Cracker Barrel Old Country Store, Inc (CBRL) Q3 2022 Earnings Call Transcript

Good morning, and welcome to the Cracker Barrel Fiscal 2022 Third Quarter Earnings Call. All participants will be in a listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Jessica Hazel, Investor Relations. Please go ahead.

Thank you. Good morning, and welcome to Cracker Barrel's third quarter fiscal 2022 conference call and webcast. This morning, we issued a press release announcing our third quarter results. In this press release and on this call, we will refer to non-GAAP financial measures for the third quarter ended April 29, 2022. The third quarter non-GAAP financial measures are adjusted to exclude the noncash amortization of the asset recognized from the gains on our sale and leaseback transactions and the related tax impacts. The Company believes that excluding these items from its financial results provides investors with an enhanced understanding of the Company's financial performance. This information is not intended to be considered in isolation or as a substitute for net income or earnings per share information prepared in accordance with GAAP. The last pages of the press release include reconciliations from the non-GAAP information to the GAAP financials. On the call with me this morning are Cracker Barrel's President and CEO, Sandy Cochran; Senior Vice President and CFO, Craig Pommells; and Senior Vice President and CMO, Jennifer Tate. Sandy and Jen will provide business and initiative updates and Craig will review the third quarter financials and outlook. We will then open up the call for questions for Sandy, Craig and Jen. On this call, statements may be made by management of their beliefs and expectations regarding the Company's future operating results or expected future events. These are known as forward-looking statements, which involve risks and uncertainties that, in many cases, are beyond management's control and may cause actual results to differ materially from expectations. We caution our listeners and readers in considering forward-looking statements and information, particularly in the current environment. Many of the factors that could affect results are summarized in the cautionary description of risks and uncertainties found at the end of the press release and are described in detail in our reports that we file with or furnished to the SEC. Finally, the information shared on this call is valid as of today's date, and the Company undertakes no obligation to update it, except as may be required under applicable law. I'll now turn the call over to Cracker Barrel's President and CEO, Sandy Cochran. Sandy?

Thank you, Jessica, and good morning, everyone. This morning, we announced total revenue growth of 10.8% compared to the prior year and 6.8% compared to the third quarter of fiscal 2019. Although I'm pleased with the work that our teams did to drive our sales above pre-COVID levels, our top line came in below our expectations, while cost pressures and deleveraging continued to challenge our bottom line. We were seeing encouraging sales trends as February progressed, but the macroeconomic environment and higher inflation slowed our recovery in March and April below our expectations. Three things in particular impacted our sales during the quarter: first, guests over 65 years old have been slower to return to in-person dining than other demographics in our guest base; second, the challenging economic environment caused some of our guests to manage frequency and check during the quarter; finally, we believe that high gas prices disrupted traditional spring break travel patterns, resulting in lower travel visits. On the positive side, our off-premise business continued to meet our expectations, and we partially offset our dine-in headwinds with continued strong retail performance as we grew comparable store retail sales by 9.7% over the prior year quarter and by 21.6% compared to the third quarter of 2019. With regard to cost, we continue to experience historically high commodity and wage inflation as Craig will run through. Although we've taken pricing to help us protect our margins, commodity inflation outpaced even our own robust expectations for the quarter. Craig will now go into some greater detail about the quarter and the current environment, as well as how we're thinking about the cost side. Once Craig is finished, I'll address the growth and top-line initiatives that we're pursuing to position us well going forward. Craig?

