El Pollo Loco Holdings Inc (LOCO) 2006 Q3 法說會逐字稿

Good afternoon. My name is Kristy, and I will be your conference operator today. At this time I would like to welcome everyone to the El Pollo Loco Third Quarter 2006 Earnings Conference Call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

Mr. Carley, you may begin your conference.

Thank you. Steve Carley here, President and CEO of El Pollo Loco, and welcome to our third quarter fiscal '06 earnings conference call. We are pleased to spend some time with all of you to share our results for the third quarter, but before I do, please note that during this call we may make forward-looking statements and we would refer you to the Safe Harbor statement that is in our press release that you all should have received, which describes the limitations of any forward-looking information.

Now let's go onto the third quarter of fiscal '06 summary. Operating revenues for the 13 weeks ended September 30, 2006 were $66.3 million, which is an increase of $4.7 million or 7.7% for operating revenues for the 13 weeks ended September 30, '05 of $61.6 million.

Same store sales for the system, which include sales for both company operated and franchise stores, increased 3.8% in the third quarter of fiscal '06. Company operated restaurant same store sales increased $2.1 percent and franchise restaurant same store sales increased by 0.2%.

For company-operated restaurants, the components of the same store sales increase were an increase in transactions of 0.2%, an increase in the average check of 0.1%, and an increase in price of 1.8%. Operating income for the third quarter of fiscal '06 was $9.1 million. That's an increase of $800,000 or 9.1% from the third quarter '05 operating income of $8.3 million.

EBITDA for the third quarter of fiscal '06 was $11.7 million, a slight decrease of $300,000 or 2.4% from third quarter '05 EBITDA of $12 million. Interest expense for the third quarter of fiscal '06 was $7.2 million, an increase of $2.5 million or 52.6% from the third quarter of '05.

Net expense was $4.7 million due to higher levels of debt incurred in conjunction with the November '05 acquisition of the Company by affiliates of Trimaran Capital Partners.

Due primarily to the increased interest expense and a higher [inaudible] effective tax rate, net income for the third quarter of '06 was $500,000, which was a decrease of $1.6 million from third quarter '05 net income of $2.1 million.

Now for some more in-depth detail around our financial operating performance, I'll going to turn it over to Joe Stein, our CFO, then I will discuss progress we have made in the area of store growth and franchise development after Joe. Thanks.

Thanks, Steve. I'm going to start first and elaborate a little bit about our third quarter results. In our press release, we include some charts that showed costs as a percentage of restaurant revenue, and if you'll note, there are two [inaudible] significant changes in our restaurants' operating margins. The first area is product costs, which I'll talk about, and second is in the restaurant other operating expenses.

On product costs, product costs actually decreased 0.9% as a percentage of restaurant revenue. They went down to 31% for the third quarter of '06 compared to 31.9% in the prior year third quarter. There's a few factors causing that risk. One of them is chicken meal restructuring that we completed in May of last year. That was where we introduced two-tier pricing for basically breast and wing or leg and thigh choices, which actually helped from a product cost standpoint. Also, we did take menu price increases in January and March of 2006. Those were the major factors that helped the reduction of product costs.

So let's [inaudible] restaurant other operating expenses, which includes utilities, repair and maintenance, advertising, property taxes, occupancy and other increased as a percentage of restaurant revenue by 3.2%, so it's up to 21.6% for the 2006 third quarter from 18.4% for the prior year third quarter. And let me break down why that increased that much.

A significant part of that, about $900,000 worth, is due to occupancy expense, which is mostly attributed to the revaluation of our leases that was completed with the sale of the Company. Prior to the acquisition, we had a negative leasehold liability that was part of revaluation of the leases back in 1999 at the time of that sale that we were advertising, which had the effect of reducing a rent expense. It was sort of non-cash amortization entry.

This benefit has now actually gone away once we revalued the company once again in November '05, so you have about $900,00 more rent expense because you don't have this offset, this non-cash offset that we had previously.

The second [inaudible] is part of the increase in restaurant other operating expenses was an advertising expense, which was $800,000 higher in the 2006 third quarter then the prior year, and the reason for that, advertising expense in the third quarter of this year was 4.2% of sales, which was slightly over the planned annual rate of 4%, but last year in the third quarter of '05, it was only 3.2% of sales.

