Q3 2023 Carrols Restaurant Group Inc Earnings Call
Participants
Anthony E. Hull; VP, CFO & Treasurer; Carrols Restaurant Group, Inc.
Deborah M. Derby; CEO, President & Director; Carrols Restaurant Group, Inc.
Gretta Beth Miles; VP, Controller & Assistant Treasurer; Carrols Restaurant Group, Inc.
Frederick Charles Wightman; Research Analyst; Wolfe Research, LLC
Jake Rowland Bartlett; VP; Truist Securities, Inc., Research Division
Jeremy Scott Hamblin; Senior Research Analyst; Craig-Hallum Capital Group LLC, Research Division
Joshua C. Long; MD & Research Analyst; Stephens Inc., Research Division
Presentation
Operator
Welcome to the Carrols Restaurant Group, Inc.'s Third Quarter 2023 Earnings Conference Call. (Operator Instructions) 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 Beth 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 M. 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 2.8x. 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 '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 2 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 4 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 franchisee 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.
Anthony E. 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.
Question and Answer Session
Operator
(Operator Instructions) Today's first question is coming from Joshua Long of Stephens.
Joshua C. Long
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 2 -- those dynamics come together in what otherwise could be seen as somewhat of a still challenging operating environment.
Deborah M. Derby
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 C. Long
Great. 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.
Anthony E. 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, 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 2 things that are kind of driving the mid-single-digit comp growth in the fourth quarter.
Deborah M. 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.
Joshua C. Long
Great. 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 M. 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.
Operator
The next question is coming from Jeremy Hamblin of Craig-Hallum.
Jeremy Scott Hamblin
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.
Anthony E. 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.
Jeremy Scott Hamblin
Got it. So I think historically, that's been more like in the 2% to 3% range, correct?
Anthony E. Hull
Yes.
Jeremy Scott 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 M. 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.
Jeremy Scott Hamblin
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 the capital allocation plan and having a dividend, which should kind of open you up to a broader set of potential investors, is there kind of a payout ratio that the company is thinking about for a rule of thumb?
I mean the free cash flow generation is tremendous this year, I think, well over $1 a share by our math. But I wanted to just get a sense if there's kind of a ratio that's being targeted? And then kind of coupled with that, in terms of whether or not the company is going to -- would consider additional share buybacks down the road, how do we balance the tension of those 2?
Deborah M. Derby
I guess I would just say, obviously, the dividend is an expression of the Board's confidence overall just in the momentum and strength of the business, and that's really what drove that. And I think from a capital allocation perspective, as we go into next year, we kind of continue to look at it with kind of a 3-pronged approach, which is 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 3 guiding principles as we move forward.
Jeremy Scott Hamblin
Great. Last one quickly, if I could sneak this in. As we look ahead, Tony, to 2024, what's the -- and we look at your occupancy costs, what is the same-store sales level needed to lever rent next year? Are we looking at kind of 3% to 4%? Is there kind of a baseline that you'd be looking at to lever on that number?
Anthony E. Hull
Yes. There are 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 whatever falls out of that in terms of leverage on labor or leverage on COGS, it will be where it will be. But we'll have to -- we'll get further into that when we get into 2024.
Operator
(Operator Instructions) The next question is coming from Jake Bartlett of Truist Securities.
Jake Rowland Bartlett
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?
Anthony E. Hull
Sure. So the menu price increase in the third quarter was 6%. And our view on traffic, given all the advertising and momentum we have right now is we expect to be positive. We're not giving specific 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.
Jake Rowland Bartlett
Okay. And is that outlook predicated on what's coming ahead with the marketing, the supplemental contribution from Burger King? Or is that kind of already kind of what you're seeing? Just trying to get a sense as to how much of that is aspirational or kind of what you're seeing in current trends?
Deborah M. Derby
I think, Jake, it's 2 things. I think it's one, obviously, the increased marketing spend that we're anticipating from Burger King, but it's also the operational improvements that we've made over the past 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.
Jake Rowland Bartlett
Great. And then the kiosk rollout, a pretty significant rollout across the system. I guess it's kind of free for you. So in terms of the ROI, I guess, that's pretty high. But what do you expect that to do? I mean, are you excited about the potential for a kiosk to drive check or traffic? Is it going to be a real driver of sales in '24?
Deborah M. Derby
So I think we're very excited about it. Obviously, we're in the early stage of rolling it out. But based on what we've seen from some others that have already implemented in their kiosks that we are expecting to 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 2 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.
Jake Rowland Bartlett
Great. And then last question is on the remodel. 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, how much of a sales lift, better or worse than expected, that would be helpful.
Deborah M. Derby
So we did about half that amount in 2023, but I would say we got a late 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 just opened literally, I think it was the beginning of last week, and 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.
Operator
The next question is coming from Fred Wightman of Wolfe Research.
Frederick Charles Wightman
The mid-single-digit comp outlook for 4Q, did you guys give an October comp number?
Anthony E. Hull
No.
Frederick Charles Wightman
Can you?
Anthony E. Hull
I mean we gave you a quarterly number. So it's definitely consistent with that, mid-single-digit that we gave.
Frederick Charles Wightman
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?
Anthony E. Hull
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 on that deal.
Operator
Thank you. At this time, I would like to turn the floor back over to Deborah Derby for closing comments.
Deborah M. Derby
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.
Operator
Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines and walk off the webcast at this time, and enjoy the rest of your day.
