Carrols Restaurant Group, Inc.
Q3 2021 Earnings Call Transcript

Published: 10 Nov 2021

[Operator:]

Good morning. And welcome to Carrols Restaurant Group, Inc. Third Quarter 2021 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 and instructions will be given at that time. I would like to remind everyone that this conference call is being recorded today, Wednesday, November 10, 2021, at 8

[Gretta Miles:]

Thank you, Melissa, and good morning, everyone. By now you should have access to our earnings announcement released earlier this morning and an 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 posted to management may include forward-looking statements or comments with respect to our strategy, intentions or plans, and the future direction of revenue, input costs or other aspects pertaining to our businesses. 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, including among other things, 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 GAAP measures is available with our earnings release. With that, I will now turn the call over to our Chairman and CEO, Dan Accordino. Dan?

[Dan Accordino:]

Thanks, Gretta and good morning, everyone. Before I discuss our third quarter 2021 top line, let me address the elevated labor and commodity cost headwinds that we and the restaurant industry generally are experiencing; they both hit our adjusted EBITDA and margins hard in the quarter. From a labor standpoint, in the third quarter, we worked to keep our restaurants open from at least 6

[Tony Hull:]

Thank you, Dan. Total restaurant sales for the third quarter increased 3.6% to $421.7 million, compared to the prior year period of $407 million. Our Burger King comparable restaurant sales increased 2.7% during the quarter with an average weekly sales per Berg King restaurant of $30,186; this is an improvement of 3.1% from 2020 levels and more importantly, exceeded 2019 levels by 4.9%. The primary difference between overall sales growth in the quarter to comparable restaurant -- compo Burger King restaurant sales growth was due to the contributions from the 19 restaurants acquired during the second quarter of 2021 and three newly opened Burger King restaurants, offset by the closure of 17 Burger King restaurants since the end of the third quarter of 2020. Let me give you our Burger King performance by region as we operated 1,027 restaurants as of the end of the Q3 across 23 states. In the Northeast, representing 21% of our Burger King restaurants, comparable sales were up 5.7%. In the Midwest, representing 29% of our Burger King restaurants, comparable sales were up 3.2%. In the South Central, representing 24% of our Burger King restaurants, comparable sales were up 1.7%. And finally, in our Southeast region, representing 26% of our Burger King restaurants, comparable sales decreased 0.9%. With respect to our Popeyes restaurants, which represent less than 5% of our total revenues in the third quarter of 2021, comparable restaurant sales decreased 3.2% versus a positive 5.5% during the same period of the previous year. Staffing challenges during the evening hours of operation this past quarter were particularly impactful to Popeyes comparable sales. However, our results still represented a 3.8% increase on a two-year basis. We outperformed the Popeyes U.S. system by 140 basis points in the last quarter. As a result of the inflation challenges experienced in the third quarter, adjusted EBITDA decreased $15.5 million to $18.6 million, while adjusted EBITDA margin decreased 400 basis points to 4.4% of restaurant sales. Cost of food, beverage and packaging as a percentage of net sales increased 130 basis points, primarily because of higher beef, pork and other commodity costs; commodity inflation in the quarter was 9.2%. Recall that last quarter, we stated that our food supplier forecasted beef costs would be between $2.40 and $2.45 a pound from September to December of 2021. At least as far as September is concerned, this did not come to pass and as it was $2.68 per pound in the quarter overall. Although, we have seen modest reduction in beef costs in the last two weeks, we now believe that commodity costs will remain elevated through the remainder of the year. Restaurant labor expense increased 250 basis points as a percentage of restaurant sales in the third quarter of 2021 compared to the same quarter a year ago. Again, the dramatic contrast between the restrained operating environment we experienced in the third quarter of 2020 and the impact on labor cost of the economy reopening was unprecedented. On an absolute basis, labor costs increased $15 million or 12.1% from $126 million to $143 million. The imbalance between the supply and demand for workers required us to quickly increase hourly wages to remain competitive and operational with adequate staffing levels. While the base numbers of hours worked by team members were about even with the same period last year, the dollar impact of the higher average hourly wages increased our labor cost by $6 million in the quarter, paying team members premiums to take on additional responsibilities such as opening and closing our restaurants in overtime added $4.8 million to the overall increase in labor. The need for overtime hours for our assistant managers that were restricted last year in response to pandemic, along with salary increases for retention, cost us an additional $3.7 million in the quarter. Other restaurant operating expenses increased 90 basis points due to a number of factors, including higher recruiting spend and other employee-related incentives, utility rate increases and rising insurance costs. We also installed Smart Safes in a majority of our Burger King locations that provide for faster cash collection and greater security, which also added to operating expenses. Restaurant rent expense in