Anthony Hull, the CFO of Carrols Restaurant Group, received a phone call on New Year’s Day from Alex Sloane, one of the Burger King franchisee’s directors. Hull’s boss, Carrols CEO Paulo Pena, died the night before.
The death was a shock. Pena had become the CEO eight months earlier. He was just 50 years old and seemed fine. Now, the company was dealing with the loss of the second major company executive in four years, following the 2019 death of longtime CFO Paul Flanders.
And it couldn’t have come at a worse time for the business. Carrols under Pena was at the outset of a turnaround strategy. The 1,000-unit franchisee had been battered by the pandemic, a failed chicken sandwich introduction and brutal inflation, coupled with an overly aggressive discounting strategy that sapped much of its earnings and led to significant questions about its future. Now the company had to start all over.
“It was just a complete shock,” Hull said. “And how can this happen? Especially after we’d been through the pandemic, and we’re going through inflation, and then we’re just at the tail end of this inflation issue. Everything was kind of going in a good direction. And it was just completely devastating.”
But Carrols by that point had become accustomed to overcoming challenges and obstacles. And in the months since then, the operator has completed one of the industry’s most impressive turnarounds. It improved operations, generated surprising sales and traffic growth and walked back from the precipice of a financial disaster. The company has improved margins, tripled its earnings and has been the top-performing restaurant company on Wall Street.
In the process, it shows how a focus on the basics, and a supportive franchisor, can make all the difference.
Emerging questions
Carrols is one of the oldest franchisees in the country. The company was formed in Syracuse, N.Y., in 1960, when Herbert Slotnick was given the rights to operate Carrols Drive-In Restaurants in New York. The company grew to more than 150 locations by the mid-1970s, when it agreed to convert those restaurants into Burger Kings.
The company got into the brand operations game in the late 1990s when it acquired the Florida chain Pollo Tropical and then the Texas concept Taco Cabana. It spun the brands off in 2012 and devoted itself full-time to the business of operating Burger King restaurants. The franchisor in the process took a stake in the business, something it still has to this day. Two board members come from Burger King.
Carrols then set about to expand. Over the next seven years, the company acquired hundreds of restaurants, more than tripling in the process. Today, it operates about 1 out of 7 Burger King locations. It also operates 62 Popeyes locations, which the company acquired in a 2019 merger with another Burger King operator, Cambridge Franchise Holdings. It generates nearly $2 billion in annual sales and is one of the country’s largest franchisees.
Carrols is the only publicly traded franchisee in the U.S., which means its earnings are visible for the public. That can be a problem for the franchisor, especially when investors start questioning those finances.
Those questions grew in late 2019, when the company began taking steps to preserve cash flow. It slowed acquisitions after seven years of furious restaurant buying. And then it slowed remodels. The goal: Cut capital costs to improve cash flow and pay down debt. And all this came before the pandemic.
Hull joined the company late that year, not long after the death of Flanders, who had been CFO since the late 1990s.
Hull had been the CFO of the real estate franchise Realogy. Hull took that job shortly before the company was taken private by the private equity group Apollo, which was followed shortly by the real estate crash and the Great Recession. “I learned a lot of things about how to help with capital structure when you’re under a lot of stress because, you know, your EBITDA is $600 million and your interest expense is $800 million,” he said, referring to earnings before interest, taxes, depreciation and amortization.
He would get another such lesson at Carrols because the pandemic hit three months after his arrival.
The problem with Burger King
The difficulty with operating a franchise is you’re only in so much control. Much of Carrols' success was dependent upon its franchisor, in this case, Burger King. And Burger King had some issues.
The fast-food burger chain has long looked up to its rival McDonald’s, which now generates well over twice the average unit volumes despite similar real estate strategies. The company had shown some life in the years after 3G Capital acquired the firm, but by 2018 the company had started relying too heavily on discounting.
