Fiesta Restaurant Group Inc (FRGI) 2016 Q3 法說會逐字稿

Greetings and welcome to the Fiesta Restaurant Group Third Quarter 2016 earnings conference call. I would like to turn the call over to Rafael Gross, Managing Director at ICR.

Thank you Operator. The Company's Third Quarter 2016 Earnings Release was issued after the market close today. If you have not already accessed it can be found on the Company's website www.frgi.com under the investor relation section. Before we begin I must remind everyone that during the call today the company will include statement that are not based on historical information. These forward-looking statements include without limitation statements regarding the Company's future financial position and results of operations and business strategies budget projected costs and plans and objectives of management for future operations. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements and the company can give no assurance that such forward looking statements will prove to be correct. Important factors that can cause actual results to differ materially from those expressed or implied by the forward-looking statements can be found in the company's SEC filings. Please note that during today's conference call, certain non-GAAP financial measures will be discussed which the company believes can be useful in evaluating its performance. Any discussion of such information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP and the reconciliation to comparable GAAP measures is available in the company's earnings release.

Now, I'd like to turn it over to Danny Meisenheimer, Interim President and Chief Executive Officer.

Thank you Raph, and good afternoon everyone. Leading Fiesta during this transitional period carries a great deal of responsibility in which I take it seriously. For those of you who don't know me I've been with the company since 2012 and prior to taking on the role of Interim CEO, I was the Chief Operating Officer at Pollo so I'm no stranger to FRGI and its two great brands. In my current role I'm working closely with both the board and our management team in evaluating our strategic plan and taking definitive steps to stimulate improved performance and advance our initiatives. We're dedicated to on going engagement with all of our shareholders and value their constructive input towards the mutual goal of long term shareholder value. As we previously communicated a committee of independent board of directors with the assistance of Heidrick & Struggles an international recruiting firm has initiated searches for a permanent CEO and for an experienced Restaurant Executive to serve as non-executive Director to fill the open Board Seat. We'll announce the results of these searches as soon as the right individuals have been identified.

On a related note we have suspended the search for a Taco Cabana brand CEO. The board has concluded that continued brand ownership of Taco Cabana is in the shareholder's best interest. I'm pleased Mark Phillips is serving as Interim Chief Operating Officer for Taco Cabana. Mark been with the brand for over 20 years serving in various leadership positions including as Vice President of Operations at Taco Cabana since to 2012. I'd like to take a moment to reflect where we have been and to share where we are headed. First, we operate two unique and special brands that generate leading four wall economics in the competitive fast casual segment of the restaurant industry.

Our brands continue to operate at very high levels in the respective core markets. However, over the past 3 years we have seen rapid expansion of our Pollo Tropical concept nearly doubling size of the chain during this time. In Texas alone, we opened 38 new Pollo restaurants while introducing the brand to new guests across the state. The brand expansion was not isolated to Texas but also included the national and Atlanta markets where we opened more than 20 restaurants combined. Unfortunately, despite the loyalty of valued guests and efforts of dedicated teams some of those locations have struggled due to increasingly challenging market conditions and restaurant concentration and lack of brand awareness.

In addition, our rapid expansion has to some degree caused us in these new markets to take our focus off of what is most important, providing our guests an exceptional Pollo Tropical experience. As a result of a restaurant Portfolio review we recently closed ten Pollo Tropical restaurants in the expansion markets. Of these ten locations, three restaurants in Texas may be converted to Taco Cabana restaurants. Team members from the closed restaurants were offered positions either in nearby Pollo Tropical or Taco Cabana restaurant were possible. These closures come on the heels of our announcement that we have for the time being suspended additional development in Texas.

In addition to evaluating our restaurant portfolio in our emerging markets we are planning and addressing long term opportunities which exist. We will focus on building an exceptional guest experience while expanding brand awareness in Texas, Tennessee and Georgia. Through the use of radio, direct mail and local store marketing and off premise programs we believe we can build frequency and reach to better balance consumer demand with restaurant supply. We have implemented a new operational structure with decreased spans of control and great leaders in place to focus our teams on operating excellence.