Thank you, Sandy, and good morning, everyone. For the quarter, we reported total revenue of $790.2 million. Restaurant revenue increased 11% to $632.2 million, and retail revenue increased 9.7% to $158 million versus the prior year third quarter. Comparable store total sales, including both restaurant and retail, grew by 10.7% compared to the prior year. Comparable store restaurant sales grew by 10.9% over the prior year, driven primarily by dine-in traffic growth and 5.9% pricing. Despite this growth, restaurant sales performance was below expectations. We are pleased with our continued strong retail sales growth and solid off-premise retention levels, and the work our teams have done to evolve these businesses to offer our guests increased flexibility and convenience. Third quarter comparable store off-premise sales remained significantly elevated compared to pre-COVID trends. Off-premise sales were 19% of restaurant sales for the third quarter with strong year-over-year growth from our catering business and third-party delivery, offset by year-over-year declines in our individual to-go sales as more guests returned to dine-in. Comparable store retail sales increased 9.7% compared to the third quarter of the prior year, driven by toys, décor, and food convenience offerings. Apparel, which was one of the harder-hit merchandise categories during the pandemic, has now returned to its pre-COVID level, and we believe there is further growth in this category as dine-in traffic returns. Moving to expenses, total cost of goods sold in the quarter was 31.6% of total revenue versus 28.8% in the prior year quarter. Restaurant cost of goods sold was 27.8% of restaurant sales versus 24.3% in the prior year quarter. This 350 basis-point increase was primarily driven by commodity inflation, which was up 18%, combined with elevated freight costs running ahead of our pricing. We experienced higher-than-anticipated inflation across all protein categories, as well as fruits and vegetables. Retail cost of goods sold was 46.9% of retail sales versus 46.5% in the prior year quarter, primarily driven by higher freight costs. Third quarter labor and related expenses were 35.9% of revenue versus 35.1% in the prior year quarter, primarily driven by wage inflation and increased staffing at both managerial and hourly levels. Finally, adjusted other operating expenses were 23.1% of revenue, the same as in the prior year quarter. This culminated in GAAP operating income of $30.5 million. Adjusted for the noncash amortization of the asset recognized from the gains on the sale and leaseback transactions, adjusted operating income for the quarter was $33.6 million or 4.3% of revenue. Net interest expense for the quarter was $2.2 million compared to $9.6 million in the prior year quarter. This decrease is due to lower debt levels, as well as a lower weighted average interest rate due to the convertible debt offering we completed in the fourth quarter of fiscal 2021. Our effective tax rate for the third quarter was 2.7%, driven by increased tax credits on lower-than-expected earnings. Third quarter GAAP earnings per diluted share were $1.19, and adjusted earnings per diluted share were $1.29. In the third quarter, EBITDA was $59.6 million, a 28.1% decrease compared to our prior year third quarter EBITDA results. Turning to capital allocation and our balance sheet, we remain committed to a balanced approach. Our first priority is investing in the growth of Cracker Barrel and Maple Street. Beyond that, we plan to return capital to our shareholders while maintaining appropriate flexibility and a conservative balance sheet. In the third quarter, we invested $29 million in capital expenditures, a significant step-up from the approximately $15 million per quarter in the first half of the year, due to higher maintenance capital spending, which has been below normal over multiple quarters, as well as increased spending on new unit growth. Additionally, we returned $69.5 million to shareholders in the third quarter through a combination of dividends and share repurchases, bringing our year-to-date total to more than $158 million. Today's $1.30 quarterly dividend declaration and new $200 million share repurchase authorization reflects our Board's commitment to returning capital to shareholders while investing prudently in our business. Lastly, we ended the quarter with $373 million in total debt, compared to $615 million at the prior year quarter end. While we are increasing our share repurchase authorization, we will maintain a conservative approach to managing our balance sheet. Sandy and Jen are going to speak to many of the initiatives that we believe are positioning us for near-term and longer-term success. But as we look to our fourth quarter financial expectations, we anticipate the near-term pressures we faced on both our top and bottom lines in the third quarter to persist. Clearly, we plan to offset some of our cost pressures over the remainder of the calendar year. While we've seen some guests managing check, our plan is to take price increases in a staged and thoughtful manner. We will take an increase in late June, followed by another in early August. Together, these will support an approximately 7% total combined year-over-year pricing through the end of the calendar year. We will continue to monitor the consumer and inflationary environment and maintain the flexibility to take additional pricing if we believe it will be prudent to do so. As Sandy mentioned, at the outset of the quarter, we saw improving sales trends before a spike in gas prices and inflation resulted in increased consumer uncertainty and a decline in our traffic recovery. We expect the current traffic trends to continue through the end of our fiscal year. We anticipate this, coupled with our pricing plans, will result in fourth quarter total revenue of approximately 8% above the fourth quarter of 2021. We expect fourth quarter commodity inflation of 16% to 18%, and wage inflation of 8% to 10%. While this level of inflation is more moderate compared to the third quarter, it is higher than we previously anticipated and represents a margin headwind. Furthermore, versus the prior year fourth quarter, we expect additional inflation in other areas of the P&L, most notably, utilities and off-premise supplies, higher expenses for manager and hourly staffing and training, and investments in technology and in Maple Street infrastructure. Taking all of this into account, we expect fourth quarter operating margin to be in the range of 4% to 4.5% of total revenue. Lastly, as we continue to work on our business model, we are very focused on identifying and pursuing sustainable opportunities to improve margin and long-term profitability. Savings from our new food cost management system are already providing a modest offset to commodities inflation, and early results from our labor management system tests have been promising. We believe the labor system, coupled with continued enhancements in our digital infrastructure, will drive improved productivity and more cost-effective wage administration, beginning in the later part of fiscal 2023. And as we continue to navigate this high inflation environment, we are implementing both short-term and sustainable long-term cost-saving options across our food and beverage, equipment, and supplies categories. With that, I'll hand it back to Sandy.