The company relied on deals to bring customers in the door. And costs were increasing, too. All that, coupled with Carrols’ heavy debt load, left the company with little cash. “When I first started, I didn’t realize how little liquidity we had,” Hull said. “So I vowed that day, that’s never going to happen to this company again, so long as I’m here.”
And then the pandemic hammered the company’s sales after dining rooms were closed. But the company quickly figured out delivery and drive-thru sales returned. Carrols optimized costs and closed some underperforming restaurants. “By the end of the year we actually hit our budget,” Hull said. Indeed, he added that the pandemic helped the company withstand the financial challenges it was about to face.
Burger King struggled in 2021. The company that year introduced the Ch’King, placing much of its effort into a product it felt would be a major competitor in the chicken sandwich wars.
But there was a problem. “You had 42 steps in order to make that thing,” said Joe Hoffman, Carrols chief restaurant officer. “I remember them showing me that the first time … and thinking, ‘Who do they think is in their kitchens? And execute that perfectly It was very, very hard, in my opinion. Next to impossible.”
The difficulty in making the sandwich slowed service and frequently angered customers. Sales declined the quarter the product was offered. Complex new products should generate more sales, to make it worth the effort. The decline would prove to be a disaster.
And Burger King quickly shifted back to discounts, even though consumers weren’t buying on a deal at the time. At one point, 20% of Carrols' sales were discounted. “They were very risk averse,” Hull said. “They didn’t want to threaten their traffic by reducing discounting.”
All that came to a head by late 2021 and into 2022, when inflation took off as consumer spending soared more quickly than people were ready to rejoin the workforce, leading to soaring costs for both food and labor. Weak revenues and high costs and a lot of debt are a bad combination.
In the first quarter of 2022, for instance, the company’s ratio of EBITDA to revenues was just 1%. Credit rating agencies downgraded the ratings of the company’s bonds. Carrols’ stock, which was trading at over $10 a share before the pandemic and $6 per share in 2021, had fallen below $2.
Other large-scale franchisees in the system also had their bonds downgraded, and by this year multiple franchisees would file for bankruptcy. Hull, for his part, said that was never a danger because Carrols had favorable terms on its debt deals. “The only question was, if the EBITDA went too low, and when our covenants started getting measured, we’d have to go back to the banks and have a discussion about a waiver,” he said. “We never got there, but we were running a lot of scenarios in case we had to.”
The tragedy
Meanwhile, both Burger King and Carrols went through an overhaul of their executive teams. Burger King named Tom Curtis, a former Domino’s operations executive, to head the brand in North America. Then parent company Restaurant Brands International in 2022 named Patrick Doyle, the former Domino’s CEO, to be the executive chairman. And Josh Kobza took over as RBI’s CEO. Their primary task: Turn around Burger King in the U.S.
The company revealed a $400 million plan last year, called “Reclaim the Flame,” to revive the chain.
Carrols went through an upheaval of its own. In 2021, Dan Accordino, who had been CEO since 2012 and an executive with the company for 50 years, announced his retirement. He was replaced the next year by Paulo Pena, who was notable for his career overseeing McDonald’s corporate locations.
Pena came into the job intent on fixing Carrols’ finances and improving operations in the restaurants. But he would also represent a major change for the company.
“He did make us look at our business differently,” Hoffman said. “We had Dan for 50 years, and did a lot of things exactly the same way.”
The company had started to see some progress. Inflation was starting to ease. And those profit margins that were so low early in the year had started to come back. And then on New Year’s Eve Pena passed away. “It wasn’t something you could believe because he didn’t appear ill or anything like that,” Hoffman said. “It was like, ‘boy, we got to start all over.’”
Hull led the company as an interim CEO. But Carrols didn’t go far to find a permanent replacement. It instead tapped Deborah Derby to take the helm.