We're also in the process of exploring how to regionalize our product promotions and menus to improve appeal and profitability in each of our Pollo Tropical markets. New product innovation has been an area of keen focus at both brands balanced with minimizing related operational complexity. Starting in late August at Pollo Tropical we promoted a new Churrasco Steak offering across the system which contributed to generating positive transactions in September. In October we began promoting a Chipotle Shredded Chicken meal deal priced at $4.99 at Taco Cabana. More product innovation is underway in the fourth quarter and throughout 2017 at both brands. We expect to open a total of 31 new company-owned Pollo restaurants and 4 new company owned Taco restaurants by 2016. As of the end of the third quarter we had opened 26 Pollo Tropical and 2 Taco Cabana restaurants. In addition by year-end we will have reimaged 14 Pollo restaurants, five in Atlanta and nine in South Florida.

To date we have seen sustained lifts at restaurants we have remodeled with trends meeting or exceeding our 5-year after tax cash pay back target. Let me now touch on capital allocation in 2017. During the coming fiscal year we are ranking to open 12-13 Pollo Tropical restaurants throughout Florida where all of our markets generate AUV's with at least $1.9 million we are also planning to reimage 22 restaurants in South Florida primarily in Miami-Dade County where we operate our busiest and most profitable restaurants with AUV's of approximately $3.5 million. At Taco Cabana we will focus on entering smaller Texas markets as well as adding restaurants in existing markets with a total of eight to ten openings. We also expect to reimage one restaurant in San Antonio. In smaller markets we will utilize a smaller scale able building prototype that we believe can produces target investment returns while still delivering the full menu and brand experience.

Lastly, turning to our focus on off-premise business we are now system wide at both brands with online ordering and mobile app platforms. The mobile app platform is crucial to the success of our loyalty program for both brands. We have been piloting our Pollo Tropical loyalty program in Orlando since April. Given the results of this pilot, we recently rolled out the program to our North Florida and emerging markets to build frequency of visits within our current user base. In Orlando we found that more than 80% of those guests that opted into the Pollo loyalty program were not previous rewards e-club members. Providing evidence that we are engaging incremental guests to our new frequency platform.

Leveraging our experience at Pollo we are planning to begin piloting our Taco Cabana loyalty program in November beginning with our Austin market. We also continue to make progress on third party delivery at Pollo with a few restaurants in each of the few markets. Houston, San Antonio and most recently South Florida. While still in the early stages we are generally pleased with the positive feedback we are receiving from our guests and operators and plan to roll out delivery to both brands to additional markets in the coming months. Finally, we are allocating resources to focus on catering sales which we believe can be a much bigger part of our business in the years ahead.

With that I'll now turn the call over to Lynn.

Thank you, Danny. For the third quarter we grew total revenues by 5.9% to $182.3 million through sales contributions from the net new 33 company owned restaurant openings over the past year which offset declines and comparable restaurant sales at both brands and while those brands had negative comp sales they perform above industry bench marks in Florida for Pollo and Texas for Taco. Pollo comparable restaurant sales decreased 1% which included a 2.5% decrease in comparable guest traffic and 1.5% increase in average check. Sales cannibalization from new restaurants on existing restaurants negatively impacted comparable restaurant transaction growth by approximately 1%. Average check was primarily driven by menu price increases that positively impacted restaurant sales by 1.9%. On a 2-year basis, Pollo quarterly comparable restaurant sales grew 3.2%.

Comp restaurant sales at Pollo in the first 4 weeks of fiscal October were down 4.7% due primarily to the negative impact of Hurricane Matthew included related temporary store closures. Excluding the estimated impact of the hurricane, comp store sales declined .5%. The good news is we did not sustain any material property damage from the storm. In the prior year, October period, we generated a comp sales increase of 1%. Turning to Taco Cabana, comparable restaurant sales in the third quarter decreased 4.1% as a result of a 3.5% decrease in comparable guest traffic and 0.6% decrease in average check while menu price increases positively impacted restaurant sales on a 1.3%.

On a two year basis comparable restaurant sales grew 0.7%. Through the first 4 weeks of fiscal October, comp restaurant sales at Taco decreased 0.3%. This compares to the prior year period when we generated a comp sales increase of 1.3%. In terms of quarterly restaurant expense and cost drivers please refer to the earnings press release which provides explanation for each P&L line item on a consolidated basis. Unfortunately , with negative comparable sales at both brands this quarter, sales deleverage negatively impacted profitability at both brands across fixed and semi fixed operating costs. G&A increased $0.3 million to $14.5 million in the third quarter 2016. As a percentage of total revenues G&A decreased to 8% in the third quarter this year compared to 8.3% in the prior year period.

