Carrols Restaurant Group, Inc. (NASDAQ:TAST) Q3 2023 Earnings Call Transcript

Carrols Restaurant Group, Inc. (NASDAQ:TAST) Q3 2023 Earnings Call Transcript November 9, 2023

Operator: Welcome to the Carrols Restaurant Group Inc.’s Third Quarter 2023 Earnings Conference Call. At this time, all participants are in 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 9, 2023 at 8:30 a.m. Eastern Time and will be available for replay. I will now turn the conference over to Gretta Miles, Carrols’ Controller and Assistant Treasurer. Thank you. Please go ahead.

Gretta Miles: 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.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 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.

Deborah Derby: Thank you, Gretta, and good morning, everyone. We are 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 a 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 1020 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 US.

The introduction of Sweet ‘N 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 Carrols’ team members and I want to thank them personally for their continuing efforts and commitments. 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 our relatively strong dinner and late-night performance with the latter continuing to be aided by our increased hours of operations 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 expenditures 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 with meaningful contributions from our franchisor for our 2024 remodels through the 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 Sizzle, was unveiled in October at the Burger King franchisees, convention. The New Sizzle image will meaningfully enhance the guest experience through Digital Improvement, 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 quarter 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, Carrols 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 Hull, for a more detailed discussion of our financial results.

Tony Hull: 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 Popeyes restaurant increased to 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 of between $145 million and $149 million for 2023. This equates to adjusted EBITDA of between $28 million and $32 million in the fourth quarter. For the third quarter, our net income was $12.6 million or $0.20 per diluted share compared to the net loss of $8.7 million or $0.17 per share per diluted share in the prior year period. On an adjusted basis, third quarter net income was $10 million or $0.16 per diluted share compared to an adjusted net loss of $7.3 million or $0.14 per 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 fees, 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 outsetting 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 $0.02 per share. This dividend will be paid on December 15, 2023 to shareholders of record as of November 21, 2023. This concludes our prepared remarks. We’d like to thank you again for your interest in Carrols. Deb, Gretta and I are now happy to answer any questions that you may have. Operator, please open the line for questions.

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Q&A Session

Operator: Thank you. The floor is now open for questions. [Operator Instructions] Today’s first question is coming from Joshua Long of Stephens. Please go ahead.

Joshua Long: Great. Thanks for taking my question. Just curious, if you could talk a little bit about 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 pre-COVID period or coming out of COVID rather. But 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 – those dynamics come together in what otherwise could be seen as somewhat of a still challenging operating environment.

Deborah Derby: Yes. 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 business 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. I also think that our franchisor 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.

Joshua Long: Great. Thank you for that. And when we think about the guide for the mid-single digit interest 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 it. But just curious as you see there – as your team sees it kind of any pushes and pulls kind of that could influence that mid-single-digit comp either way.

Tony Hull: Well, I’d say that the Ying and the Yang of the comp is that, we continue to expect positive traffic in the fourth quarter. We think that’s going to be bolstered by the additional incremental spending that Burger King is planning on doing, that they’ve sort of been saving up for the fourth quarter. And they announced on their call, it would be about a $35 million incremental. So I think that would really bolster — that will 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.

Deborah Derby: And 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 occurring. And so as we continue to potentially have some more challenging economic environments, we believe that will absolutely sustain our business.

Q – Joshua Long : Great. Thank you. And then one more if I could. I think there was a 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 is flexibility in that number? And just how you think about arriving at 50% of the system. Maybe there’s just certain elements or trade areas that just don’t make sense, but just trying to contextualize the opportunity on kind of bringing that new store format into the system.

Deborah Derby: 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 it makes sense economically to be able to put it into the Sizzle format, we’re absolutely going to want to do that because we’re pretty excited, with some of the features at that 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 we gave out of approximately half. At this point, 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.

Q – Joshua Long : Understood. Thank you.

Operator: Thank you. The next question is coming from Jeremy Hamblin of Craig-Hallum. Please go ahead.

Q – Jeremy Hamblin: 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 breakpoints 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.

Tony Hull: 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 one drop — big price increase drop off in September. So, that gets us to sort of this year. I think for next year, we’re very cautious about it and we’re very — we’re going to — 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 — in terms of frequency of price increases and levels percentage increases, which were pretty modest obviously pre-COVID. So our expectation is that’s the way — that’s how we’re going to do it next year.

Q – Jeremy Hamblin: Got it. So I think historically, that’s been more like in the 2% to 3% range, correct?

Tony Hull: Yes.

Q – Jeremy Hamblin: Got it. And then 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 it hadn’t really been a part of the BK turnaround story, until that kind of August time frame, but I wanted to just get a sense for are there kind of expectations on additional new products that are — that could be big traffic drivers here as we think ahead to 2024?

Deborah Derby: I guess, what I’d say, on that one Jeremy is that what I thought was awesome about the wraps that it almost wasn’t a new product. I mean they were taking a sandwich that already exists the Royal Crispy Sandwich and we’re 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 franchisors in BK continues to work on new opportunities and they’ll unveil them at the appropriate times.