the third quarter decreased 30 basis points as a percentage of sales compared to the prior year period, primarily due to sales leverage. General and administrative expenses fell to $19.2 million in the third quarter of 2021 from $20.4 million last year and declined 40 basis points to 4.6% of restaurant sales. The decrease in dollar terms was due to lower incentive compensation accruals this year, and was partially offset by higher regional administrative costs. Our net loss was $9.9 million in the third quarter of 2021 or $0.20 per ship per diluted share. On an adjusted basis, excluding certain non-operating items, third quarter adjusted net loss was $7.8 million or $0.16 per diluted share. In the prior year period, adjusted net income was $5.7 million or $0.09 per diluted share. Free cash flow for the quarter was the third quarter of 2021 was $13.5 million, compared to $23.8 million in the prior year period. The difference was primarily due to the reduction in adjusted EBITDA this year. We ended the third quarter with cash and cash equivalents of $89.4 million and long-term debt, including the current portion and finance lease liabilities of $523.3 million. We had $47.1 million drawn on our $215 million revolving credit facility, and had $9 million of letters of credit issued under such facility. This left $158.9 million of unused availability under our credit facility, and when added to our cash balance, provided us with $248.3 million of liquidity at the end of the third quarter. We funded the special dividend -- special cash dividend of $24.9 million on October 5, 2021. As a reminder, our ability to utilize our revolver capacity requires compliance with one senior secured leverage ratio, and is only in effect with more than 35% of the available capacities being used. At this point, we are below that threshold and have no maintenance covenant requirement. When in effect, we need to stay under 5.75x senior secured net debt to covenant EBITDA. Our senior secured ratio was at 1.24x at the end of the quarter, so we have considerable headroom to use our current available revolver capacity. Our total net debt compared to covenant EBITDA as defined in the senior credit facility stood at 4.03x at the end of the third quarter, in line with the ratio at the end of the third quarter of 2020. We did not repurchase any shares of our common stock during the third quarter. We now believe that our net capital expenditures will be below our earlier $60 million target as construction delays have pushed some newbuilds and remodeling projects to next year. Our current 2021 capital expenditure forecast is $50 million and will include the remodel of 28 restaurants, half of which will be completed this year and the remainder in 2022. This plan includes nine Popeyes remodels that will mostly be completed next year. We are also building eight Burger King restaurants in 2021, of which six will go online this year. The $10 million reduction in 2021 spend will move into our 2022 capital expenditure plan. On the M&A front, we do not currently have any multi-restaurant transactions in the pipeline. To conclude, while the near-term cost headwinds affecting our business are certainly clear, as we move into next year, we believe that we'll be able to clawback a portion of the margin erosion we are now experiencing. And we believe this will be achieved through menu price actions taken to date and in the future, combined with potentially easing cost pressures on a year-over-year basis, particularly in the back half of 2022. In the meantime, our liquidity is ample as is our ability to generate meaningful EBITDA. And with that, operator, let's go ahead and open the lines for questions.

[Operator:]

Thank you. Our first question comes from the line of Fred Whiteman with Wolf Research. Please proceed with your question.

[Fred Whiteman:]

Hey guys. I just wanted to follow-up on sort of the margin outlook here and I understand that there's inherent degree of unpredictability here. But when you guys are talking about clawing back a portion of the margin loss in the back half of next year, how should we think about sort of the structural revisions to the margin performance of the business going forward?

[Tony Hull:]

I think it's going to be a combination -- first of all, we totally agree with -- it's unpredictable. But we know the menu price increases that we put in place today and how they'll carry over to next year. We plan on doing at least one early year menu price increase next year. So in terms of margins, that will be helpful to margins. The traffic is -- the traffic direction is kind of almost out of our hands because it's really reliant on some RBI activities. But we feel good about the menu price increases, and that they're holding that -- they're not affecting traffic at this day. And then, I just don't -- we don't see the kind of hourly wage; there will be -- there will likely be hourly wage increase next year and certainly in the back half, but we don't believe it could possibly be as strong as we -- as high as it's been this year, given that it's -- we probably got three or four years of wage increases in one quarter of this year. So, you know, our view is it's unlikely that it will be that dramatic next year; so we'll get some sales leverage based on that. So that's -- again, it's totally unpredictable. We don't -- we have no idea what the labor situation will be like a year from now, but it just seems reasonable. And then, the other thing is we're seeing stabilization in commodity costs. And even though we think that the labor -- the production and distribution aspects of our commodities will not see a lot of relief, you could see some raw materials relief next year. So that could mean that the cost of sales are going up less robustly than they did in the third quarter this year.