Thanks, Craig. Despite the challenges of the third quarter, many of which are likely to continue to one degree or another for the balance of our fiscal year, we're actively pursuing strategies and initiatives that I believe position us well both for the near and longer term. Obviously, there are business model and cost-saving actions that Craig referenced. And from a revenue perspective, in addition to pricing, we have numerous initiatives to drive check, position the brand to drive increased visitations and attract a broader audience of guests while continuing our retail performance and our thoughtful expansion of Maple Street. I'll run through some of what we're doing and then ask our Chief Marketing Officer, Jen Tate, to provide additional details about how we're driving check and positioning the brand more generally. The first place we're focused is store-level execution. We believe that the best way to preserve our reputation for strong value in an environment where we're taking additional pricing is through operational excellence and enhanced hospitality and service. Consequently, our biggest initiative is to focus on our operations and make sure that every guest who visits us has an experience that we can be proud of and will continue to give us high marks for value. This focus should pay dividends for us, and we're seeing excellent recent guest experience scores, including notably on Mother's Day, which is traditionally one of our highest volume days of the year. Building on this momentum, we're investing resources to ensure that our managers and hourly employees have ample support and the development they need to care for our guests like family. For example, we recently rolled out an in-person training and development program focused on operational excellence, hospitality, and service to all of our district managers across the country. Of course, great operations begin with ensuring that we're adequately staffed. Our talent acquisition teams remain focused on making sure we attract and retain employees around the country, particularly servers, and we continue to make solid progress in this regard. A number of our stores with meaningful staffing challenges are now essentially back to our historic norms, and we believe we should remain sufficiently staffed to handle continued recovery in guest traffic. As I noted in my opening comments, retail remains a strength for us, and our retail teams have done an incredible job keeping our stores filled with unique and nostalgic everyday merchandise that resonates with our guests. They've managed our supply chain extremely well, and we're able to avoid any significant disruptions to our retail floors. To protect our important holiday season and continue our strong retail performance, we proactively pushed up some of our ordering timelines and will remain focused on supply chain management. Finally, we're focused on growing Maple Street, which just opened its 50th location and has continued to perform above our expectations, despite dealing with its own inflationary pressures. We remain very excited about this brand and are seeing it deliver on our investment thesis that the fast casual breakfast and lunch space is an attractive one. We've been focused on and have made great progress ensuring that we've got the right infrastructure in place to grow the brand, including honing the Maple Street real estate model, developing training and operational programs, and hiring key leadership. In this regard, I'm pleased to announce that we added John Maguire as President of Maple Street a few weeks ago. As many of you likely know, John has over 30 years of experience in the restaurant industry, including as Executive Vice President and Chief Operating Officer of Panera Bread, where he was a key leader in growing Panera to one of the most successful brands in the fast casual restaurant space. As I mentioned, driving check and positioning our brand for the long term to drive increased frequency and make ourselves even more appealing to a broader audience of guests are all strategic priorities for us, and I'm pleased about where we're headed in this regard. I've asked Jen Tate to provide you with more details and walk you through some of the initiatives that we're pursuing. Jen?

