Carrols Restaurant Group Inc (TAST) 2020 Q3 法說會逐字稿

Good morning. Welcome to the Carrols Restaurant Group, Inc. Third Quarter 2020 Earnings Conference Call. (Operator Instructions)

I would like to remind everyone that this conference is -- call is being recorded today, Thursday, November 5, 2020, at 8:30 a.m. Eastern Time and will be available for replay.

I would now like to turn the conference over to Tony Hull, Chief Financial Officer. Please go ahead, sir.

Thank you, Jerry, and good morning, everyone. By now, you should have access to our earnings announcement released earlier this morning and an earnings review 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 will include forward-looking statements, which may consist of comments regarding our strategies, intentions or plans. These statements are not guarantees of future performance and therefore, undue reliance should not be placed upon them. We also refer you to our filings with the SEC for more details, especially the risks that could impact our business and results, including 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 isolations -- or 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?

Thanks, Tony, and good morning, everyone. I want to begin by expressing my appreciation to the entire Carrols' team, whether they are in our restaurants, serving our customers while adhering to our strict safety and sanitation protocols, in the field overseeing operations and our support center or even remotely, helping our restaurants succeed. They are persevering and working very hard in the midst of this pandemic and enabling us to put our best foot forward.

As I said last quarter, but it bears repeating today, we have done an exceptional job pivoting operations, and those adjustments have positively impacted our financial performance.

Now let me provide a brief synopsis of the current state of our business. Number one, we were pleased to have increased comparable restaurant sales at both Burger King and Popeyes during the third quarter and improved our profitability as measured by our adjusted restaurant-level EBITDA, adjusted EBITDA and net income compared to the year ago period. Secondly, we generated $23 million of free cash flow during the third quarter, bringing free cash flow generation to $47 million year-to-date in 2020. Our liquidity position was already ample at the end of the second quarter at over $180 million, has improved since then with current available liquidity of nearly $205 million. And thirdly, we are in the process of negotiating and revising our Area Development Agreement with our franchisor, Burger King Corporation.

At a high level, we expect the requirements under the previous agreement relating to new restaurant development, and restaurant remodeling provisions will be significantly modified. After considering restaurant development and remodeling as well as other system-wide upgrades and initiatives, we remain committed to what we said last quarter in terms of annual CapEx spending of $40 million to $50 million over the next 3 years. At this level of spend, we believe we should be able to continue generating positive free cash flow for the foreseeable future.

Now let's discuss each of these points in some greater detail. Our service model is based upon convenience given our limited and no-contact channels, such as drive-through, at-the-counter takeout and recently implemented delivery business, where, in aggregate, we generated approximately 99% of our sales last quarter. We believe these attributes have positioned us well to navigate COVID since all of these channels have proven to be resilient sales platforms. We did, however, increase the number of our dining rooms open to 35% in the third quarter, which was up from 20% in the second quarter.

We have also benefited from having a geographically diverse restaurant portfolio of more than 1,000 restaurants across 23 states. This is because the shifting impact of the pandemic has provided us somewhat of a cushion as short-term staffing or supply issues have been thankfully limited to only a few restaurants at any one time. From a regional perspective, we are performing relatively better in the Northeast, but worse in the South Central region. And Tony will discuss how we are faring by region in more specific terms.

For the full quarter, comparable restaurant sales for our Burger King Restaurants increased 0.8% against a tough 4.5% comparison from last year. This marked an impressive turnaround from the second quarter when comp sales fell 6.4%. However, it is clear that our trends softened as we move through the third quarter and into October. We attribute this to several factors.

Number one, first, we believe that customers exhausting their stimulus checks and constrained in their spending due to a weakening Main Street economy had a negative impact on sales in the latter part of the third quarter into October. Second, we think increased competitive pressures within the fast food segment during the third quarter affected our market share, including heightened promotional activity and discounting. Third, over the past 2 weeks, the increase in COVID cases, along with related renewed dining restrictions in many states, is likely to have at least temporarily dampened consumer demand. And lastly, we lapped the introduction of the Impossible Whopper last year, which made comparisons more onerous beginning in August. Impossible orders were averaging 50 per restaurant per day upon launch and are now less than half of that.