During the current year quarter we recognized a $0.8 million charge for estimated costs including legal fees and other costs related to a class action settlement and a $0.6 million write-off related to costs incurred for locations we decided not to develop. These costs were partially offset by lower incentive based compensation. In the third quarter of 2015, we incurred a charge for estimated costs including legal fees and other costs related to a class action settlement totaling $0.9 million. In the third quarter of 2016 we recognized an $18.5 million impairment charge related to the 10 closed restaurants and six other Pollo restaurants and one Taco restaurant we continue to operate.

We will recognize lease and other charges related to the closed restaurants which we anticipate will be between $2 million and 4 million in the fourth quarter of 2016. And as previously disclosed the ten closed restaurants contributed about $4.8 million of pre tax operating losses to result in fiscal 2016 through the end of the third quarter. In the third quarter of 2016, we generated a net loss of $4.5 million or $0.17 of diluted share compared to net income of $7.9 million or $0.30 per diluted share in the prior year period. Third quarter adjusted net income was $8 million or $0.30 per diluted share with the bulk of the pre tax adjustments related to impairment and other lease other charges.

This compares to an adjusted net income of $8.8 million or $0.33 per diluted share in the prior year period. Our consolidated restaurant level adjusted EBITDA margin a non-GAAP measure, decreased in the third quarter by 90 basis points compared to the prior year period, primarily due to margin contraction at Pollo. Pollo's restaurant level adjusted EBITDA margin decreased by 180 basis points in the third quarter versus the prior year period as favorable commodity costs were not sufficient to off-set higher labor, rent, advertising and other restaurant operating expenses as a percentage of sales.

Taco's restaurant level adjusted EBITDA margin decreased ten basis points compared with the prior year period as favorable commodity costs were offset by higher labor, rent, advertising and other restaurant operating expenses as a percentage of sales. At quarter end we had a cash balance of $4.9 million and after reserving $5.2 million for letters of credit we had $78.9 million of borrowing capacity under our senior credit facility. We continue to be in compliance with all related covenants. As a reminder we disclose a great deal of brand specific financial and operating performance in our quarterly earnings release tables and in our SEC filings. This information brings brand specific comp and non-comp restaurant average unit volumes and income statement line item details and variance explanations.

We plan to file our 10-Q document today similar to what we have done in the past to give investors as much information as possible as quickly as possible. We have also provided an update of our expected operating results in 2016 in our earnings release issued today. As Danny mentioned we are planning to open 12-13 new Pollo restaurants in Florida and eight to ten new Taco restaurants in Texas in 2017. We anticipate that up to three of the Taco restaurant openings may be conversions of closed Pollo restaurants. Total capital expenditures for 2017 are expected to be $57 million to $68 million.

This includes $35 million to $43 million for new restaurants and $14 million to $16 million for remodelling and capital maintenance and $8 million to $9 million related to other technology and operating equipment projects. To conclude the Company is focused on improving the trajectory of the business and actively working on building the strategy that will drive profitable growth and shareholder value in the years ahead. With that let's open the line for questions please.

We will now be conducting a question-and-answer session. (Operatior instructions). One moment please while we pull for questions. The first question comes Alex Slagle from Jefferies. Go ahead.

Thank you. I had a question on the plans to accelerate growth at Taco Cabana. I was wondering if you could talk through the thought process behind that and what are the new store economics and what's different versus a couple of years ago. Obviously we have seen success of the reimaging of the system, improved operations but it has been many years of little or no growth. Just wanted to figure out what's different now and what gives you confidence to ramp the growth after all those years.

Hi, Alex. Yeah, just a few comments on that. The first is If you looked at the trending of Taco Cabana over the last several years you have seen an improvement of overall results and the brand has been operating at peak performance through the end of last year. Of our 10 stores we're developing in 2017, four are conversions including up to three of the Pollo closures that we recently announced. So the returns around those investments are certainly very, very strong. In addition to those, we have six other openings we're projecting. Of those openings about two of the six are using our smaller prototype. What the smaller prototype provides for is an investment cost of less than $1.6 million. If we can get to $1.7 million AUV in the second or even the third year, we can see returns of 20% or more. So essentially the increase in development at Taco is a combination of improved performance along with reducing the risk profile associated with the investment.

Great. And then on Pollo, question on the new store volumes for the fourth quarter. Previously you talked about expecting that year-over-year decline that we had seen in the first half continuing through the second half. Is that still the case for the fourth quarter as we're now lapping over some more significant new volume declines from last year in the fourth quarter?

Yeah, well I mean, as you saw in the third quarter we did see continued declines. The good news is some of the cannibalization we've been experiencing has been mitigated. So we were previously reporting I think about 2% cannibalization in the first half of the year and that number has gone down to about 1% in the current quarter or the third quarter. You do see some benefits associated with that trend in addition to easier comparisons year-over-year.

