Carrols Restaurant Group, Inc. (NASDAQ:TAST) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Carrols Restaurant Group, Inc. First Quarter 2023 Earnings Conference Call. [Operator Instructions] I would like to remind everyone that this conference is being recorded today, Thursday, May 11, 2023 at 8:30 a.m. Eastern Time and will be available for replay. I will now turn the conference over to Jeremy Watchus, Carol’s Senior Director of Finance. Please go ahead.

Jeremy Watchus: Thank you, operator, and good morning, everyone. By now, you should have access to our earnings announcement released earlier today in our earnings presentation that are both 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, including answers to questions posed to management, may include forward-looking statements or comments with respect to our strategies, intentions or plans in 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 new President and CEO, Deborah Derby.

Deborah Derby: Good morning, everyone, and thank you, Jeremy. I’m delighted to be speaking with you this morning on my first call as Carol’s new President and CEO. As I just finished up my first week on the job, so to speak, I will keep my initial comments brief and then turn the call over to Tony and Gretta to discuss the details of our spectacular first quarter. First, I want to reiterate how excited I am to be part of the Carol’s team during this dynamic period. As some of you may know, I have served on the Board of Directors of Carroll for the past 5 years. So I’m familiar with the opportunities and challenges of the business as well as the outstanding people that make up the company. I have seen the team persevered during one of the most challenging business environments of our time, and it is great to see the results of their hard work finally beginning to flow through to the bottom line.

Second, I want to thank our partners at RBI and Burger King on their recent diligent efforts to reinvigorate and reinvest in the brand and their franchisees. Those efforts are also starting to yield results. I spent my first week in meeting with our corporate team as well as training and working in the evening shifts to one of our local Burger King restaurants. From that experience, I have renewed appreciation and respect to what our team members do. My takeaway from my various interactions last week is that we have an incredible group of talented, engaged and dedicated employees who are passionate about the company, our brands and our customers. And I am confident that this is the foundation which will serve as the springboard for our continued future success and upon which we will continue to grow our business.

Thank you for your time today, and I look forward to our continued dialogue during future earnings calls. I will now turn the call over to Tony Hull, our CFO and Treasurer.

Tony Hull: Thank you, Deborah, and good morning, everyone. We’re thrilled with what we were able to achieve in the first quarter of 2023. This included posting 11% growth in total restaurant sales, delivering $30.7 million of adjusted EBITDA and reducing our net leverage ratio to 5.2x. In the first quarter of this year, our comparable sales increase of 11.7% at our Burger King restaurants was driven by menu price increases and lower promotions and discounting, which together resulted in a low teens increase in average check. Combined with moderating inflation and our continued focus on operational efficiencies, we were able to flow much of the $46 million year-over-year increase in sales during the quarter into higher adjusted restaurant-level margins, which improved to 12.2%.

To put this in perspective, this is our best first quarter restaurant level margin in 5 years. Adjusted EBITDA improved to $30.7 million, an increase of $26.4 million relative to last year. Finally, we greatly improved our capital position as we achieved positive free cash flow during the quarter, paid off the outstanding year-end balance on our revolver and reduced our net debt leverage ratio to 5.2x, a reduction of almost 2 full turns relative to the 7.1x reported at the end of 2022. We — on the sales front, top line growth was aided by the repositioning of promotional discount strategies by our franchisor, which drove higher sales of full margin products, along with the cumulative impact of menu price increases taken over the past year.

These actions combined with renewed brand equity investments from the reclaim the claim effort and lapping weather-related softness from a year ago resulted in only a slight traffic decline in the face of an average check increase of 13%. This turned out to be a winning formula for us and one we expect will continue into Q2 of this year. With that, let’s discuss the progress we are making in our restaurant operations. The quarter produced continued sequential and year-over-year margin improvement, driven by increased flow-through on our higher average check. In fact, our food packaging and labor costs only increased $7 million compared to Q1 of 2022 against the $46 million revenue improvement. The margin leverage we saw in labor was especially encouraging, considering we also expanded our hours of operations and simultaneously reduce labor hours on a year-over-year basis.

Additionally, we saw a deceleration in wage increases and a dramatic moderation in team member turnover during the quarter, aiding both efficiency and the guest experience. At the same time, these beneficial operating trends unfolded, we meaningfully improved our guest satisfaction scores during the first quarter as compared to the same period last year, with an increase of over 35% at our baking restaurants and over 10% at our Popeye’s restaurants. Guest satisfaction is a priority for us and one we believe is a key driver of repeat visits and incremental traffic growth Overall, we’ve made substantial progress on operations. We’re among the top operators in the BURGER KING system, but we continually strive to be the best. In terms of capital expenditures, we expect to maintain our spending at approximately $40 million for 2023.

However, as a result of the financial subsidies we expect to receive from Burger King as part of their reclaim the flame initiatives, we have been able to increase the number of high teens return remodel projects we have undertaken. In addition, under our franchisors World Reset program, we are able to proactively upgrade our restaurant digital technology over the next 8 months at no incremental cost to Carol’s as long as we match those investments with equivalent spend on restaurant maintenance and improvements. Overall in the past 2 quarters, we believe we have showcased the power of our operating model when we have sustained solid top line growth and a renewed focus on operational excellence. While we are pleased with our results to date, there is much more to be done.