[Fred Whiteman:]

Makes sense. And if we just think about the October trends that you touched on, it looks like the two-year trend decelerated versus what you guys did in the third quarter. So, could you sort of touch on what you're seeing on the top line and when we should sort of expect that to get moving in the right direction again?

[Tony Hull:]

We saw 5% in October, and it was -- it consisted of -- average ticket was up in the low single -- low teens and traffic was down consistent with what was down in the third quarter, about 5%, 6%; so that's what we're seeing. I think the big driver -- we probably think that's -- the price is probably good -- the price aspect of it is probably good through the quarter. But again, the traffic piece is a little bit uncertain.

[Fred Whiteman:]

Great. Thanks, guys.

[Operator:]

Thank you. Our next question comes from the line of James Rutherford with Stephens Inc. Please proceed with your question.

[James Rutherford:]

Great. Thanks very much. Dan, congrats on the announced retirement on a very incredible career in the industry, I know we have you for another six months or so, but we'll certainly miss you on these calls once that transition happens. So, congratulations.

[Dan Accordino:]

I still have another call, anyway.

[James Rutherford:]

Sorry, what was that?

[Dan Accordino:]

I said I'll still have another call anyway.

[James Rutherford:]

Yes. But we're glad; we're certainly glad. I want to start from the staffing levels versus 2019 levels. I'm curious how those trended through the quarter? And as a second part to that question, do you think the wage increases that you've put in place are sufficient to make your stores competitive enough? Or do you expect to need to increase wages again at any meaningful level in the fourth quarter to get those staff levels back to 2019 levels?

[Dan Accordino:]

The staffing levels through the quarter actually were pretty consistent. We're ending up with a fair number of applications. The application flow has picked up in the past month. The challenge continues to be with retention. I think the core average hourly rate is fine. Where we're seeing the biggest part of the inflation in labor is we're paying premium wages to keep the stores open past 9 o'clock at night; that's where we seem to be struggling the most, and that's true for the whole industry. We really don't want our restaurants to close prior to 11 o'clock and 12 o'clock at night, and consequently, rather than increase the base wage, we pay a premium wage of $0.50 or $1 to get employees to work beyond that period of time. So in terms of a percent increase in wages in 2022, my sense is it should be much more -- it will be much less of an increase than what we're experiencing currently.

[James Rutherford:]

Okay. And Tony, was that 13.3% wage growth inclusive of the overtime and shift premiums? Or is that additional to that?

[Tony Hull:]

No. It was just the base wage.

[James Rutherford:]

Okay, that's just the base wage. Thank you. And then, just one more question for me and I'll turn it back to the queue. But can you give a sense of how menu price trended throughout the quarter? I don't know if you want to give it necessarily by month or whatever, but with the different increases put in place? And overall, where are you running today with the 80 bps you added in October?

[Tony Hull:]

It went up during the quarter because the first increase was at the end of July, and that was on the backs of March -- late March increase to 2%. And then we did one -- a pretty sizable one in August. So, I think it ended up for the quarter being about 5% plus or minus of the check increase was due to menu price increases. And right now, we're sitting at about 7.5% from menu price increases.

[James Rutherford:]

Okay. And then there's also, I think, a little bit less discounting in there as well which is not included in the 7.5%; is that a fair way to think about total sort of net check?

[Tony Hull:]

Yes. It's pretty significant, James. It's not a small -- I mean, we're -- our discounting is like 300 basis points to 400 basis points less this year this quarter than it was the year ago period. So, it's just an interesting trend that we're seeing that; A) we're raising the prices on some of the promotional items and it's sticking, and there are fewer guests who are sort of spending very few dollars in the restaurant, the more the guests are spending more which helped drive the average ticket price up and reduce the promos and discounts.

[James Rutherford:]

Certainly, it's a very interesting dynamic. Okay, thanks for the help.