As you may know if you followed our calls for a while, each quarter advertising may be above or below the planned annual rate, which is around 4%. It just depends on the timing of the marketing promotion and the relative weights and price of the media spending. But, once again, for the full year we expect and we historically have been pretty close to that 4%, so the third quarter was a little bit low, but you'll see in the fourth quarter last year advertising expense bumped up over 4%. So that's probably a timing issue there.

Finally, a portion of the increase in the other restaurant other operating expenses is also due to higher utilities and higher repair and maintenance costs. Those had an affect of about $300,000 each for those two categories. So I think there's a little more flavor on that margin chart.

Let's talk about year-to-date for the 39 weeks ended September 30. Revenues were $195.3 million, which was an increase of $17.9 million or 10.1% over operating revenues of $177.4 for the prior year 39 weeks. Same store sales year-to-date through September increased 6.3% for the system. To break that down for you, company-operated same store sales increased 4.5% and franchise increased 7.8%.

Now for the company-operated restaurants year-to-date, the components of that same store sales increase of 4.5% breaking that down for you is a transaction increase of 3.7%, a decrease in average check of 1.5%, and most of that is because of the introduction of the dollar menu last year, which got introduced about May, so this year had a full-year effect of that, an increase in price of 1.8%, and an increase attributed to the chicken meal restructuring we talked about of about 0.4%, so that gives you the components there.

The other operating income for the 39 weeks, it was $25.3 million, which was a $5.1 million increase over $20.2 million for the prior year 39 weeks.

So that takes me now to EBITDA for the 39 weeks of '06. EBITDA $32.8 million, which is a $1.9 million increase over EBITDA of $30.9 million for the 39 weeks of 2005.

Interest expense now is $21.4 million for the 39 weeks ended September of '06, which was a $7.2 million increase, or just over 50%, from the prior year of $14.2 million of interest expense. And once again, that's due to the higher levels of debt that we now have as a result of the November '05 acquisition.

And then down to the bottom line for the 39 weeks, net income was $1.8 million, which is a decrease of $1.9 million from net income in the prior year 39 weeks of $3.7 million, primarily as a result of the higher interest expense. With that, I'd like to now turn the call back over to Steve Carley.

I'd like to give you some exciting news about where we are on our national expansion from a franchise standpoint. Let me tell you where we are with new store openings through the end of September. We have opened six new company stores and nine new franchise stores through September.

The company stores have opened in the greater Los Angeles area, metropolitan Las Vegas, and in Fresno, which is in the Central Valley of California. Franchise stores have opened in Tucson, Arizona, Phoenix, Arizona, Denver, El Paso, San Diego, and the greater Los Angeles area.

Our current expectation is that we will end fiscal '06 by opening a total of eight new company stores and 15 franchise stores for the year. This means that we expect to open two more company stores and six franchise stores in the fourth quarter of the current year.

We're particularly excited about an opening scheduled next week for our franchise store in the Foxwoods Casino in Connecticut. This unique location, which hosts almost 15 million visitors annually, will expose a very broad cross-section of northeastern consumers through the [inaudible] first time.

Specific to our franchise development, you should have seen our press release earlier this week that described recent sightings of a number of multi-unit development agreements with quality franchise partners that have committed to open 61 El Pollo Loco restaurants in the states of Georgia, Missouri, Arizona, Virginia, and Utah. The largest of these is a 25-year development agreement with the former chief operating officer of [Chersas] Chicken and his partner who was the former president of the largest Cinnabon franchise group.

Other recent development agreements announced by El Pollo Loco include a ten-year agreement in Norfolk, Virginia, a three year agreement in Williamsburg and Newport News, Virginia, an agreement for six units in St. Louis, Missouri, one for 15 unites in the State of Utah, and another agreement for two locations in Yuma, Arizona.

These are in addition to existing franchise development agreements that include the states of California, Arizona, Illinois, Oregon, and Washington. So we are very excited about the progress we're making taking the brand across the country.

Before I open up the call to questions, many of you have called asking about the withdrawal of our S-1. We have been consistent in our message that this endeavor started as a reaction to a very favorable market for high growth restaurant stocks earlier in '06 courtesy of Chipotle. By the time our S-1 was declared effective, it was many months after this window in the market, although much improved from its summer doldrums, did not look as attractive to us as we thought.

We continue to be very comfortable with our current capital structure and there are no plans to re-enter the public market at this time. This is subject to change, as you all know, depending on market conditions.

Since most of you on this call are bond holders, I do want to thank you for your support and participation in the tendered offer, even though we did not complete the transaction. Also, I want to remind you that the exchange order deadline for the bond is Monday for those of you who have not submitted your notes for exchange yet.

