward.

Great. Last one quickly, if I could sneak this in. As we look ahead, Tony, to 2024, and we look at your occupancy costs, what is the same store sales level needed to lever rent next year? Are we looking at 3% to 4%? Is there a baseline that you'd be looking at to lever on that number?

Yes, but there's a lot of ins and outs for next year, so that's probably not in the highest priority of those things we're looking at. We said in our prepared remarks that we expect to continue to grow EBITDA next year, so I think that's basically... you know, whatever falls out of that in terms of leverage on labor, leverage on COGS, you know, it'll be what it'll be. But, you know, we'll have to, you know, we'll get further into that when we get into 2024.

Great. Congrats. Thanks for taking the questions. Thank you.

Once again, ladies and gentlemen, that is Star 1 if you would like to register a question at this time. Next question is coming from Jake Bartlett of Truro Securities. Please go ahead.

Great. Thanks for taking the questions. Tony, my first question is on – you gave guidance for mid-single-digit positive comps in the fourth quarter, but also mid-single-digit price. So I just want to maybe get a little more specific there because it sounds like that implies flat traffic. So any detail there on the pieces of the comp in the fourth quarter? And then, Tony, could you give us the exact – what the level of menu price was in the third quarter?

Sure. So the menu price increase in the third quarter was 6%. And, you know, our view on traffic, given all the advertising and momentum we have right now, is, you know, we expect to be positive. You know, we're not giving specifics, you know, detail beyond sort of mid-single digit, but there's a lot of pluses and minuses. But we do expect traffic to continue to increase in Q4.

Okay. And, and is that, is that outlook, you know, um, predicated on, you know, what's coming ahead with, with the marketing that you have a supplemental contribution from Burger King, or is that kind of, you know, already kind of what you're seeing, just trying to get a sense as to how much of that is, um, aspirational or, or, or kind of, you know, what, what you're seeing in current trends.

I think Jake did two things. I think it's one, obviously the increased marketing spend that we're anticipating from, um, from Burger King, but it's also the operational improvements that we've made over the past, you know, several months this year that we believe that is, again, the key to kind of that repeat traffic and incremental traffic. So I think all those together is what make us optimistic about the traffic continuing to be positive.

Great. And then the kiosk rollout, you know, pretty significant rollout across the system. You know, I guess it's kind of free for you. So, um, you know, in terms of the ROI, I guess that's pretty high, but, um, but what, you know, what do you expect that to do? I mean, are you excited about the potential for kiosks to, you know, to drive, um, you know, check or, or traffic, you know, that's going to be real, you know, driver of sales in 24.

So I think we're very excited about it. Um, obviously we're in the early stage of rolling it out, but based on, you know, what we've seen from some others that have already implemented in our kiosks that we are expecting, You see an increase in average check. So that's what we're pretty optimistic about on that one. And we also just think from a guest satisfaction. I mean, in certain areas of the country, people like to actually interact with the kiosk more than potentially a person just because it can be faster. And that's just how they like to do it. So I think those two things are things that we're hoping to see realized. When we do the pilot, there's always obviously the possibility of labor efficiencies down the road as well, depending on how far along the track you go with that. But like I said, at this point in time, we just want to kind of prove out the initial concept, and then if that's good, then we'll plan on taking it further.

Great. And then the last question is on the remodels. And so you're opening or you're going to do 45 next year. How many do you expect to do or have you done in 23? And I'm wondering whether you can just comment on the kind of lift you're seeing, you know, how much of a sales lift, better or worse than expected, that would be helpful.

So we did about half that amount in 2023, but I would say we got a lead start in 2023. So a lot of the work got underway in the second half of the year. So in terms of actually openings on them, a lot of those will actually drift into the first quarter of 2024. But based on the few that have opened, and they've really just opened in the last few weeks. I mean, we had the Marion sizzle one just opened literally, I think it was the beginning of last week. We had Bennington, Vermont that opened the end of last week, so we're just really seeing it, but we've been very pleased with the soft openings on those.

Great. I appreciate it.

Thank you.

Thank you. The next question is coming from Fred Reitman of Wolf Research. Please go ahead.

Hey, guys. Good morning. The mid-single-digit comp outlook for 4Q, did you guys give an October comp number?

No.

Okay. Can you?

I mean, we gave you a quarterly number, so it's definitely consistent with that.

Okay, that's all. Okay, great. And then just on the new vendor agreement, I think you called that out as a 70 basis point benefit in the quarter, a 20 basis point benefit, I think is what you said, on an ongoing basis. What exactly is that?

You know, Burger King negotiated... an improved deal with one of their large vendors at the end of August, I think it was. And the benefit of that was there were incremental dollars that went to the ad fund from that, and then there were incremental dollars going to the franchisees. So we're really happy with that. It was kind of an unexpected benefit for the year and for the next 10 years. So I think they did a fantastic job renegotiating that deal.

Okay, perfect. Thank you.

Thank you. At this time, I would like to turn the floor back over to Deborah Derby for closing comments.

Thank you again, everyone, for joining us this morning and for your interest in the company. We appreciate your time, and we look forward to speaking with you next quarter.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your line to log off the webcast at this time and enjoy the rest of your day.