El Pollo Loco Holdings Inc (LOCO) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the El Pollo Loco fiscal 2006 year end results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [OPERATOR INSTRUCTIONS]. Your speakers for today are Mr. Steve Carly, President and CEO, and Mr. Joe Stein, Chief Financial Officer of El Pollo Loco.

It is now my distinct pleasure to turn the conference over to Mr. Steve Carly. Please proceed, sir.

Thank you. We're delighted to spend some time with you to share our 2006 full-year results. 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. Let's go talk about the full-year summary for 2006.

Operating revenues increased 9.6% to $259.9 million, driven mostly by same-store sales increases for the system of 5.3%, and the opening of 26 company and franchise restaurants. Breaking down comp sales further, company stores increased 3.6% and franchise restaurants increased 6.7% for the year. On the store openings, we opened nine company stores and 17 franchise stores in 2006. Operating income was $30.5 million, an increase of $8.2 million, or 37% from prior year. Operating income in 2006 was negatively impacted by $1.8 million in costs related to public equity offering efforts that were abandoned in the fourth quarter of 2006.

Operating income in 2005 was negatively impacted by $3.1 million in selling expenses related to the November 18 acquisition of the company by Trimaran. Interest expense for fiscal 2006 was $28.8 million, which decreased $13.3 million from $42.1 million in fiscal 2005. In 2005, we paid $15.7 million in tender premiums related to the retirement of the notes, and $6 million related to the write-off of deferred finance costs, both of which occurred as a result of the acquisition. Net income for fiscal 2006 was $600,000, an increase of $12.4 million from a net loss in fiscal 2005 of $11.8 million.

At this point, I'm going to turn it over to Joe Stein, our CFO, to give you some more financial detail, and I'll be back to close the call. Thanks.

Thanks, Steve. I'm going to go into some of the cost details of the full- year 2006, starting with product cost. As a percentage of restaurant revenue, 2006 product costs decreased by 0.4%, down to 31.4% for '06 versus 31.8% for 2005, and this decrease is primarily a result of the a price increase we took at the beginning of 2006, which was 1.9%.

We also -- moving to payroll costs, did see payroll costs drop 0.3%, down to 25.7%, which is -- actually, it was 25.7% in '05, and it dropped 0.3% to 25.4% in fiscal 2006. And that's primarily because of the same-store sales leverage similar to what we experienced in product costs. One item in the restaurant P&L that did go up was restaurant other operating expense, and that increased 1.7% from 19.3% in '05 to 21% in '06, and there's two major reasons for that. The most significant reason was a non-cash event and that is occupancy expense. We revalued our leases at the time of the sale in November of '05. Prior to that, we had a negative leasehold liability related to a previous valuation that we were amortizing, which had the affect of reducing rent expense.

So prior to the November '05 acquisition, rent expense had an approximately $2 million on an annual basis non-cash credit reducing rent expense. That benefit has largely gone away with the revaluation of the company that occurred in November '05. So starting in December of '05 and into '06, we didn't receive the same kind of negative leasehold liability credit to rent expense. The second biggest part of the increase, which was about 0.4%, was increased repair and maintenance fees. A big part of that was prior maintenance project that we completed early in '06 and we did have some other normal -- higher-than-normal outside vendor expenses because we have a number of open facilities technician positions in '06, so we had to go and use more outside vendors.

General and administrative expenses decreased $600,000, that actually is about a 2.1% decrease, down to $26.8 million in '06 versus $27.4 million in the prior year. Steve mentioned some of the largest items affecting the G&A comparison, which was a $3.1 million in '05 of expenses related to the acquisition, and the $1.8 million in '06 related to the proposed public offering. And more detail on G&A will be available in our 10-K filing. We do expect to file our 10-K by Monday at the latest, which will have complete information on the company for '06, including balance sheet and cash flow info. Fourth quarter, let me give you some results on the fourth quarter. Operating revenues for the fourth quarter totalled $64.6 million, which was a $4.8 million increase or 7.9% over '05.

Same-store sales for the system increased 2.3% in the fourth quarter, with company-owned restaurants increasing 1% and franchise restaurants increasing 3.4%. Just to note the numbers we were hurdling in the prior year, prior fourth quarter same-store sales system-wide were up 12.1%. Operating income for the fourth quarter of fiscal 2006 was $5.2 million, which was a $3.1 million increase or 148.7% from operating income of $2.1 million in the fourth quarter of fiscal '05.