Delivery comprised approximately 3% of total Burger King restaurant sales during the third quarter with an average order size of $17. This was approximately twice the overall average order size during the third quarter of 2020. We have partnered with 4 leading service providers: DoorDash, Uber Eats, Postmates and Grubhub, who are now providing fully integrated delivery services at approximately 870 of our Burger King Restaurants, up from 800 at the end of the second quarter. Looking ahead, we believe more of our Burger King Restaurants could provide a delivery option as providers begin servicing their markets in a meaningful way.

Comparable restaurant sales at Popeyes increased 5.5% versus a 5.8% increase last year. We view this outcome positively as we had not expected to see this level of resiliency given that we lapped the chicken sandwich launched from last August.

Turning now to restaurant level and corporate expense management. We certainly made great progress. This is reflected in lower food waste as we have adjusted our production requirements because of the shift away from breakfast to late night and even more so in labor, where we have incurred higher wage rates but have been able to modify labor hours based on day part sales trends.

Our current team size for Burger King restaurant averaged 20 employees during the third quarter, up from 19 in the second quarter. This increase was due to the normalization of certain labor elements depending on geography and local conditions related to expansion of hours. In the third quarter of last year, we averaged 23 employees.

Briefly on the Cambridge integration. We continue to see a meaningful sequential improvement in labor costs. Comparing the third quarter of 2019 to the third quarter of 2020, restaurant labor expense as a percentage of net sales of the Burger King Restaurants improved by about 250 basis points and at the Popeyes restaurants by 640 basis points. Certainly, some of this improvement relates to the current environment, but it also reflects the successful implementation of our labor scheduling process.

As it relates to cost of sales, we have made progress in managing these costs. We still have more systems integration work to complete, particularly at our Popeyes restaurants. In addition to favorable expense trends at the restaurant level, we've also benefited from reduced regional and corporate overhead by having streamlined our regional management structure earlier this year while improving our training process.

In total, we increased our adjusted restaurant-level EBITDA margin by 225 basis points and adjusted EBITDA margin by 200 basis points during the third quarter compared to the prior year period. These are both positive outcomes and in line with what we said during our second quarter call as we had not expected the more substantial margin gains that we had realized in the second quarter to repeat.

Year-to-date, we have opened 6 new restaurants with 2 additional locations to open by year-end. We have also permanently closed 19 underperforming restaurants. While we had earlier planned to close a total of 22 restaurants in 2020, we now expect to close approximately 35 to 37. So an additional 16 to 18 locations are expected to close by year-end. These restaurants were losing money in a post-COVID environment, and the closures will benefit our EBITDA next year.

Turning to our balance sheet and related metrics. We were already in a very strong position financially as we exited the second quarter and built upon that further during the third quarter. We ended the quarter with $67.8 million in cash and cash equivalents, up from $46 million at the end of the second quarter and $136.2 million under our revolving credit facility available for borrowing. We also believe we have a very manageable debt level of $496 million with no near-term maturities, and we have no outstanding borrowings under our revolving credit facility.

As you know, we have been committed to keeping our expenditures in check, which we said repeatedly throughout 2020 and continue to expect operational capital expenditures to total about $40 million this year, net of sale-leaseback proceeds. As I referenced earlier, we generated $23.3 million in free cash flow during the third quarter and $46.7 million through the first 3 quarters of the year. Recall that before the pandemic, we had targeted up to $25 million in free cash flow in 2020. So we've obviously surpassed that amount considerably.