I'll now open the call to questions.

[OPERATOR INSTRUCTIONS.]

Your first question comes from Reza Vahabzedah.

Good afternoon.

Hi.

Hi.

On the operating expense side, you went through a bunch of line items. Were there any IPO expenses in there that were captured in this year's third quarter?

No, there have not been in the third quarter. If there are expenses that we do need to incur, you're more likely to see them in the fourth quarter.

Okay.

So we're still analyzing that, but nothing in the third quarter.

All right. Then the lease revaluation, that was a non-cash contra-expense item and so this new lease accounting treatment, the lease expense [inaudible] line item is basically all cash. Is that accurate?

That's accurate.

Okay. So --

You've got that right.

-- essentially last year's lease expense was depressed by this prior treatment?

Exactly. And if you look at our prior year filings you'll see discussion of that. If you search for that negative leasehold liability in any of our filings last year, it gives you more detail on that.

Okay. On the gross margin, you talked about pricing, as well as menu re-engineering. Can you split apart the difference? How much was placing menu re-engineering and then the impact of the chicken contract?

For which period, the third quarter or the year-to-date?

Yes, 3Q '06 versus prior year.

I think, Steve, you did that here where you talked about the Company stores, which is what we have the data for.

Yes, we've got -- in the third quarter of '06 we have increase in transactions of 0.2.

Yes.

An increase in the average check of 0.1, which would be a menu engineering type of benefit, and a price increase impact of 1.8%.

Right. No, I was talking about just a gross margin change. We had a food cost change --

Oh, I see, the gross margin. We don't have that breakout of how much of that is a decrease in food cost is due to -- there's a lot of variables there. Obviously, you increase your price, your food cost as a percentage of sales will decrease. Also what you have commodity cost increases that will push it back up. Then you have our promotions, which we vary every year, and depending on if they're discount kind of promotions or price point promotions that will impact the food cost during the time or period that promotion's run, and then the final factor is how we position the menu board. The most significant change I can point to is a dollar menu, that was just May of '05, that will also impact your margins, and then remember, we also went to ten combo meals.

Let me ask it a different way. The chicken contract renewal, is there a quantifiable annualized cost impact just from that one element?

That's a good question because chicken is almost half of food cost. In '05 when we -- those contracts renewed, there was an increase in probably the neighborhood of a couple percent for the June contracts themselves -- '06 we didn't see much in the way of increase on a net basis because we had a slight increase in whole chicken, but we had a decrease in our salad cut and breasts contracts. So from a net basis, we actually didn't see much price increase in chicken contracts in '06.

Yes, so, but on the flip side we did see a lot of pressure from the oil based --

Petroleum based.

-- yeah, petroleum based, plastics, and paper, which is only 4% of our total restaurant revenue, but it's still -- it [inaudible] a lot of pressure in those areas.

Right. Really, the gross margin improvement was based on all pricing and a menu change?

[Inaudible].

That's right.

And then as far as labor expense, obviously your numbers were relatively stable as a percentage of revenues, but what is your outlook for labor costs going forward?

Well as you know, our primary base of operations is in the State of California. California approved a two phase minimum wage increase beginning in January of '07 and then another bite at the apple in January of '08. We are modeling that now. Our average wage for our total hourly employee base is above that level, so we don't have our entire employee population eligible for this, so we're monitoring that and looking forward to that in our '07 planning.

And typically, we, like other operators caught in this position, would look to recapture that in pricing.

Yes, okay. And then lastly, cap ex for the quarter and debt levels at the end of the quarter?

Yes, we haven't disclosed that yet. You'll see that in the press -- the 10-Q that's coming out. Let me see, Veteran's Day is tomorrow, so on Monday morning. So we'll come [inaudible] then.

And even if the debt level's higher?

No. Not at this time. We haven't published that.

And what about the cap ex for the year? Any guidance for that?

No. We believe we'll come in within the covenants that are in our bank debt.

Beyond budget.

Yes.

Thank you.

Sure.

Good questions. Thanks.

Your next question comes from Bryan Hunt.

Thank you. I was wondering if you could tell us, Joe, if there were any non-cash items within SG&A?

Of significance, not that I can think of. Non-cash, we didn't have any impairments or any kind of write-downs or anything like that.

Okay.

So, no. Nothing of significance that comes to mind.