The two primary reasons were the $3.1 million of expenses in the fourth quarter of '05 for the acquisition compared to the $1.8 million public offering costs that we booked in the fourth quarter of '06. So finally, net loss for the fourth quarter of fiscal '06 was $1.2 million, and that is a decrease from a net loss of $15.4 million in the fourth quarter of fiscal '05, so that decrease is $14.2 million, between those two numbers. And that decrease is primarily related to the payment of tender premiums and write-off of deferred costs and selling expenses that Steve described that occurred in 2005.

With that, I'm going to turn it back over to Steve to talk about some other items.

Thanks, Joe. I want to comment a little further about what we see in fiscal 2007. We'll have our toughest comparable sales quarter in the first quarter of fiscal 2007 as we compare against a very strong early 2006 comparable sales growth number. This is the reverse from last year, with respect to comparable sales growth as in 2006, the easiest comparison was versus 2005's first quarter.

We expect to open approximately ten company-owned restaurants and 20 franchise restaurants in fiscal 2007. The company openings will be in our core greater Los Angeles and Las Vegas markets, while our franchise openings are expected to occur in up to 12 different states. We currently have 25 active development agreements covering 15 states in place. The states include Georgia, Virginia, New York, New Jersey, Missouri, Illinois, and the five New England states.

Let me move on to labor. On January 1, 2007, the minimum wage in the state of California increased from $6.75 per hour to $7.50. We implemented a price increase of approximately 2% at the beginning of fiscal '07 in order to mitigate the impact on profits of the minimum wage increase. On a national level, there is a push to raise the federal minimum wage to $7.25. This is still lower than California's minimum wage and would not impact our company stores very much as we have only company-owned stores outside of California.

I think there's only about 12.

Yes. The other area ill like to touch on is product costs, particularly chicken prices. As of March 2007, the company has chicken contracts with three primary suppliers that expire in Feb '08 or Feb '09. Two of these contracts have fixed pricing and one of these contracts provides a floor and ceiling price for the chicken we buy. The company believes this structure gives us better predictability for product cost in an environment where corn prices, which are the primary feed for chicken, are very high due to the increasing demand for the production of ethanol and the ethanol plants coming online.

That wraps up what we see both in '06 and how we are looking at major issues going forward in '07. So at this point I would now like to open it up for any questions.

Maria?

Thank you very much. [OPERATOR INSTRUCTIONS] Our first question comes from the line of [Reed Kahn] from Merrill Lynch. Please proceed.

Hi, Steve, hi, Joe.

Hi, Reed.

Just a couple questions on the -- for the year, I was wondering if you could break out what you spent on advertising?

Advertising was 3.8% of company revenues, so I'll figure out the dollars in just a second, but -- let me get a calculator.

Contractually, we target spending 4% of combined system revenues in advertising. It varies a little year-over-year, especially when we have very strong comps at the end of the year, we basically can't spend the money fast enough from what we budgeted, so we comment a little bit less and carry it over and try and spend it in the next year.

Usually you could forecast, we're going to try to spend around 4% each year.

That's a pretty good number as we're contractually obligated. In new markets with new franchisees, those contracts have a 5% advertising contribution.

But that amount would not be an expense for the company, that's just an amount we manage for them.

Correct.

Got it. And so is 3.8% for the year and -- I'm sorry, I actually don't have it for last year, was that a comparable number in '05?

Yes, it was.

Yes. We're contractually obligated to spend 4% in the vast majority of our contracts, company and franchise. The only reason it's not exactly 4 is a reflection on how the business moves towards the end of the year and we're not going to spend the money just to hit a 4% number we planned and execute our budgets and that's why it varies a little bit from 4.

So it's about $9.2 million in '06, Reid.

9.2, okay. As far as -- I believe you would have classified your participation on The Apprentice as an ad spend. Was that all in the fourth quarter?

We did pay for The Apprentice out of the advertising fund and it did hit third and fourth quarter.

It hit when it ran. When did it run?

It ran in January.

Actually, it would have -- the way the advertising expense works is you incur the expense when the related advertisement airs, so actually that would probably be first quarter. Yes, primarily a first quarter expense. It doesn't matter when you pay the money, it's a matter of when the related advertising runs.

Okay.

So that'd probably be first quarter. But that would have been budgeted into our overall spending.

Okay. It would have been within that 4% budget?

Exactly.

Okay. And on the price increase, is that -- should we think of that as something that's going to more or less cover your wage exposure?

Yes, more or less. That's correct.

Okay. And then as far as how the chicken prices evolved this year, that's really something that you fall back on your contracts, which again allow you to smooth the impact, but not necessarily hide from it entirely.