We are excited about the positive momentum in our business and what we believe we can achieve during the remainder of 2023 and the years to come. Before I turn over the call to Gretta, I’d like to touch on some of our thoughts for the remainder of the year. First, we are optimistic about the positive traffic impact the incremental marketing from the claim the flame could have on our business as additional initiatives are rolled out through the remainder of the year by our franchisor. Second, as I mentioned before, we have seen our average check improve favorably over the past 2 quarters driven by reduced discounting and menu price increases. This has provided us with an opportunity to expand restaurant margins and drive EBITDA growth. As we look to the back half of 2023, we do not anticipate the same level of average check benefit for 2 reasons.

One, as inflationary pressures ease, we expect that our ability to raise menu prices in tandem will moderate. And two, we will lap our recently improved promotion and discounting profile in the third quarter of 2023. Consequently, we believe that positive changes in the trajectory of traffic trends in the back half of 2023 will be the most meaningful driver of comparable sales growth. Finally, our top priority remains fortifying our balance sheet and reducing our net debt balances. We expect to stay the course on organic growth and do not currently anticipate making any multiunit restaurant acquisitions, increasing capital expenditures over the approximate $40 million we’ve already communicated or returning cash to shareholders in 2023. In closing, it has been a pleasure working closely with our talented management and restaurant operations team for the first 4 months of 2023 as interim CEO.

And I am proud of what we were able to achieve together and look forward to working with Deborah and supporting her efforts to continue to build upon the positive momentum we have generated over the past year. With that, I will now pass the call over to our Controller and Assistant Treasurer, Gretta Miles, for a detailed discussion of our financial results.

Gretta Miles: Thank you, Tony, and good morning, everyone. Restaurant sales in the first quarter increased 11.4% to $445.2 million compared to $399.5 million in the first quarter of 2022. For the quarter, comparable restaurant sales at our Burger King restaurants increased 11.7%, comprised of a 13% increase in average check, which was partially offset by a 1.1% decline in traffic. Comparable restaurant sales at our Popeye’s restaurants increased 9.5%, comprised of a 10% increase in average track and a 50 basis point decrease in traffic. Turning to expenses; our cost of food, fabric and packaging improved 260 basis points to 28.2% of restaurant sales as commodity inflation of approximately 8% was more than offset by the positive benefit from pricing actions and lower promotional discounting.

Beef averaged $2.53 per pound during the quarter, which was a 7% decrease from the same period last year but has risen to the mid-80s in the last few weeks. From where we stand today, we expect commodity inflation to be in the mid- to high single digits for the second quarter of 2023. Restaurant labor expense decreased 260 basis points to 32.9% of restaurant sales as labor inflation was more than offset by reduced labor hours and the impact of pricing actions and lower discounting. Average hourly wage rates for our team members before overtime increased by 5.6% during the quarter compared to the prior year period. As we look ahead, we expect wage inflation in the mid-single digits in 2023 compared to the high single-digit inflation we saw last year.

Other restaurant operating expense increased $3.7 million and decreased by about 80 basis points to 15.5% of sales. The dollar increase was driven by higher royalties on higher sales as well as higher utility costs. Renting expense decreased 60 basis points year-over-year as a percentage of sales compared to the prior year period, primarily from the benefit of higher sales on fixed rental agreements. General and administrative expenses as a percentage of sales increased 30 basis points year-over-year due to incentive compensation accruals that were absent in the prior year period. Excluding non-recurring costs as well as stock compensation expense and including the impact of higher incentive compensation accruals this year relative to last year, we anticipate 2023 G&A expense of $23 million to $24 million per quarter.

For the first quarter, our net income was $900,000 or $0.01 per diluted share compared to net loss of $21.3 million or $0.42 per diluted share in the prior year period. On an adjusted basis, first quarter net income was $7,000 compared to an adjusted net loss of $17.1 million or $0.34 per diluted share in the prior year period. Free cash flow for the first quarter was $1.1 million, a significant improvement compared to negative free cash flow of $39.1 million in the same period last year. As a reminder, our first quarter cash flow included our final $10.8 million repayment of the deferred FICA obligation. In the first quarter of 2023, we used free cash flow generated, along with cash on hand to pay down our outstanding revolver balance of $12.5 million in full.

Cash and cash equivalents was $4.9 million at the end of the quarter and long-term debt, including the current portion in finance lease liabilities was $478.7 million. Our overall interest rate on our debt this past quarter was 5.8% as approximately 90% of our debt is fixed. As of quarter end, there were no revolver borrowings, and we had $10.5 million of outstanding letters of credit, leaving us with $204.5 million of availability under our revolver at the end of the quarter. And with that, this concludes our prepared remarks. We’d like to thank you again for your interest in Carrols, and we are now happy to answer any questions that you may have. In addition to Deborah, Tony and myself, Joe Hoffman, our Chief Restaurant Officer, is also available during the Q&A session.

Operator, please open the line for questions.

Q&A Session

Operator: Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Joshua Long with Stephens.

Operator: Our next question is from Jeremy Hamblin with Craig-Hallum.

Operator: Our next question is from Jake Bartlett with Truist Securities.

Operator: Our next question is from Hale Holden with Barclays.

Operator: [Operator Instructions] Our next question is from Carla Casella with JPMorgan.

Operator: Ladies and gentlemen, we have reached the end of today’s question-and-answer session. I would like to turn the call back over to Deborah Derby for closing remarks.

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

Operator: Thank you. This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.