Thanks, Sandy. We are very excited about the potential we have to drive check, grow the brand with our core guests, and broaden our appeal. We recently concluded a six-month segmentation study that has given us a greater level of insight into key groups we can newly attract or from whom we can increase visitation. Through this study, we learned more about who these groups are, what they want from us, and how big a prize each group represents. Although we have a number of guests who are over 65 and have been slower to return to normal dine-in patterns, we believe they will eventually do so. That said, we are fortunate to have a multigenerational guest base; approximately 30% of our guest base are millennials between the ages of 25 and 44, many of whom also constitute core users of the brand. This group generally gives us very high marks for our food, value, and atmosphere. When we ask those who use us less frequently about the things that they wish we did better, many of these relate to technology, which we're actively addressing. Strategically speaking, we're pursuing initiatives where we lean into our strengths of strong value perception and delicious food to grow check and attract visits while also addressing our opportunities in technology and digital, including a new loyalty program. Some of these initiatives are shorter-term in nature, while others are longer-term, and we believe that the things we're doing should resonate both with our core guests as well as the other groups we’re trying to attract. Let's begin with what we're doing to enhance our strengths of value and food. Regarding value, we are focused on making sure that our guests feel like the price they are paying is a great deal in light of their entire experience. As Craig noted, we will continue to approach pricing aggressively but thoughtfully over the next six months. Given guest acceptance of the pricing we've taken thus far, we believe we can take the pricing Craig mentioned while still maintaining a high guest perception of value. Pricing is only one prong of a multipronged strategy that we are implementing to grow check through the end of the calendar year while still enhancing guest perception of value. The other prongs are menu-related where we will be introducing more shareable starters, alcoholic and non-alcoholic specialty beverages, and premium size and add-ons. We have many guests who are looking for an affordable treat for special indulgence, and we want to offer them the opportunity to select into a more premium experience if they so choose. At the same time, we will continue to offer dishes at compelling price points across all three dayparts to meet the needs of our more price-conscious guests. In addition to new menu items and limited-time offers to enhance check, we will be leaning into breakfast to increase the attractiveness and profitability of this daypart by launching the first phase of our breakfast menu evolution. Centered around menu consolidation and the launch of a build-your-own breakfast option, our enhanced breakfast menu will allow us to feature new craveable items in our marketing and make it easier for guests to navigate our menu and individualize their meals. It should also help us offer some of those premium items that I mentioned to build check while reducing the time it takes for our employees, particularly newer servers, to learn our menu and deliver a better guest experience. Finally, we are continuing to focus on our beer and wine program, which is broadly appealing to our key guest segments. We're making great progress towards our 2% dine-in mix target through enhanced selling, in-store marketing, and new seasonal offerings, and we'll be working to drive further awareness and growth in this category in the fourth quarter and beyond with marketing support. Longer term, we are developing and testing other drink concepts to further enhance our appeal to our guests and deliver the additional items they’re telling us they want. Those are the areas where we are leaning into our strengths. Now, let's talk about the things that guests want us to offer or to do better, whether they are guests we want to attract or from whom we want to increase visitation. As I said, many of these revolve around technology and digital, where they are looking for us to remove friction and offer a loyalty program. In April, we rolled out Mobile Pay, and later this quarter, we will be adding the convenience of Apple Pay and Google Pay. We're also continuing to enhance our digital store and revamping our app to streamline the ordering process, provide an even more personalized experience, and reduce remaining friction on mobile devices. With regard to loyalty, we believe this could be particularly impactful for our brand with our strong guest engagement, travel guest, and both restaurant and retail offerings, which will allow us to offer creative and unusually appealing rewards beyond just discounting. Given the investment here, we are approaching it prudently and thoughtfully, and we'll have more to share with you about this initiative in the future, but we're optimistic about its potential to drive frequency and check growth. Then, of course, we have our other initiatives to attract new guests and continue to grow our off-premise business, including most notably our virtual brands and our catering. Our virtual brands continue to generate growing sales, which we believe are incremental to our business, and catering is growing impressively in both the B2B and B2C spaces. Year-to-date, our catering sales are up more than 20% over the same period last year, and they are projected to continue on this trend line. As employees return to the office and companies use special occasions to gather remote workers together, and as more individuals allow us to be part of their personal celebrations and gatherings, we believe we are well positioned for growth. To communicate all that we're doing and ensure that our messages resonate, we continue to evolve our marketing by making it more personalized and taking more targeted approaches through digital and social channels. When combined with the loyalty program, we think we'll be especially well positioned to increase frequency from our core guests and attract new guests to Cracker Barrel. Summing it all up, we are very bullish that we have a brand that stretches across generations and that we have the ability to do what we do well, even better, and to offer enhancements that both our core and other key guest groups want. With that, I’ll turn it back over to Sandy.