Exactly. We have -- like we said in the press release, we have -- and earlier today, we have three contracts, two of them actually have the prices fixed for this next year and one has a floor and ceiling. There's a max it can go up with. We can predict within a range where it's going to be.

Okay.

So it will be interesting to see how this year plays out with what's been happening out there.

I seem to remember that going into this announcement today, you had two contracts, and that they expired -- I think they both expired this year, correct me if I'm wrong? Does that mean that you know have -- you've added net an additional contract and you've actually updated all three?

We actually had three before, except the third one was much smaller.

Okay.

The third one that was smaller is now bigger, so it's worthy of mention, if you will. And there has been a change in the environment. We have -- we brought -- two of our previous suppliers merged, and so then we brought a new guy on.

So we still have three. A little confusing, but we still have three contracts in place this year. And they're all weighted a lot more evenly between the three versus last year when we had two big ones and one small one we didn't really mention.

Is there any way you can give us a little, I know you don't like to give guidance, but based on price progression of commodities through the current day, if we were to flat line that over the year, which is probably not the accurate way to look at it, but if we did, what kind of a gross margin hit there would be either way?

Yes, that's something we really don't do.

Okay.

Yes. Apologize.

Just one for me and I'll pass it on. I was just curious for the new store development plans as far as the corporate side, what we should use for our growth CapEx number and then any other items in CapEx at the corporate level that we should use in our model this year?

On the CapEx, that's actually a really relevant question, because right after this call we're having a meeting to talk about CapEx for '07. We budgeted a number, but we're trying to do a gut check to see if that compares against what's going on in the environment right now. I would hate to give you something if it's a little bit off. I think historically in previous Ks, we've talked about $1.1 million, $1.2 million give or take, and that's excluding the land, but I can't tell you that that's the number we'd use for '07. So -- because we're still looking at that, because it's been a pretty dynamic environment out there on a construction cost standpoint.

And the timing of the corporate-owned stores, is it going to be front end weighted in the year?

Typically it will be back end weighted, no matter what we say, it ends up being an end of the third quarter, fourth quarter push to close.

We do -- if you do the calculation in the stores as of today, we have opened two company stores so far out of the projected ten. All right. Thanks. I'll pass it on. Thank you.

[OPERATOR INSTRUCTIONS]. Our next question comes from the line of Bryan Hunt from Wachovia. Please proceed.

Thank you. Good afternoon -- or good morning to you out there.

Hi, Bryan.

Hi. Can you just remind -- to continue on the CapEx, Joe, can you talk about what your maintenance is, just as a reminder?

Yes.

Maintenance CapEx.

Maintenance CapEx. It tends to run similar to what you've seen in the press -- that we disclosed actually in our -- I think it's in the cash flows sections of our previous Ks, around $2 million a year, give or take, the maintenance CapEx for all company stores.

All right.

Yes.

All right. Maybe you all could talk about transactions, they were down in the most recent quarter. Is there something driving that in the environment, whether it's the mortgage environment, the wage environment, or has the environment become more competitive? I saw some of the couponing you all were doing in the fourth quarter and early in the first quarter. Could you talk about why you believe your transactions were down?

Well, transactions move around a little bit over the course of any given year, and they also move around depending on what our marketing programs are specifically. The reality is, we're in a very competitive environment and that just -- that's a fact, and it's going to continue to be that way. We, on balance, would not take as much pricing as we have taken to cover minimum wage.

Typically, our consumers particularly at the lower end of the income scale are very sensitive to price and they have X amount of money in their pocket. They buy the same thing routinely when they come in, and when they come in and there's a price increase, one of the first things they do is they take a little bit of time to absorb that and the frequency of their visit may slow down a little bit. Typically, it pops up later, but we think that's worked. We have a very competitive environment, we have very aggressive couponing from our competitors, and we've had to take pricing to cover minimum wage, and that puts pressure on transactions, too.

There's a lot of talk out there on gas, and the impact on price. Gas here in California especially is ridiculous.

It's back over $3.30, is it?

Yes. There's also talk about the mortgage industry and what impact that has, and there's two pieces to that, the whole subprime thing, which is on the top of the news, but the more critical thing to watch is all these adjustable rates for folks that are adjusting up. And on that, we don't know and we can't calculate if that's impacting our sales. In one respect, I could say gas prices didn't because in the height in the summer, our comps were fine. But it's really -- there's no statistical information that we've been able to find to correlate either of those two items. Logically, you think there could be some impact there, but we have not been able to determine if that indeed is the case or not.

Right. And you can't discount the fact that we've had seven straight years of comp store sales growth and transaction increases. So we're lapping pretty stunning absolute numbers, and you're going to -- we're going to clear the bar, but it's going to be more like a high jump. Our shorts might touch the bar, but we're going to get over it and that's going to move around a little bit.