Lastly, we are in the process of negotiating a revision to our Area Development Agreement with Burger King Corporation as it relates to our new restaurants and remodeling requirements. We anticipate that our proposed revised agreement will reduce the minimum new restaurant development requirements down to a total of 50 units over the next 5 years and removes annual remodel commitments that were part of the current agreement. We expect that we would also give up our right of first refusal that we believe has diminished in value in the current QSR business environment. We believe that this new arrangement when entered into will allow Carrols to ramp up its organic growth on a balanced basis. It should be noted that while we expect to enter into this new agreement, at this stage, the parties have agreed to a term sheet, and there is no assurance that such new arrangement will be entered into on such terms or at all.

As we committed to last quarter, we intend to spend $40 million to $50 million per year for capital expenditures over the next 3 years. Within that total amount, we intend to build 8 to 12 new restaurants per year beginning in 2021, with fewer being completed next year before accelerating thereafter. Given the time needed to identify real estate, secure permits and commence construction, a large portion of our newly constructed restaurants will be built using third-party capital to finance all but the equipment costs related to those new restaurants. We plan on remodeling 20 to 25 restaurants per year commencing in 2021 over a 3-year time frame.

We believe that the combination of our share of investment towards new restaurant development, along with remodeling, maintenance CapEx and other system-wide upgrades and initiatives such as upgrading our outdoor digital menu boards, our CapEx spend should remain within our committed amount per year through 2024.

As it relates to acquisitions, we are still holding off on these until our adjusted leverage ratio, as defined in our credit agreement, drops below 4x, which we expect to occur early next year. At that point, we will consider pursuing opportunistic bolt-on restaurant transactions as long as we remain below 4x leverage ratio target on a pro forma basis.

Given our size, capital structure and operational track record, we believe to be able to complete transactions -- we expect to be able to complete transactions without needing a ROFR.

To conclude, we believe our third quarter performance is demonstrative of our business strength through the pandemic and positions us well when eventually all of this is behind us. We are benefiting from our reliance on drive-through, carryout and delivery channels with only minimal reliance on our dining rooms, although we're aware that consumer spending has softened in the near term. We have improved our margins and increased our adjusted restaurant-level EBITDA and adjusted EBITDA. We have enhanced our liquidity. We are generating more free cash flow than we originally anticipated this year, even under pre-COVID conditions, and we are reaffirming our intention with respect to our CapEx spend outlook. This expected annual expenditure level of $40 million to $50 million will be sufficient to maintain the quality of our current portfolio of restaurants and grow our footprint longer term.

We believe we are positioned to execute on our stated goals and will soon be poised to step up our organic and nonorganic growth levers in a balanced way while keeping our leverage in check. Our game plan is to continue generating a significant and growing level of free cash flow, and we are confident in our ability to execute on that objective.

With that, let me turn the call over to Tony to review our financials.

Thanks, Dan. For the third quarter, restaurant revenue increased 2.2% to $407 million compared to the prior year period of $398.4 million. Our Burger King comparable restaurant sales increased 0.8% during the third quarter of 2020, outpacing the U.S. Burger King system by 400 basis points. While there are many factors that impacted these results, we are pleased with this performance, especially considering that we were lapping a robust year ago comparison of 4.5%.

Given the size of our Burger King portfolio of 1,000-plus restaurants and its dispersion across 23 states, we thought it might be useful to provide additional color on comparable sales by region. In the Northeast, representing 21% of our Burger King Restaurants, comparable sales were up 5.6%. In the Midwest, representing 28% of our Burger King Restaurants, comparable sales were flat. In the South Central region, representing 25% of our Burger King Restaurants and consisting mainly of Tennessee, comparable sales were lower by 4.5%. And finally, in our Southeast region, representing 26% of our Burger King Restaurants, comparable sales were up just over 1%.

Turning now to Popeyes, which represents less than 5% of our total revenues, comparable restaurant sales increased 5.5% against the 5.8% year ago comparison. We underperformed the overall system average in the latest quarter due to the availability of the chicken sandwich in many of our restaurants for most of the month of September of 2019, whereas the rest of the system lacked availability. In addition, our Popeyes restaurants are located in the brand's weakest region, the South Central.