Thanks, Jen. In the near term, we expect to navigate a uniquely challenging environment, including the sales headwinds I discussed and the cost pressures that Craig reviewed with you. Despite all this, for all the reasons Jen shared with you, I'm confident that our near- and long-term strategic plans, coupled with our unique brand and culture of hospitality, will aid our recovery, strengthen our business model, and position us to deliver long-term growth and returns for our shareholders. By enhancing the things that make Cracker Barrel one of the most differentiated and beloved brands in the industry and investing in technology to improve our appeal across our guest base, we're pursuing initiatives that we believe will make us a destination of choice for our guests and our employees for years to come. Of course, none of this would be possible without the extraordinary efforts of our more than 70,000 employees who dedicate themselves every day to serving our Cracker Barrel and Maple Street guests. It is a challenging environment right now from both the consumer and operational perspective, and our field leadership, store, and home office employees are doing a great job navigating these challenges while bringing to life our mission of pleasing people. I thank them for their efforts. And now, I'll turn the call over to the operator for questions.

Our first question will come from Jeff Farmer with Gordon Haskett. Please go ahead.

First question, just looking for essentially a high-level update on the business model. And what I mean by that is I'm curious where you stand right now in terms of your customer base local versus travel, so sort of the mix breakdown local versus travel? And then, what does that mix look like as you head into the summer driving season, how much larger does that travel mix get in the summer? And then, I have one additional follow-up after that.

Okay. Good morning, Jeff. It's not going to be an easy question to answer because we haven't done that research since the beginning of the pandemic. Historically, travel was particularly important to us in the second and the fourth quarter and then during the spring break period, but we surveyed guests and they self-identify their visits as a travel occasion or a local visit. With travel coming back, we believe that the guest is a bigger percentage than it was, certainly during the pandemic, but we don't think we have returned to normal at this point. In fact, we believe the spring break travel pattern was disrupted due to the issues that we talked about in the prepared remarks.

Okay. And then just one quick follow-up. So bigger picture, longer term as it relates to the operating margin performance of the business pre-COVID, I believe you're right at 9%, low 9% operating income margin. Obviously, it's fallen below that with sort of the COVID backdrop. And then as we moved into 2022, some pretty high levels of both wage and commodity rate inflation or commodity price inflation. But, not asking for sort of details here, but as you think about '23 and '24, how do you think about the margin, the operating income margin of the Cracker Barrel business, sort of moving forward? How close to 9% do you think you can get in the future or returning to that prior level, rather?

Thanks, Jeff. Good morning. This is Craig. I guess, here's what I think we can say now. We're talking about an elevated level of pricing. You talked about 7% going through the remainder of the calendar year. And then, Jen, you talked about additional kind of menu add-on and menu mix opportunities beyond that. That's a higher level than we've done historically, meaningfully higher, to bring the business model closer. We are meaningfully below where we started. So that will help. In addition to that, there is a fair bit of work around the supply chain side of the business and the menu side of the business regarding product changes, specification changes, and so on that will also be meaningful. We've talked over a longer period about things like our PCM food and PCM labor initiatives that are designed to improve productivity and reduce waste. So, there is a fair bit happening there. We believe we will be making progress assuming that inflation does what we think it's going to do, but that's been tricky. I don't have a firm answer as to when do we get back to pre-COVID levels. But if our assumptions play out, then we do think we'll be making meaningful progress.

Our next question comes from Alton Stump with Loop Capital. Please go ahead.

I just wanted to ask how you balance the need to increase pricing to offset inflation with the fact that consumers are also experiencing inflation. How do you maintain the value proposition that you are known for while implementing higher prices, which you mentioned is around 7%?

It's a great question, and it is something that we are spending a lot of time talking about. I'll let Jen maybe touch on how we are thinking about our strategy regarding pricing and check driving.

I think what we see is there really are more than one type of consumer out there right now. For sure, there is a consumer that is pulling back, both in terms of visits and in terms of managing how much they spend. For that group of consumers, we are committed to protecting our strong everyday value, right? We've got great value at breakfast, lunch, and dinner, affordable price points, and we are committed to protecting that and continuing to market that for those folks. On the other hand, we do see that there are a group of consumers who may be cutting back on some more luxury items, trips, or vacations. When they come to Cracker Barrel, they actually want to splurge a little bit. They want to treat and indulge. That is why we are adding some higher-priced, more premium entrees and add-on items so that they can indulge a little more. I think that will help to grow our check and assist the business model. So, we are making sure that we have the right pricing strategy for the various segments in our business.