Could you talk to us about your current contracts? I know you alluded that two of your chicken contracts are fixed and the other ones have a floor and the ceiling. Are you up against that ceiling coming into the year? And also can you also talk about when you might go to your suppliers and start negotiating to renew your contracts that expire in February 2008.

We actually just went through the contract negotiations in the last couple of months, started in December '06 and ended in February. And that's where we, as we've disclosed, have a contract that goes through '09 and another one that goes through '08. That one that goes through '08 had ended in '07. So two of the three contracts we just renewed.

And Steve Lash, who's our Director of Supply Chain Management and I and other folks are always looking at and strategizing around chicken, since it's such a big part of our product costs, we're never really not looking at it. And if there's an opportunity, whatever that is that seems to make sense for us, we'll jump on it. We don't wait until December of each year, we're always looking at it. So in answer to your question, it could be anytime where we might say, here's a good time to extend a contract out. We don't know when that is, it just depends on what the opportunity is at that time.

Would it be fair to say that given the way chicken prices have moved since November, that what you're paying is below the current spot, or materially below the current spot?

That goes into information I don't want to share for competitive reasons.

Okay. Could you tell us, Joe, whether there was any non-cash comp or any other non-cash items in Q4 as well as all of 2006 that flowed through the income statement?

Non-cash comp. The only one -- yes. The only one would be stock option expense.

And could you tell us how that fell out and how much was in the fourth quarter?

Yes. It wasn't huge, but the total amount was probably around $600,000.

And that was for Q4?

The whole year. So it's not a big number. And Q4, I can't remember the amount, but it's not going to be significant.

Okay. While I'm also doing nitpicky items, can you tell us what cash and debt is at year end?

That's going to be out either tomorrow or Monday, all that information. So we're just waiting for final auditor sign-off.

Do you know how much medicine I'm going to have to take to adjust for that?

I'm sorry?

Nothing. I was saying how much medicine I was going to have to take. I'm anxious.

I appreciate your patience, Bryan.

Can you talk about your store at Foxwoods and how it's performing?

Our store at Foxwoods behaves a lot like our store at Universal Studios because it tracks very closely to the attendance at the facility. So we opened, of course, in the fourth quarter of '06, and that's the trough of attendance at Foxwoods and the franchisees were still very pleased with the volumes and the volumes are climbing very nicely as the traffic to that facility is going up, and we don't release per-store kinds of numbers, but I would anticipate as we get into the peak season, that this will be an eye-popping volume level and the franchisees are very happy with it. And even at the trough, it was a terrific number that far exceeded any of the pro formas that we do in our season.

They've had peak days like on a Saturday in good weather, pretty incredible volumes. I think the best gauges for any of you guys on the call who are on the east coast to go visit the location, especially if you want to see them really cranking, like on a weekend, when the most people tend to go there. If you hit it there, you'll see some pretty impressive throughput.

The other thing we really are pleased about is on these peak days, when there's a lot of traffic in the casino, our volumes approach that of our next door neighbor, Panera Bread.

Wow, that's fantastic.

Yeah, that benchmark is really terrific. Now on lower-volume days and given the fact that Panera Bread has breakfast, they do a proportionally better job. But when there's a lot of traffic, we're approaching the same kind of numbers as Panera Bread, and that's our first foray in the east coast.

Okay. I'll get back in the queue. Thank you.

Thank you.

Actually, we have nobody else queueing up for questions, so if you wish to continue asking questions, that's fine.

Fantastic. Looking at the beginning or late last year, you all signed up a significant number of franchisees to new agreements, the Atlanta market is an example. Do you have anything in the pipeline you're negotiating right now?

Yes, we do. We're very pleased with the quality of those folks and that's probably all I'm going to tell you about it.

Okay.

Like real estate, it's not over until it's over and once it's over, you'll be very quick to know.

I think we've had a couple releases in the last three months and you can see on our Web site some of the more recent signings. Which includes North Jersey and Long Island, a very experienced Panera Bread operator there.

Tremendous progress in Chicago.

Two more.

Two more groups in Chicago, St. Louis.

Yep. So those are the ones we've signed in the last few months.

All right. Two more questions. One, could you talk about your quality of the most recent openings and whether they're hitting your AUV targets? And two, whether those locations, because you're opening a lot of stores in market next year, do you anticipate cannibalization of your current store base?