Adjusted EBITDA increased $8.4 million in the quarter to $34.1 million from $25.7 million in the third quarter last year. Adjusted EBITDA margin increased 200 basis points to 8.4% of restaurant sales. Adjusted restaurant-level EBITDA increased $9.8 million to $52.8 million in the quarter from $43 million in the third quarter last year. Restaurant-level adjusted EBITDA margin was 13% of restaurant sales and increased 225 basis points compared to the prior year period. The improvement in margins was mainly due to lower labor costs and reduced operating expenses as a percentage of revenue.

Cost of sales was essentially flat as a percentage of net revenue compared to the year ago period. This was due primarily to less food waste, offset by higher ground beef prices, which averaged $2.32 per pound during the third quarter, an increase of 5.5% from the year ago period. Notably, cost of sales trends have continued into Q4 at approximately the same rate as Q3.

Restaurant labor expense decreased 160 basis points as a percentage of restaurant sales compared to the prior year period despite a 5.2% increase in the hourly wage rate at our legacy restaurants. The improvement is a reflection of the adjustments we have made to our labor requirements and hours based upon operating day part sales trends, along with reduced -- along with having reduced our costs across most restaurants that are not operating dining rooms.

To be clear, we were already back to normal operating hours of breakfast during the second quarter and saw some improvement in that day part. However, our late night hours are still less robust than they were prior to COVID. Even the restaurants that are operating 24 hours -- that were operating 24 hours pre-COVID are closing at midnight, and we do not expect this to change anytime soon.

While there are many factors outside of our control in managing labor, within what we can control, we have proven adept at making adjustments due to changes in revenue trajectories. Therefore, we do believe that restaurant labor as a percentage of sales should contribute to overall margin improvement in Q4 as it has in the previous 2 quarters. Restaurant rent increased 20 basis points as a percentage of sales compared to the prior year period, primarily due to the impact of leasing activity over the past 9 months. Other restaurant operating expenses decreased 50 basis points as a percentage of sales compared to the prior year period due to lower utility, repair, maintenance and other operating costs to benefit from dining room closures. Operating expenses in the third quarter included $900,000 in COVID-related supplies, including face masks, thermometers, sneeze guards and sanitizers.

General and administrative expenses were $20.4 million in the third quarter of 2020, which includes $2 million of higher bonus accrual due to the improved operation performance compared to last year. We expect this expense to remain at approximately the same amount in the fourth quarter.

The third quarter 2020 includes the impact of many corporate cost efficiency initiatives, such as streamlining our regional management structure and reengineering of the training process that were completed earlier this year. We expect these savings will carry over into 2021.

Our net income was $3.5 million in the third quarter of 2020 or $0.06 per diluted share. On an adjusted basis, excluding certain nonoperating items, third quarter adjusted net income was $5.7 million or $0.09 per diluted share. In the year ago period, we had a net loss of $6.8 million or $0.15 per diluted share.

As Dan said, free cash flow generation has been very strong over the past 2 quarters. As a result, our adjusted leverage ratio on our credit agreement stood at 4.06x at September 27 compared to 4.18x at the end of June of this year.

Having already paid down a revolver in the second quarter and suspended our share repurchase plan in the first quarter, we intend to continue building cash in the near term. This is because if we were to use cash to pay down our term loan, we would lose -- Term Loan B, we would lose capacity, and we do not want to reduce our access to capital in this uncertain environment.

As a reminder, we had previously withdrawn our 2020 earnings guidance, although in the course of our formal remarks, have provided some guidelines with respect to the balance of this year and beyond. Note that the 2020 fiscal year also has one additional operating week compared to 2019.

And with that, operator, let's go ahead and open the lines for questions.

(Operator Instructions)

The first question is from Jake Bartlett, Truist Securities.

My first is on the same-store sales trends, the October deceleration. My question is, what kind of levers do you have to reaccelerate that?

I believe compares get easier in November and December versus October of last year. But what kind of other sales drivers do you have such as maybe reopening dining rooms, maybe the impact of new outdoor menu boards, so maybe your level of confidence in the promotional calendar going forward?