Great. You expect that --1% cannibalization going forward in the near term?

Yes, we do.

Great. That's it for me. Thank you.

The next question comes from Nicole Miller from Piper Jeffrey.

Good afternoon. Would you talk a little bit about the Pollo mix kind of going up and down each quarter? And what --drove down the taco mix this quarter, please?

A lot of it, Nicole, has to do with what we're promoting and some promotions and discounts that we are experiencing especially on the Taco side, I think we saw sales mix impact -- same store sales for the third quarter about 60 basis points in terms of a downward movement year-over-year. And that had to do with the promotional environment that we've been experiencing and the fact that we chose to offer a variety of meal deals as opposed to a singular meal deal, which we have in the recent past and that has resulted in higher discounts and promotions.

And one additional note, from a product promotion standpoint at Pollo, the Churrasco Steak promotion began in late August and really carried through September where we saw definite improvement in transaction and sales trans versus previous year where we were positive to that same period from the 2015, and then the same for Taco in terms of trend improvement although still down. Definite improvement over July and August with the $4.99 meal deals as we entered into the October period.

That's very helpful. I'm really sorry. I missed the CapEx breakdown you gave. I assume that was for 2016 not 2017, right?

No, actually the CapEx breakout was for 2017, and the --

Okay.

$57 million to $68 million in total.

Can you give the break out again.

New restaurants $35 million to $43 million, remodeling and capital maintenance $14 million to $16 million, and technology and other operating equipment projects $8 million to $9 million.

Thank you, appreciate it.

The next question comes from Will Slabaugh at Stephens, Inc.

I had another question on CapEx with that number coming down can you talk about plans for capital deployment with that free cash you have available, I know you're ramping up some development at Taco but seems like there still should be some free cash. Curious if that might be used towards share repurchases given where the stock is.

Yeah, we are expecting free cash flow and It continues to be a matter between discussions between the board and the management team as we moved forward.

And on Pollo trends just to clarify the quarter-to-date commentary when we take out the hurricane hit I believe you said you would have been down negative 0.5% so that implies a modest improvement from what we saw last quarter. If you're seeing a continued improvement there, if you feel like it is an improving trend and if you expect negative comps to continue or is there a possibility for us to see a positive comp out of Pollo in the fourth quarter.

Well, that is going to be very close. The trends continue to be as they were stated in October and we look at our product promotions for the balance of the quarter in it our core markets of Florida we are continuing the Churrasco Steak promotions but the emerging markets in Atlanta and Texas and in Nashville we're introducing a new spicy chicken product that began on October 31st so it's still very early and trends to be right around that 0.5% that we saw in October. So it will be very close.

Got it and one more quick one if I could. On the portfolio review of Pollo Tropical new markets, would you consider this to be a final review or could there be additional closers announced down the road?

The discussions in terms of the Texas market is, we're looking at the four markets, Austin, San Antonio, Houston, Dallas/Fort Worth to continue to evolve over the next 18 months. When we went about the closure process we took a really hard look at these sites, in terms of creating the space around them so that negate the sales transfer so we can improve our operating term and generate trade area and market wide awareness. So we felt comfortable when we went through this process that we had addressed those stores to give us the best opportunity to really build brand awareness and sales and transactions and the 30 remaining restaurants and the four Texas markets and the same for Nashville as well as Atlanta. But primarily Texas.

Got it.Thank you.

The next question is from Brian Vaccaro from Raymond James. Please go ahead.

Thanks and good evening. Just had a come of questions on the ten Pollo Tropical units that were closed. I know you disclosed the Pollo Tropical operating loss in those units, the $4.8 million. You can provide what the year-to-date sales in store level profitability were on those units?

I don't have the sales number off the top of my head but the overall profitability contribution to the loss was $4.7 million to $4.9 million.

Okay. I guess -- can you -- maybe we can get that off line from you. But in terms of how the operating loss is defined is there a G&A cost allocation that you included in that figure and also are there any pre opening costs in that $4.8 million operating loss?

Yeah there was a minor amount of pre opening cost and it was really restaurant level EBITDA so it didn't include any G&A expense.

Okay. All right. That's helpful. And thinking about cannibalization a little bit, obviously been a headwind at Pollo for several years, but how should we think about the magnitude of cannibalization into 2017, sort of trying to balance the impact of continued unit growth in the core of Florida markets, but maybe offset a little bit by the 10 unit closures?