All right. And then, Stephen, if you look at the last couple of quarters, you've had very difficult comparisons from a year ago. Your franchisees have outpaced the Company's same store sales number by a measurable amount, and I was wondering if you could delineate what's happening maybe with the franchisees relative to the Company and stores?

Sure. We've got a little bit of a historical issue going here. Typically, past management has sold the lowest volume of Company stores to the franchisees so the franchise AUVs are a little bit lower, which gives them some more headroom to grow.

Number two, we have very aggressively been encouraging our weakest of single unit operators to go find employment with another concept and sell out to our strongest multi-unit franchisees who routinely come in and pick up a store like this and can raise sales surprisingly double digits, and 20% plus is not unheard of when you put a good operator in. That impacts these numbers.

The third and more current thing that drives that is our largest franchisees are very aggressive on a couponing basis. So they will put a handful of bounce back coupons for multiple offers into the bag of every consumer that comes through the drive-thru and the front counter. We, obviously, approve and endorse that, although on the Company side we don't use that strategy anywhere near as frequently as some of our larger franchisees.

And for a [inaudible], Bryan, that gap between franchise and Company stores same store sales has been very consistent over the last six years. Since 2000, you've seen that differential, so those facts Steve mentioned have been pretty consistent over the years.

Okay. Great.

Yes.

Could you talk about your current promotion? You're doing a $5 gift card on a family meal. I mean, what's the impetus behind that, and is it a response to maybe some competitor activity or is this a normal promotion that you've run before?

Well, we always craft our promotions in a pretty tight box from an ROI standpoint, a breakeven perspective, and what we expect them to do on the business. So in terms of this promotion, it's consistent with what we've been doing in the past. We know at this time of year that being able to drive our family chicken meals is really critical to our profitability and our ability to comp.

And so this $5 reward card with a very short expiration, by the way, of four to six weeks after we hand it out, is really designed to get an extra visit or even two out of our chicken family meal guests during this key holiday period. And on that basis, [inaudible] models and forecast and is turning out to be doing just that.

So, a chicken family meal purchaser has a frequency of about once every six weeks. So if you could pick up a visit once every four weeks in this key period, which makes very good sense, that has big implications for us in our profitability of comp standpoint.

So it sounds like, I mean, you're pretty encouraged about the performance of this promotion?

Yes. It is. It's hitting our pro forma as what we expected to do and more than breaking even.

All right. Moving on, looking at the 61 franchisees that you signed -- these development agreements you signed for 61 stores, what does that bring in total to your unbuilt pipeline of franchisees?

It's probably close to 140-50. Something like that.

Yes.

And that is over what type of window? Seven years?

Five.

Yes, the longest one is probably seven. The average is probably closer to five like Steve said.

Yes.

Okay.

And as you know in our public conversations about our expectations for growth reviews, that 130 to 150 total new franchise store number over five years is our target, so I guess the big news here is we're really pleased with our ability to have that pipeline where it's at now.

Do you think that the number of openings from the franchisees given the magnitude of the store base you have now in the pipeline is going to accelerate next year from what you saw this year?

Yes, sir. And it will accelerate the year after that also on the franchise side. It's an accretive kind of an activity where franchisees open their first door successfully, and then they open their second and third. Then the new franchisees are opening their first, and that builds in a hockey stick fashion over the next one to four years.

You played right into my next question. Could you talk about the most recent stores you've opened up, how they're performing on an AUV basis compared to the average for the company as well as stores that you have recently opened out of market and how those continue to perform?

Yes, we don't have -- we don't currently, unfortunately, Bryan, publish data on a store-by store basis. That's something we could think about doing, but that's currently not publicly disclosed so we can't talk about it in this call.

I guess I'm asking regarding momentum. I mean, do you feel like your new openings are out-performing your current AUVs or are they in line?

Well, the way to think about it, Brian, is not so much our current AUVs but our AUVs that we represent in our UFOC.

Yes, it depends if you're talking about company and franchise.

And the franchise that you would user are a little bit lower than company, so we usually use a benchmark of success of whether the stores are annualizing at or above the franchise AUV that we put in our UFOC.

And to date we're pleased with the performance of the stores.

And I did not catch it. Is that Foxwoods location going to be Company-owned or franchisee?

That's a franchise store.

Yes, it's a franchise store and that's going to be, obviously, a very unique location. It's actually almost double the size of our normal stores. It's got seven --

Seven cash registers, four production lines --

Yes. It's [inaudible] unique.

That sounds exciting.