Yes, Jake. This is Dan. We expect that the next couple of months of the fourth quarter, given the current marketing calendar with Burger King and the comparable sales from last year, will be more favorable than the October trend, that's for sure.

Got it. So would you describe your -- without kind of any details, but your confidence in the promotional calendar kind of accelerating versus what we've been seeing in the last month or 2?

I think you're going to see some enhanced activity over the next couple of months. And that will -- that in conjunction with the numbers that we're rolling against in last year give us confidence that November and December will have a better trend than October, yes.

Got it. And then my next question is just about unit growth and your commitment to developing, but also just the prospect of starting acquisitions. How do you look at unit growth versus acquisitions?

I think historically, you've relied much more on acquisitions. But do you think it should be more balanced going forward? What's your confidence that acquisitions can be a significant driver to unit growth in the next coming years?

Well, I'm not sure how significant it will be. There haven't been a lot of transactions in 2020 because of the whole COVID thing, I would assume. We would expect that the deal flow will increase in 2021. And as we indicated in our prepared remarks, we expect that our leverage will be below 4x, so that we'll be in a position to take advantage of those acquisition opportunities.

As far as the organic growth in -- and by the way, that is also -- that considers both Burger King and Popeyes. In terms of organic growth in 2021, because we really shut down our development in 2020, we've got to ramp that up again. So restaurants that will be -- we will be building in either brand will be in the latter part of 2021.

Next question is from James Rutherford, Stephens Inc.

I wanted to follow up on Jake's question on the decel in October. I guess another way to slice this is just asking how much of that deceleration do you think is some of the macro things you called out, be it COVID cases and the Main Street economy compared to the competitive dynamics that you also called out? And then I have a follow-up to that question, please.

It's difficult to determine how much the Main Street economy affected us. Certainly, we got a bit of an uptick when the stimulus checks happened. And obviously, as time went on, they ran out.

But as you well know, from your reporting, James, McDonald's and Wendy's both had pretty good Octobers.

Yes, certainly. And on the discounting, in particular, you mentioned some -- the calendar for BK in the back -- in the last couple of months here of the year, it does look like -- looked like you guys reintroduced a 2 for $5 promotion here in October. And it seems like promotional activity has been pretty aggressive at BK already. So I'm just curious if you're referring to incremental promotional activity or if it's more just getting the full benefit of that 2 for $5, which they came in mid October?

Both. I think that we will see for the -- in the fourth quarter, a continuation of the 2 for $5 and marketing tactics of that ilk. And then I think that there will be some modification to the value positioning in 2021.

Okay. That's helpful. And my final question is on the right of first refusal. And it does seem that in immediate environment, there's likely little use for that. But was your comment that the right of first refusal has diminishing value, was that given your own position and desire to focus on organic development in the near term? Or is that comment driven more around your view about growth prospects in the BK system more broadly?

The second, James. We haven't done a right of first refusal acquisition in some while, 18, 24 months. Deals that we have done have been deals that either the seller came to us or Burger King came to us and asked us to look into the opportunity that existed. So we haven't really relied on a right of first refusal, I'm going to say, for probably 24 to 36 months.

The next question is from Jeremy Hamblin, Craig-Hallum.

I wanted to just come back to the store development here and just ask about the 8 to 12 units that you mentioned in here for 2021, kind of slated more in the second half of the year. Would those be situations where you'd look for sale-leaseback opportunities? What are the type of capital outlays that you would expect at this point in time given where the Burger King concept is and the parent company playing with some redesigns of the kind of Burger King in the future?

The organic growth, Jeremy, will come from a combination of sale-leaseback opportunities, of which we've already identified several and some build-to-suit opportunities. There may be a couple that we do out of pocket. But for the most part, that's what they will be and therefore, the only cash outlay is the equipment.

Okay. And then just thinking about the uses of capital moving forward, you suspended your share repurchase plan, but at a kind of $50 million to $60 million free cash flow run rate kind of improved balance sheet, are you -- is that something where you and the Board would consider restarting that? I mean, from a free cash flow yield perspective, you're looking at like a mid-teens level with the stock at the current prices.