[Operator:]

Thank you. Our next question comes from the line of Jake Bartlett with Truist Securities. Please proceed with your question.

[Jake Bartlett:]

Great, thank you. Thanks for the question. And Dan, congratulations on a long and fruitful career, it's been great working with you over these years. I -- my first question was just on the sales trajectory. And I know that RBI has communicated a plan to really take a look at the strategy, work with franchisees, communicate that strategy and then put it into place in 2022 to try to regain market share. But the question is, in the meantime, how confident are you that there's some measures in place or strategies in place to really start to move the needle in the near term? So, rather than waiting for the long-term strategy shift or approach, how confident are you that in the near term that Burger King can regain some of this market share that it's been leasing ?

[Dan Accordino:]

I think it's going to be a challenge for the next six months. The marketing plan for the balance of this year, we know what it is, and it was pretty much put in place some while ago. The new plan and the new strategy will be provided to the franchise community at their -- at the convention in December, but it will take a while for that to take effect and implement. So, I think the market share challenges will continue for at least until the mid-part of 2022, Jake.

[Jake Bartlett:]

Got it. Okay, that's helpful. And then, the -- the less discounting, I believe maybe through less paper couponing seems good support for margins probably impacting sales a bit. But as you shift over to the digital channel, is there an interim period where you have -- we have less of the paper coupons but don't have the digital channel quite up to speed because it hasn't been -- loyalty hasn't been launched in story yet. So the question is, once that does happen, would we just expect the discounting to kind of go back to a more normal level just in the form of -- on the digital channel? Or do you think that there's a kind of a real permanent shift here in less discounting for the brand?

[Dan Accordino:]

Well, it's not just the couponing and the digital; there's been changes in the menu. I mean we had the dollar menu on the value items, those caps were all lifted. So we're charging more now for those items on a regular basis. And a year ago, we had a two for five as opposed to currently we're running at two for six and two for ten kind of things. So I think those changes are probably more relevant than whatever is going on with the couponing, Jake.

[Tony Hull:]

And more sustainable.

[Jake Bartlett:]

Got it. Great. And then the last question is, is really on free cash flow. Tony, maybe if you can just remind us if there's anything lumpy in terms of payment ins and outs in working capital, just so we can kind of make sure we understand that? And then, as we look to 2022 for CapEx; some of the CapEx has been -- you mentioned pushed into '22. Any indication on whether you'd expect to maybe open fewer stores than previously planned, given the environment and the cost pressures? Or also, whether there's -- how likely it is that there is going to be a capital kind of requirement from whatever measure Burger King puts in place to turn sales around? Any indication on what 2022 CapEx could be? And then, just making sure we know the ins and outs on working capital for free cash flow?

[Dan Accordino:]

I'll deal with the CapEx and Tony can deal with the working capital. In terms of opening restaurants in 2022, my sense, Jake, is that we've got some that are already in the works and they'll open in the first part of next year. Beyond that, my guess is, it's probably going to be later in the year simply because we're having problems getting the equipment and so forth. There's about a 3.5, 4-month lead time now to get kitchen equipment. So even if we wanted to open the restaurant, they would be -- it's going to occur later in the year. So I think new store development could be less next year than what we had originally planned. Remodeling, again, we've got some carryovers on remodels, we've got some that we hope to get completed by the first part of next year. And then we'll see again what the supply chain looks like in terms of our ability to get the equipment. In terms of both equipment mandates for both, Burger King and Popeyes, there are -- the digital menu board rollout will be completed by second quarter of 2022 in both brands and the required kitchen equipment for Burger King will be in place by the end of Q1. It's already been ordered and the required kitchen equipment for Popeyes will be in the second half of 2022, again, because of supply constraints.

[Jake Bartlett:]

Got it. And then, Tony, I would just -- the question on the working capital. But again, in terms of the equipment for the Burger King and the Popeyes, is that a significant investment to boost up -- should we expect that to boost the '22 CapEx significantly?

[Tony Hull:]

I don't think it's going to boost the '22 CapEx significantly. The -- the major CapEx dollars are remodels and whatever new construction we may do. So that will be, as I said, that's going to be somewhat fluid based upon the -- our ability to get the supplies to open and remodel restaurants. The CapEx requirements for both, Popeyes and Burger King, are relatively small percentage of our overall CapEx budget.

[Jake Bartlett:]

Great.