And Jen, for a follow-up. I have a quick question before I return to the queue. Regarding the pricing front, the 7%, should I consider a greater emphasis on retail compared to the restaurant business for that 7% or will both segments be fairly comparable?

I'm not sure I understand the question. Are you saying, does the 7% include retail, or is the price increase in retail the same?

Yes, yes. That was my question. Sorry.

We look at those two decisions differently, and a lot about the retail has to do with whatever the mix is. But no, I would say, on a constant mix basis, retail prices are not increasing at that level.

Our next question comes from Todd Brooks with The Benchmark Company. Please go ahead.

Obviously, a difficult operating environment, and you talked about the headwinds on the call. I'm just wondering if you can lay out maybe some of the thinking behind the guidance for 8% revenue growth year-over-year, maybe talking to assumptions around that 65-plus customer, your assumptions on gas price pressures? And just how did you come up with that point estimate in what's a really tough environment to forecast in general?

Thank you, Todd. This is Craig. That's a great question. Regarding the 8%, there are several factors to consider. We have noticed some performance trends and have discussed a slowdown. Sandy mentioned the deceleration we observed around March, coinciding with the spike in gas prices in late February. These gas prices affect us both directly and indirectly, influencing overall inflation, consumer confidence, and our specific usage case as a company. This environment, along with other factors, has influenced our 65-plus demographic. The 8% estimate incorporates some of our recent trends and assumes a reasonable summer travel season, which starts around this time. There are many considerations behind that figure, but generally, it reflects macroeconomic elements we see in the near term, especially gas prices, the over 65 age group, and the potential impact of the summer travel season. Sandy, do you have anything to add?

No. I think to the question we got earlier about travel as a percentage of our business, we're building back. It is an important component of the fourth quarter. Although I think we're expecting some not as strong as pre-COVID, we do see some improvement from today. I think our teams are ready for guests to come back, and I think we are optimistic that they will.

That's helpful. Thank you, both. And then, my follow-up is, and Jen, you talked about better segmenting and knowing your customer segments more intimately with the work you've done over the past six months. Can you speak to maybe or identify a performance gap between, let's say, that millennial cohort and the 65-plus cohort? And then, any qualitative commentary you can give us on if there was a gap there, if it's closing at all as we're moving further away from the Omicron impact that we had at the start of the year? Thanks.

Yes. I think one of the things that was most interesting about the segmentation learnings was to find that if you look at the segments that are heavily millennial versus those that are more the 65-plus traditionalists, they have more in common in terms of the drivers and what they give us high marks for than you might imagine. For example, both groups share a genuine love for our food, the welcoming atmosphere, and for the quality of the food and the experience they have. The big thing that is very different is that millennials really have high expectations regarding technology and digital. That is why you hear me talking about things like the new app and the loyalty program. In terms of performance, we have seen that the 65-plus guest has been reluctant to return to the dining room at the same rate as our younger guests; our data suggests this is driven by a couple of things. One, they still have concerns about COVID. With this recent surge, all of our data suggests they're still reluctant to socialize in public places and particularly dining out. Additionally, the recent economic concerns have caused them to be more pessimistic than younger generations. Therefore, they are worried about their financial future and spending less. We are definitely seeing a bigger pullback from a traffic perspective from those 65-plus. I would say we have every hope that they will return as COVID hits the rearview mirror and hopefully, as these inflationary pressures wane.

Our next question comes from Jake Bartlett with Truist. Please go ahead.

This is actually Jack on for Jake. Thanks for taking the questions. My first one, I just wanted to ask about G&A. You mentioned some incremental investments in technology and in the Maple Street infrastructure. Does that imply a step-up in G&A in the fourth quarter? And then, I guess, what do you expect for G&A going forward into fiscal year '23?

I don’t think we want to go into too much detail on G&A right now. There are some short-term factors as we normalize, but when it comes to the long-term view of G&A, I don’t think we will discuss that today.

Okay. That's fair. And then, I guess, my second question is on the food cost management system that I think you've finished implementing in April. Would you be able to quantify what maybe the benefit of that will be in the fourth quarter? And then, I guess, will that benefit increase into next year as you have more learnings with the system?

Yes, Jack. This is Craig again. We have tested the food cost management system and feel confident about its capabilities. We see it as a modest improvement that offers several benefits, but the actual reduction in costs is minor and has been factored into our projections.