Yeah, we certainly hope to see a positive sales transfer related to the closed stores in some cases and I think we're trying to keep our cannibalization in 2017 at or below 1%.

Okay. That's helpful. And then just on capital deployment ask it from a different angle. Is there a comfort range on your leverage ratio that you are thinking about, either from a net debt to EBITDA or lease adjusted basis.

Yeah, I think obviously as we think about our leverage we want to balance leverage with risk and the current environment, and it continues to be an on going discussion.

Fair enough. Thank you.

(Operator instructions) Our next question is from Jeff Farmer of Wells Fargo. Please go ahead.

Thank you. The advertising expenses as a percent of sales at Pollo was up pretty significantly in the 3Q and year-to-date. I'm just curious how we should be thinking about that expense not only heading into the Q4 but also 2017?

From a timing standpoint I believe, in fourth quarter we should see an improvement in terms of cost of sales as a percentage. Going into 2017 what we'll be talking about is not only the core markets where we'll continue to invest-- throughout from Tampa all the way to Dade and Broward County it is from a television and traditional media standpoint. In San Antonio and Atlanta we'll continue that march with our traditional TV and radio support where we continue to see improvement in sales as a result of the additional awareness. In the remaining markets primarily Houston and Dallas, will be more trade area focused and more market focused in terms of our catering support, where we have specialists in the market selling our catering programs, loyalty program and online program will be promoted throughout the markets and throughout the stores. And then we'll be taking a very hard look at the Dallas/Fort Worth market in terms of what we do with the possibility of going on air in that particular area sometime in the second or third quarter. It's still under discussion but one of the things we're definitely looking at for 2017

I would say as we look at 2017 right now I think we're trending to about 3.8% in terms of restaurant sales as a percent of advertising expense and we would expect to be at that level, maybe a little bit lower next year.

Okay. And then two labor questions. So, looks like the labor cost pressure at Pollo did narrow pretty significantly in the 3Q and I know you have been working on a handful of labor costs initiatives. I'm curious if you think you hit the run rate in terms of your labor cost efforts or if there's more to come again in the fourth quarter into 2017.

I think we're trending better and we expect a continuation of an improved trend versus what we have seen earlier in the year. Obviously there is some additional pressure that we're looking at as we look into 2017 with wage inflation, over time rules and things of that nature. So we think from a margin standpoint, from a percent of restaurant sales as it compares to labor expense that we'll see pressure next year compared to 2016.

Okay Lynn, you lead right into the follow-up question which was wage rate inflation. For 2016 what is it look like you are going to see. I thought at one point you guys were pointing to 3%. I'm curious again a little bit further into 2016 what you think it's going to be for 2016 and again same question for 2017. Sounds like you think it will be modestly above whatever-- or at least above whatever you see in 2016.

Yeah, it's been trending up. We've been at 3%--3% plus and now we're starting to see the numbers starting to approach 4%. So right now in 2017, we're expecting roughly 3% to 5% inflation.

Okay. Thank you.

The next question is from Nick Setyan.

Hi, this is Colin Radke on for Nick. My question is on the store level economics of the stores and the newer geographies that you're not closing. Is it fair to assume those units are all profitable, or are some of those units losing money at the store level but maybe you see a path to return to profit at 2017?

Yeah, I think, we are not profitable across the board in our emerging markets in the restaurants we operate in the emerging markets. But we do see a path to becoming profitable as part of that cluster by 2018.

Okay. And just in terms of the units that you are closing. Could you comment, are there any similar or unifying characteristics across those units whether by the type of trade area or the specific sites they were in or anything along those lines?

Yes. It can be summed up best by saying the following, that it could be in some cases it could be site specific and some cases it could be execution challenges that we had at the store level and some cases it's simply a little bit closer as we were trying to build brand awareness, a little bit closer to the next available Pollo. So we were sharing guests before the awareness had a chance to pick up and build to a point that we could do that. So it's a variety of those things that you see that sort of contribute to those ten stores no longer being part of the Pollo chain.

Okay. Thanks. And then just last one for me. Just in terms of cannibalization on the Taco side, obviously ramping up more units and some of those will be in existing markets. What's the right way to think about cannibalization for Taco Cabana going forward?

We think, you know, there could be a little bit. It would be somewhere at or below 0.5% in 2017 based on our current projections.

Okay. Thank you.

There are no further questions so this will conclude the teleconference. You can disconnect your lines at this time. Thank you for your participation.