Obviously, we are pleased on balance with the performance of our new stores. There are individual situations where we thoughtfully end fill a location between several others, and we do have some cannibalization there, but it typically disappears in years two and three and we're pleased with how all the stores respond. There are other situations where because of the nature of the real estate development going on, we open a little ahead of the rest of the tenants in the shopping center and so those stores will open a little bit softer as the rest of the retail tenants fill in, particularly the anchors. And that's just a function of our agreement with the developer, and we've seen that in a recent opening or two.

One side about this, our company growth strategy of only growing here in L.A. and Vegas is the fact that we're going to impact the company comp sales, because it's getting harder and harder to put in a site without impacting another store somewhere in the area. Less true in Vegas where we have eleven stores and they're spread out pretty nicely, a little more true here in L.A. Brian, that's a good point. In future releases, we may actually calculate and let you know what that impact is, but we haven't disclosed that previously.

Last question, because I'm out on the east coast, instead of the left coast where you are. Pollo Campero announced that they've got a new franchise agreement for stores in L.A., and I know there's some stores there to date. Can you talk about how you overlap with them from a menu perspective? How do believe they are from a competitive perspective and where those stores may be if you heard they're going to be up against yours from a geographical perspective?

Well, they're going to be up against us from a geographical perspective because you physically can't do anything different. The biggest difference we see with Pollo Campero is obviously, it is a Guatemalan, Central American-based concept, and their core constituency is people from Guatemala who missed that product from where they grew up. The other key element is that it is a fried chicken product and we are not. We do trade users with KFC, Church's, Popeye's, and we trade users with Pollo Campero a little bit, too.

But we think Pollo Campero has a couple of challenges. Number one, their base -- I'll take Mexico over Guatemala every day, from a Hispanic source of strength kind of authenticity perspective, and I'll take flame-grilled over fried, because I continue to struggle with why we need any more fried chicken given all the health nutrition awareness and all of the focus on obesity. When they open close to us, we typically do feel it. One more recent opening out by the Burbank airport is interesting, because the store we have there, the Pollo Loco there, which is a company-owned store is an end-cap in an underparked shopping center, and the Pollo Campero is free-standing store with a drive-through with ample parking. So we did, for obvious reasons, because of how tough it is to park, we did feel a little bit of a hit when they opened. But we'll get that back. We're not laying awake worrying about Pollo Campero.

Any fast food restaurant that opens near our store has potential to impact stores for a little while, whether it's a McDonalds, a Baja Fresh, a Chik-Fil-A, or a Chipotle and I don't think there's any more impact from a Pollo Campero than any of those other chains, as people go to try out the new building and the new center.

This last Pollo Campero I was in out by Burbank airport, they are basically priced virtually the same as we price.

Interesting.

So that was -- I found that interesting too.

Thank you, gentleman. I'm all questioned-out.

Thanks, Bryan. Appreciate it.

And our next question is a follow-up question coming from the line of Reed Kahn from Merrill Lynch. Please proceed.

Hi. Thanks. I figured I'd ask you another once since we had a chance here. I was wondering in the quarter what the impact of some of the family promotions that you had discussed was and whether that had helped you cut the rate of decline in transactions? Any comments there?

Well, the fourth quarter of '06, the program was the double your chicken -- no, excuse me, it was the $5 gift card with a very short expiration, three different $5 gift cards upon the purchase of a family meal. We were very pleased with the performance of that specific promotion. That met our expectations and our forecasts. Obviously, transactions were a little soft. That's primarily at lunch when we're facing a pretty aggressive onslaught competitively from primarily the burger guys.

I think that's showing true. I hope that helps.

Yes, that helps. Did you notice anything in the quarter in terms of a shift in mix towards more of your dollar-priced items?

The dollar menu has been holding up pretty consistently on a per-item sales per store per week basis for quite a while. It's really been a terrific addition to our menu and it acts as a great kind of safety net for us on pricing. But it's performing about the same level it did a year ago from the standpoint of number of items sold per week per store.

Yes, very strong. We don't see a big flux in that area.

Okay. Just final one, I don't know if there's anything you can comment on this credit card-related suit that came up, is there any update you can provide us on that?

No. You'll see in our press release -- in our 10-K there'll be a little blurb about it and that's probably all we can tell you when that comes out, because we haven't disclosed that anywhere else.

Just saw a couple press items out there.

In our K, Friday or Monday, you'll see more information about that.

Thank you.

And we have no other questions at this time. Mr. Carly and Mr. Stein, I'll turn the call back you.

Thanks very much, everybody. We appreciate your time and attention, have great day. We're going to sign off. Thanks.

Ladies and gentlemen, that does conclude our conference call for today. We thank you for your participation and ask that you please disconnect your lines.