We're exited about it. It's going to be exciting for the franchisees. It's going to be -- we're very [inaudible] because these are going to be 16 million consumers primarily driven out of the Boston and New York metropolitan areas that will get exposed to the El Pollo Loco concept in a really terrific environment, at which of course seeds the awareness of the concept for our development in those markets going forward.

I would say it's a great advertisement for an IPO as well.

There you go.

Very possible.

Thank you.

Thank you, Bryan.

Your next question comes from Ken Bann.

Hi. Both of my questions have been answered, but I just wonder are you spending more on advertising in some of these markets like in the Northeast where the name is really not that well known or how are you going to get the name known out there other than just opening the Foxwoods?

Well, Ken, we -- on our new franchise agreements we have a 5% marketing contribution, which is a point higher than what we're getting here in Los Angeles as an example. Number two, we have a very comprehensive 14-month marketing calendar that really starts two months before the store opens and through the first 12 months specifically designed to drive awareness and trial of the concept and specific parts of our menu in a specific store.

And we realize that it'll be many, many years, if ever in some of these large metropolitan areas, that will be on broadcast media, and so I've designed our marketing programs to be very store-by-store centric, and we have a lot of tools designed to raise the awareness of that concept within a three-mile route of the store, which is where 99% of the traffic comes from.

Right. Okay. And could you just tell us for 2007 what do you see the number of company and franchise stores opening next year?

Yes, we disclosed in the S-1 filing that we put together that we expect around ten -- approximately ten company stores in that range next year, and on the franchise stores, we haven't set a specific number, I don't think, but we expect it to, as Steve described, to accelerate over the years, not on an exponential basis, but more of a stair step, so we're looking around 15 this year and saying something like 20 next year wouldn't be unreasonable. Maybe we can do more than that, but we don't have specific numbers yet on that.

The company stores are a lot easier for us to forecast than the franchise side since those tend to move around a little bit more, but you would expect some stair-step growth on the franchise side.

Okay. Great. Thanks a lot.

Thanks, Ken.

You have a follow-up question from Reza Vahabzedah.

Yes, just on the labor front, what portion of your labor force overlaps with the minimum wage, if at all?

Yes, the minimum wage currently in California is $6.75, and it's going to go up to about $7.50. And I believe at least a third of 1,300 employees approximately.

Yes, it might be a little bit more than that, about 1,600?

Yes. So it's sort of in that range. And you remember, there's people that are at $6.75. There's some people that are at $7.25, so not everybody is going up $0.75. Some may be only going up to $0.10 or $0.20. So that's why the announcement is pretty complex as far as determining what the dollar cost is going to be to us above and beyond the normal merit increases we get. And I want to reiterate what Steve pointed out is what we intend to do as much as we can and what tends to happen with the other competitors out here is take additional price increases to compensate for that.

Yes, the vast majority of our competition in our core market is primarily franchise owners in our competitive concepts. And they very historically, literally ratchet up their prices and pretty much [inaudible] up with the financial application of a minimum wage agreement.

I went to a corner bakery for my oatmeal this morning and they already took their price increase.

There you go.

From Monday to today. So --

Are there people right above minimum wage that would also be affected by this?

Yes, we typically refer to that as compression and there are a group of employees in that pool too. We aggressively manage our unit level folks and give them very specific processes and procedures on how to handle that and we drive it into our annual merit increase process.

So, for example, if someone's making $7.50 exactly, we might give them an additional $0.15 on top of their usually pretty small percentage merit increase.

We try and drive it on a performance basis too so there's -- if somebody is at $7.50 and they're [inaudible] performance expectations, so it's a different conversation than the really terrific cook or cashier who we want to retain.

By the way, is there a meaningful difference on the same store sales front [inaudible] between your sort of your Southern California stores and the rest of your market? I know you're a pretty strong presence in Southern California, but [inaudible] difference that you can tell?

Yes. Las Vegas is a lot stronger than Los Angeles.

Yes, we'll move it around. Some of it will depend on the promotions too.

[Inaudible] various markets.

Thanks, Reza.

The other thing, I think too that's really terrific, many of you we've talked to in previous presentations have asked questions about the Phoenix market, and we have a brand new franchisee going into the Phoenix market and the openings there are dramatically out performing the existing store AUVs.

Great.

Thank you.

Appreciate it.

[OPERATOR INSTRUCTIONS.]

Looks like [inaudible]. Thanks, everybody. We really much appreciate your time and attention and your support. And thanks for sticking with us. Bye.

And this concludes today's conference call. You may now disconnect.