Yes. As we go through 2021, Jeremy, those are the kinds of things that we are continuing to evaluate. Right now, given what we consider to be a high level of COVID uncertainty and we're really not sure where the business is going to be from a reopening standpoint and that sort of thing, we're maintaining some dry powder, if you will. But from a cash -- from a capital allocation standpoint, all things are on the table as we go through 2021. And certainly, share repurchase would be one of the things that is on the table.

Great. And then the parent company has an initiative for the new digital menu board, outdoor digital menu boards to improve the drive-through experience and productivity. Can you give us a sense of what percentage of your existing units have those in place today and what your time frame would be? I know the parent company is looking to get that done over the next 2 years, but what your time line on expectation is, so the cost of each individual board, the percent that you currently have in place in your outlook on the time frame to complete that project?

We have about 150 in place by the end of this year. And next year, we'll do between 450 and 550 and will be complete by the first part of 2022. And they're about $20,000 to $24,000 each depending upon the layout and that sort of thing. That's embedded...

Jeremy, that's in the...

That's embedded in the $50 million.

Got it. What type of lift are you seeing from those?

Difficult to tell because of COVID, Jeremy. I mean, drive-throughs are, obviously, where most of the business, almost all the business is coming from. So if I look at putting in digital menu boards compared to nondigital menu boards, it's difficult at this point to determine. I will tell you, they're a heck of a lot nicer to look at. You can see them at night. They do a much better job in terms of marketing, but I don't know what the sales lift would be at this point.

Okay. And then last thing, I think, Tony, you mentioned -- I just missed it, but you gave some guidance around store unit closings for this year. What was that figure?

So the total will probably end up at about 35 to 37 closings this year, and -- which is -- we were earlier at about 20, 22. So we've obviously increased that amount sort of looking at the impact of COVID. And that will help EBITDA next year because those restaurants are losing money at this point.

(Operator Instructions)

We have a question from Brian Vaccaro, Raymond James.

I wanted to circle back just on the Burger King October comp trends. I'm curious if the decel you're seeing is outsized in the specific day part or region or any other dynamics worth highlighting beyond the ones you already did?

Well, regionally...

Go ahead, Tony.

Yes. Thanks, Dan. Regionally, it was -- the weakest was in the same -- sort of the same regions that we had weakness in the third quarter, the Tennessee, the South Central region. The Northeast was flat to slightly positive in October. So it's definitely carrying over the same -- where we see COVID spikes, there's a bit of a dip. And then sort of what we saw in miniature back in March and April, you see a bit of a dip and then recovery once guests have adjusted to the environment, whatever is being thrown at them. So I think it's a bit of a -- we're seeing sort of a miniature version of what we saw back in March and April.

But again, as Dan said, we have easier comps. And clearly, we're more focused at this point on next year where we think there's some significant number of growth opportunities, both organic and inorganic, that we can pursue given our capital structure. So we're excited about our prospects for next year.

Okay. That's helpful. And you mentioned the South Central region as your softer region. Is that a broader industry dynamic for the QSR segment? Or is there something competitive going on there or maybe something in terms of operations that are impacting those markets? Or is it mainly COVID?

No. It's a broader QSR -- and maybe all of restaurants. But I know certainly in the QSR area, that part of the country is responding at a lower level than what we're seeing elsewhere. And yes, we've checked market share and comps with other concepts, and it's -- that's the most difficult geography right at the moment.

Okay. Great. And then on the comp outlook, just thinking about the fourth quarter sales outlook for both brands. At Burger King, can you remind us of the monthly cadence that you saw last year, either in terms of comps or average weekly sales? Just to kind of help frame the year-on-year that you were talking about earlier.

I think we were down sort of low single digits. I'd have to check specifically. But my recollections, we're down low single digits in both November and December last year. I don't know, Dan, if you have any recollection other than that?

No, they were -- that -- yes, that -- I don't have the individual months with me. But yes, that's about right, Tony.