Derby was an attorney whose career evolved into what she describes as a “jack of all trades.” She worked for years with Whirlpool Corp. and then Toys R Us for more than a decade and was later president of a crafts wholesaler before settling into a role as a board member at various companies. She joined the Carrols board in 2018. And ultimately the board asked Derby if she wanted to become the permanent CEO.
“I got to meet the senior leadership team and thought they were a really good group of people,” Derby said. “These guys just plug away and don’t give up. So I hold them in a lot of regard.”
She had no quick-service experience, however, outside of her role on the board. So she leans on Hoffman, who oversees operations and has been with the company since the early 1990s, one of many long-term employees with the operator. And operations would be key to the company’s turnaround.
The turnaround
So what did Carrols do to fix things? Let’s start with the brand itself. Burger King stopped offering so many discounts. Carrols’ discounting percentage was cut nearly in half, from 20% to 11% to 12%. There was no serious impact on traffic, as customers weren’t focused on discounts, at least not yet.
The brand itself started focusing more on operations. Under Curtis, Burger King axed the Ch’King, much to the delight of many of the chain’s franchisees. “The first time I ever met Tom Curtis, he asked me what should be done,” Hoffman said. “And I said, ‘You should eliminate the Ch’King immediately.’”
To the franchisee, that was also indicative of the brand’s shift under current leadership. “The huge difference is they listened,” Hoffman said. “They don’t always act immediately. But they hear what you’re saying.”
One example of the difference was the Royal Crispy Wraps introduced earlier this year that helped generate strong sales at Carrols’ Burger King locations. “They were taking a sandwich that already exists and we’re basically chopping it up and putting it into a wrap,” Derby told investors. It generated sales without gumming up operations.
The company itself also improved operations in other ways, by reducing the number of metrics the brand uses to measure its franchisees. It uses just a few metrics, such as customer ratings and speed of service. Hoffman himself acknowledges that Carrols in the past hadn’t done a good job of “serving customers with a smile.”
“We struggled with that,” he said.
Indeed, Curtis himself told Carrols executives that he thought the brand was an “average” operator. That came as a shock to Carrols, which had long been considered one of the brand’s top operators, given that its sales generally outperformed the system. The leadership team at the company used that as incentive, while joking with Hoffman by periodically calling him “Average Joe.”
The simplified metrics, however, enabled the operator to focus more on those elements that matter, particularly the courteous service. The company now says it is close to being considered an “A” level operator by the brand, the top score in the system. “I am still excited about it,” Hoffman said. “I’m positive we’ll get there.”
At the same time, the brand itself has pumped millions into advertising and remodels, all of which have helped improve sales and profits.
Burger King’s same-store sales have improved. At Carrols, they rose 8.1% last quarter. But traffic turned positive—earlier than the company expected—while margins improved by 530 basis points. The company itself expects to generate $140 million in EBITDA this year, nearly triple what it did in 2022. Its bonds have been upgraded.
It has also been the best-performing stock in the restaurant industry in 2023, up some 400%.
To Derby, everything came together. “There was a perfect storm,” she said. “Coming down from discounting 20% to 10% goes straight to the bottom line. Raising prices with inflation goes straight to the bottom line. And then all the operational improvements, which led to improvements in traffic and service, it’s all coming together. We had all those things superimposed with marketing and advertising from Burger King, all coming together at the same time.”
So what now?
Carrols is not looking at expansion, certainly not at the moment. The company may look at some small acquisitions if they come along, but for the “short-term” it has plenty of organic growth. It also has remodels to work on, which on their own should build sales as refreshed units tend to attract more customers.
And for all of Carrols’ improvements in the eyes of Wall Street, the company doesn’t believe it gets nearly enough credit. The operator had gone through as much as any company in the industry over the past few years and came out of it all clean and on the upswing, with expanding margins and the ability to pay off its debt without refinancing. And yet it trades at a relatively modest valuation multiple of just over 5 times EBITDA.
“It’s frustrating that investors don’t really understand that at this point, but they’ll get there,” Hull said.