[Dan Accordino:]

Yes, and they're lapping what we did this year. So, it shouldn't change that much. you know, I'd say the couple of things that are impacting working capital this year are -- first of all, we have to repay $10 million plus of the FICA deferment that we received in 2020, that's half of the total; so that will hit on December 31. And then, so that's a bad guide to working capital. A good guide -- the biggest good guide to working capital is our interest on our interest expense, our cash outflow for interest expense is going to be a lot less than last year because the interest on the bonds actually is payable in the first couple of days of next year, first -- actually the first day of our calendar -- our fiscal 2022. So, it will be a benefit to cash flow this year. And then, the payment we have -- the second payment we have in 2022 will actually also be paid in the first day or so of 2023. So, just -- that's sort of a new thing now that we have the bonds outstanding.

[Jake Bartlett:]

Great. Thanks a lot. Appreciate it.

[Operator:]

Thank you. Our next question comes from the line of Jeremy Hamblin with Craig-Hallum Capital Group. Please proceed with your question.

[Jeremy Hamblin:]

Thanks. And I'll add my congratulations to you, Dan. It's been a pleasure working with you. And again, you're demonstrating some pretty impressive execution in a really tough environment. I wanted to -- Tony, just start actually with the commodity cost; beef price. I think that the math on that was $2.67 a pound in Q3. I wanted to get an update on where things have kind of trended here to start Q4? And also, I know some of the other commodity costs, whether protein costs, whether it's chicken or pork have also remained elevated. How has that trended here in Q4 and kind of your expectations over the next several months?

[Tony Hull:]

I would say that the general view on commodities right now is that they have stabilized, and we're seeing a little bit of recovery there, a little bit of decline, not huge declines. But the current price for beef is a little bit above the average for the third quarter, and it's heading in a good direction, but really slowly. And I'd say the same with all the other -- I'd say the same with all the other commodities. They seem to have plateaued and they're slowly -- pork is slowly coming down, chicken is slowly coming down. So, some of the French fries are steady, but seems to be coming down, we have hedges in for some bakery items and from some other items; so, we don't have it but RSI, our food distributor does. So, I'd say holding steady and maybe starting to definitely stabilize but maybe some starting to see some light at the end of the tunnel and that coming down a little bit, but not a lot. I mean the inflation in the fourth quarter just because of the comparison to really low commodity costs in the fourth quarter of last year is going to probably be in the low to mid-single teens. So, it's still a headwind versus last year. So, it's going to -- and it's probably going to be the biggest headwind in the fourth quarter that we've seen all year, mostly because the base was so low last year.

[Jeremy Hamblin:]

So cost of sales probably trends up slightly from the run rate that you saw in Q3; is that a fair assumption?

[Tony Hull:]

I think it might be a little bit, yes. But I think it might be steady because of leverage, sales leverage and lower promotions and stuff like that.

[Dan Accordino:]

We've got a lot more pricing.

[Tony Hull:]

Yes, we've got a lot more pricing on that.

[Jeremy Hamblin:]

Okay.

[Tony Hull:]

So, actually I think the net of it is, it may be -- it may be a little favorable to Q3 just because of the leverage.

[Jeremy Hamblin:]

Okay, got it. And then, again, kind of extraordinary environment here on labor. As we look out, typically you have -- well, you have some days in Q4 around the holiday period that your staff and are kind of lower volume labor. Presumably, it sounds like you're getting people in -- or there's an improvement in terms of having staff there. But is the near-term expectation that labor costs are going to continue to be a challenge despite the kind of menu pricing offsetting some of that impact?

[Tony Hull:]

Again, I think for the balance of this year, I think we're in pretty good shape, Jeremy, because things have stabilized recently. Starting with next year, there's a few states that have some minimum wage movement. But generally the minimum wage just doesn't have much effect on us at all because we're paying more than that currently. So, I really -- I think, again, there may be some movement next year but it's not going to be anywhere near the magnitude of what we're currently experiencing.

[Operator:]

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to management for any final comments.

[Dan Accordino:]

Thank you all for joining us on this call, and we look forward to speaking further with those who would like to speak to us. We have a number of conferences we're attending either in person or virtually over the next 1.5 months or so. And hopefully, we'll meet a lot of you in person or virtually. Thanks very much, and we'll talk to you in the next conference call in early next year. Thank you. Bye-bye.

[Operator:]

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