Okay. Okay. Maybe we can circle up on that. In terms of reopening dining rooms, can you talk about how that impacts sales and EBITDA in those units? And how many dining rooms you might plan on reopening in the fourth quarter?

Yes, dining room reopenings is a misnomer. All of our dining rooms are open for takeout. In terms of the dining rooms that are open where we have some tables where guests can sit, as we indicated in the prepared remarks, it's about 35%. But the utilization of those dining rooms is not terribly great at this point in time. It's primarily -- we have them open where you have some walk-up traffic in intercity environments or across some college campuses. And they're being used by construction workers, in some cases, to come in and get out of the heat rooms and use the air conditioning. It's not a meaningful component at this point at all, Brian. And the fact that we don't have any of the self-service drink bars open is actually a benefit to cost of sale.

Yes. Okay. That's helpful. And then shifting to store margins. I just wanted to ask about the food cost line. It seems like spot ground beef prices, obviously, were very high in Q2. It came down in Q3, but you've seen a more stable trend. Can you just help square that? Is that a contract that's in place for the system where you're insulated from the big spike, but also maybe not some of the improvement or more favorability that we've seen in recent months?

It's not contractual. It's just the spot market. It's heading towards $2 flat. And we've just seen a continual decline in beef costs over the last couple of quarters. So they obviously spiked in the beginning of the second quarter and then have come down to sort of the $2 level more recently, and we don't see anything -- we don't see any movement up or down from that level. We think that's pretty much going to be steady for the fourth quarter. But our crystal ball is no better than anyone else's. It's just the feedback we get from our food co-op and that sort of thing.

Okay. And just to clarify that, Tony. That's helpful. So you're in the low 2s? Are they quarter-to-date or...

We're at like $2 right now, flat, $2.01 or something.

Okay. So it's a nice improvement versus Q3. And what was your comment on fourth quarter COGS? Was that a COGS ratio guidance you were giving or...

Yes. As a percentage of sales, we expect it to be consistent with Q3.

And help me understand why would that be if ground beef is going to be down kind of the...

Well, promotional -- there's a lot of factors in there. There's promotional cost. There's other commodities, which actually have been up much more than beef, at least in third quarter. They could fluctuate. So there's a lot of -- there's a bunch of factors that go into that. There's rebates. We're using last (inaudible) so the rebates are lower, even though we benefit from less waste on the beverage side.

So there's a bunch of factors, but our look at the fourth quarter says it's going to be sort of the same ratio as it was in the fourth quarter versus third quarter.

Okay. Great. And then last one for me. Just on the unit growth and thinking about the unit economics on build-to-suits and utilizing third party financing. Can you just walk us through the high level, how you would think about it? You talked about the equipment. How much is the equipment investment? And just sort of the high level, what would be the AUV store margin kind of classic cash-on-cash return you'd be thinking about on those build-to-suits?

Well, the store margins are -- obviously, we're going to look for the highest -- we're only going to build where we think there's good return on the capital. The equipment costs are probably 10% to 15% of the overall cost to build, and that's what we have to invest in versus a third-party capital provider. So obviously, we're looking -- we're being very selective and opportunistic on what we build, and it's going to -- we're going to go forward based on the overall returns being in the low teens or higher for those restaurants on a cash-on-cash basis.

To answer your question, Brian, November was -- last year was negative 0.8% and December was flat. So as we said, Tony's comment was right on the money.

We have a follow-on from James Rutherford, Stephens Inc.

I just wanted to put together some of these comments around restaurant level margins going into the fourth quarter. You're slowly adding back headcount to the box. You're opening more dining rooms progressively, and it sounds like promotional activity will remain fairly heightened. So clearly, part of this depends on where you land in terms of your comp. But if we assume things stay maybe steady-ish compared to October or maybe slightly improve, kind of where do you think, Tony, those restaurant level margins might land relative to the 13% you just did here in the third quarter?