Our next question will come from Brett Levy with MKM Partners. Please go ahead.

I guess, just two separate ones. First is just building off of Jack's last question there. When you think about your initiatives, what do you see as things that you can either delay or push back a little bit? What do you think is absolutely necessary right now? And where are you seeing the great quantification of any level of improvement? And then, just the second question. Can you give a little bit more color in terms of how you're thinking about your commodity landscape and where you're locked, where you feel there's the best upside risk in terms of what you could see for your basket? Thanks.

I can start, and then I’ll let Craig or Jen add their thoughts. Regarding our initiatives, Jen has done well outlining them. However, the most pressing initiatives focus on driving our revenue. These include menu initiatives aimed at enhancing appeal to our core customers and improving both engagement and frequency, as well as leveraging our technology to benefit our guests and increase productivity for our cashiers, resulting in a dual advantage. The initiatives that contribute to overall revenue growth for all our guest segments are of the highest priority. This includes our loyalty program, all technology and menu programs, as well as improving operational guest experience, hospitality, staffing, and training, which are all reflected in our financials. This is especially crucial in today's inflationary environment and amidst cost pressures as we strive to return to pre-COVID profitability and improve our current position. Next are the initiatives that enhance productivity and profitability in our stores. Craig mentioned one, the food system, which leads to slight improvements in waste management and aids our managers in better handling food production and inventory. As we become more adept at utilizing this system, we hope to incorporate additional features to optimize ordering and production efficiency, especially given our complex menu. Additionally, we’ve recently introduced our labor system to a district and are hopeful it will better equip our teams to align labor with the various business channels, including dine-in, off-premise, delivery, third-party, catering, and retail, particularly post-COVID with the growth of off-premise services. This new system should enhance our ability to match labor, which I believe will improve sales and increase efficiency, ultimately saving labor costs. Furthermore, regarding cost savings, this applies to various areas in our financials. We've faced challenges with off-premise supplies over the past two years due to inflation and shortages, but I am optimistic that we can soon implement some of our proposed strategies. Craig, do you have anything to add, or Jen?

The other part of the question there. I think that sums it up well, Sandy, in terms of what we should delay, and it’s really focused on driving the top line. Many of the technology initiatives deliver basically more for less, right? These are just really good investments. In terms of commodities, I think was the second part of your question. At this point, we're effectively locked. We're either locked or we have visibility to the pricing. I don’t think there is a whole lot more there for this fiscal year. For next fiscal year, the thinking is we have essentially hit peak inflation at about this point in this calendar year, and the inflation will remain significantly elevated. However, as we start to compare to the higher numbers from last year, the rate of increase will come down. That is the working assumption right now, but as we've all experienced over the last two years, this has been a tough one to pin down; we’re not anticipating any sharp retrenchment of commodities where we go back a couple of years. We're projecting that the rate of increase remains high and begins to moderate in the second half of the calendar year, and work its way down beyond that.

Our next question will come from Sara Senatore with Bank of America. Please go ahead.

I have a few follow-up questions. First, regarding pricing, do you have any insights on the net effect of price changes? You mentioned some trading down, but it seems like that's not completely balancing out the price increases. Any information on this would help as I consider forecasting check and traffic. Secondly, I want to understand more about your comments on the different customer segments. For instance, retail appears to be performing better than restaurant comparisons and has accelerated compared to 2019 in the most recent quarter. I would have expected retail and restaurants to have similar customer bases, perhaps with more pressure on checks due to inflation concerns. How can I reconcile the stronger demand and growth in retail with the situation in restaurants?

There's a lot to discuss. Let me address the retail aspect first. Our retail business has excelled, primarily due to our merchants offering fun, unique, and nostalgic merchandise at competitive prices that promote impulse buys. I believe our retail sales have acted as an ‘add-on’ for us. While some businesses may focus on selling desserts, our guests seem to utilize our retail store for that purpose; it serves as an affordable indulgence. For instance, toys are one of our top categories, featuring engaging items that appeal to families. When guests visit with their children, it creates an enjoyable experience at a reasonable price. This positioning of our retail shop, along with the efforts of our merchants and retail teams, contributes to our sales strength. Additionally, it aligns with guests seeking affordable luxuries. If there's a trend of trading down, it raises the question of how to approach that situation.