I think there'll be -- I think labor will be a little bit worse because we're adding -- we're attempting to add head count. From that -- we went from 19 employees per store per day to 20, and that will probably end up at 21, I'd say. That's our goal. We just -- it's not sustainable to have 20 folks per restaurant per day. It's a big stress on the system.

So I mean that should -- in terms of sort of sequential costs from Q3 to Q4, I think that's where we're going to see a little bit of headwind, but the rest of the COGS will be flat, as we said, we think.

And the other operating costs are -- they shouldn't change that much. They've been improving all year, and we expect that to be sequentially about the same as they were in the third quarter. So the only slight headwind, I think, will be some labor. But TBD, that could go either way. And so we'll see.

We have a further follow-on from Jake Bartlett, Truist Securities.

Great. My question was just on the potential efficiencies that you found. I know you're saving on labor right now with less hours, repair and maintenance, things like that. But Dan, do you think longer term that your margins are going to be stronger than coming out of the COVID crisis than we might have expected before the COVID crisis?

Yes. I think so, Jake. I think as Tony -- as you know, I mean, you know better than anybody, the commodity costs are cyclical. So we'll -- your ability to price is somewhat limited by virtue of whatever the market is and how much money people have in their pockets, which depends on stimulus and so on and so forth.

Some of the -- we're making more -- we've done some things with labor scheduling in both brands that I think is helpful. So I think that the margins will be more favorable than they were in 2019. I'm not suggesting that we're going to maintain the same margins we had in Q2 of 2020. But yes, I think that assuming that we can generate a continual sales increase that we forecast, I think our margins will be healthy.

We have another follow-on from Jeremy Hamblin, Craig-Hallum.

Sorry, we all got follow-ups today. I want to just revisit the cost of sales for a second. There was about 140 basis point sequential increase in that line from Q2 to Q3. And I wanted to just better understand the components of it.

And then I think, Tony, I think what you suggested was that cost of sales as a percent of sales is going to be pretty similar in Q4 versus Q3. I want to make sure I had that correct and understand kind of what the change at 140 basis point sequential -- sequentially higher in Q3. What drove that?

Yes, I would -- sequentially, I would -- first of all, again, we said in our prepared remarks, we think they'll be flat to Q3. So there should be no sequential change. But from Q2 to Q3, I'd say the biggest factor that in Q3 was lower rebates and slightly higher delivery costs than we saw in Q2. We get rebates from our food co-op. We get rebates from our beverage supplier. And because we're using less -- at least on the latter, because we're using less, we get the rebates come down. I think that had negative pressure on the cost of sales in the third quarter. But I don't think it's -- I think it's kind of -- there's nothing -- there's no change that we'll see in the fourth quarter. I think it will be pretty flat.

And the other -- I guess the other thing that happened in the third quarter was these other commodities, at least versus last year, whether it's potatoes or shortening or some of these lesser commodities, were up. But again, don't see those getting worse in the fourth quarter.

Okay. And then I just wanted to clarify on labor as well. So last year, your Q4 labor as a percent of sales was higher than in Q3. Are you suggesting that your labor in Q4 is going to be -- have a similar improvement on a year-over-year basis versus Q3 or maybe slightly less because you are likely to add maybe 1 person per store? Can you just help us with what you're suggesting?

Yes, sure. So -- got it. So I think it will be an improvement year-over-year, but it will probably be a little lower than Q3 or a little higher, cost of labor. Yes. But I think it will be...

A little higher than Q3, Tony.

Yes, that's what I meant, sorry. Yes. And then...

Labor as a percent of sales will be higher, but the improvement is less than you saw in Q3.

Yes.

Ladies and gentlemen, this time, we have reached the end of the question-and-answer session, and I'd like to turn the call back over to Dan Accordino for closing remarks.

Well, thank you all for being on the line today and for your questions. And I know that we'll be speaking with all of you, I guess -- or all of you who asked questions, we'll be speaking with you in a few moments. So thank you all, and we'll be in touch again in, I guess, February is the next call. Thank you.

Yes. Thanks.

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