Absolutely. Hi, Sara, it's Craig. So, as it relates to the price and flow-through, I'll give some texture on this. We've been using a test-and-learn approach on pricing, and we're seeing really good flow-through in that kind of test and control environment. So, we are expecting pretty high flow-through. Normally in pricing, you lose a few kind of basis points to things like new credit card fees. There are also indirect impacts from tips; for example, tips go up and FICA taxes go up as a result. I would expect pretty high flow-through, and that’s consistent with what we've been seeing using our test and learn approach.

Our next question comes from Brian Mullan with Deutsche Bank. Please go ahead.

Just a question on capital return. As you contemplate the share repurchases you were doing and might do going forward with the new authorization. How are you thinking about stabilized EBITDA or stabilized operating margins in your internal underwriting? Maybe asked another way, when you think about that use of capital and determine it's the right use of capital from a returns perspective, could you just take us through what parameters or framework you are thinking about and analyzing?

Hi Brian, this is Craig. I'll take that one. We are thinking about that as we continue to remain balanced and cautious regarding our leverage ratio. So, the Board increased its authorization, but we're still continuing to monitor the environment. We have forecast that goes against that. Our long-term approach has been to first, fund the investments that we need to sustain and grow the business, and then return capital to shareholders. We're doing all of that in context of what's the risk profile of the external environment and our internal environment. So, I think our balanced and conservative approach will continue.

Our next question comes from Jon Tower of Citi. Please go ahead.

Just a few for me, if I may. First, a clarification in terms of the breakdown of price traffic mix in the quarter at the restaurants, and then actual questions after that.

So, Jon, we have been really focused more on talking about sales, so I'm not going to get much deeper than that at this time.

Okay. Going to the inventories, it looked like they were higher seasonally this quarter, at least at quarter end than you normally have been in the past. I'm curious if that goes back to Sandy, your commentary earlier about building well ahead of holidays and securing some supply there, or is there anything else going on with respect to inventory levels?

No, I think you're right. Our teams are being careful to manage supply chain disruptions, especially for our important holiday merchandise. We've brought in our harvest for Halloween and Christmas early to ensure we have everything we need, which is why you see the increased inventory. Additionally, there's been a rise in inventory to support sales from the same time last year, as we actually wished we had more inventory last year. Our teams are thoughtfully managing inventory levels, anticipating consumer behavior without overextending.

Got it. And that kind of leads to the next question with respect to the retail side of the business. We've seen in the past several weeks and then again this morning, a fairly large reminder that some of the retailers are having a hard time managing their inventories and have decided to go after some markdowns. I'm curious to know how your business has performed in the past when other large retailers have moved toward increasing discounting.

Yes. No one operates outside the broader context of the retail environment, which is a concern. When the market becomes highly promotional, we recognize that we will be competing against that. Our customers primarily purchase impulse items. The merchandise we offer is typically unique and relatively low-priced, which we believe provides some protection against those circumstances. However, the recent announcements we have seen prompted our retail teams to revisit our strategies to ensure that we are as well-prepared as possible to manage our retail business in this new environment.

Got it. And then, just the last one for me, thinking about your messaging to consumers in this environment. I know historically, the brand hasn't really leaned on call to action or limited-time offers in the marketplace. But I'm curious to know if perhaps you guys are reconsidering that now or might pulse it, given the macro backdrop that a lot of your core customers are facing at the moment?

I'll let Jen take that one.

Yes. I think you will not see us turn to a lot of couponing and discounting, as that's never been part of who our brand is. We will continue to advertise and market our everyday great prices that we have on our menu. So, you're going to see us continue to do that. We do sometimes do and have planned some food and beverage limited-time offers, and we will be advertising some of that coming up in the late summer and fall on television, but it's not a deep discount or promotional construct. As I mentioned earlier, we are maintaining ongoing consistent pressure behind our everyday value price points and incorporating newsworthy flavor offerings that we feature in our advertising.

This concludes our question-and-answer session. I would now like to turn the conference back over to Sandy Cochran for any closing remarks.

Thank you. Well, there's still a great deal of uncertainty in the near-term consumer and inflationary environment, but as we continue to navigate these pressures, we look to the future and are confident that the strategic plans we outlined for you today, both those to drive further sales recovery and those that will strengthen our business model, are the right plans and will position us well over the long term. We appreciate you joining today's call and look forward to speaking with you again soon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.