El Pollo Loco Holdings Inc (LOCO) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by.

Welcome to the El Pollo Loco second-quarter 2015 earnings conference call. At this time, all participants have been placed in a listen-only mode, and the lines will be open for your questions following the presentation. Please note that this conference is being recorded today August 13, 2015.

On the call today we have Steve Sather, President and Chief Executive Officer of El Pollo Loco, Larry Roberts, Chief Financial Officer, and Ed Valle, Chief Marketing Officer. And, now, I'd like to turn the conference over to Larry Roberts.

Thank you, Operator. Good afternoon.

By now, everyone should have access to our second-quarter 2015 earnings release. If not, it can be found at www.ElPolloLoco.com in the Investor Relations section.

Before we begin our formal remarks, I need to remind everyone that our discussion today will include forward-looking statements. These forward-looking statements are not guarantees of future performance, and therefore, you should not put undue reliance on them.

These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. We expect to file our 10-Q for the second quarter of 2015 tomorrow and would encourage you to review that document at your earliest convenience.

During today's call, we will discuss non-GAAP measures which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and reconciliations to comparable GAAP measures are available in our earnings release.

With that, I'd like to turn the call over to Steve Sather.

Thank you for joining us on the call today. Our second-quarter results included pro forma earnings growth in excess of 20%, and our 16th consecutive quarter of system-wide comparable sales growth. For the quarter, we saw a 1.3% increase in system-wide comparable restaurant sales growth that consisted of a 50-basis-point decrease for Company-operated restaurants and a 2.6% increase for franchise restaurants. While comparable sales were below our target, the increase in system-wide comparable sales came on top of a 5.4% growth last year for a two-year growth rate of 6.7% and a three-year growth rate of 16.3%.

As we discussed in our last earnings call, our second-quarter results were impacted by the combination of higher-priced offerings and a reduction of our value portion of our menu. Specifically we ran sequential promotions featuring premium entrees with shrimp and carne asada at the same time we were eliminating our $5 combo menu panel. We believe this confluence of actions drove reduced visits from some of our more value-oriented customers. We remain confident that adding new proteins to our menu is an ongoing opportunity for us, and in fact, we have added shrimp to the menu permanently.

In the third quarter, we relaunched the $5 combo menu which will remain in our restaurants full time to reinforce our value offering. This allows us to return to our winning QSR+ strategy of introducing exciting, new, premium Mexican entrees like the new chicken and shrimp paella bowl that's in restaurants now, to a base of underlying value frequency drivers like our $5 combos. While it is early in the promotion, we are encouraged with the results so far.

In addition to providing our guests with cravable food, as part of our QSR+ positioning, we are very focused on enhancing overall experience of our customers. To that end, we are currently working on a number of initiatives to improve our customer experience. During the second quarter, we completed the rollout of two initiatives designed to drive higher throughput and faster speed of service. We rolled out our pagers to all Company restaurants and implemented peak labor hour deployment.

In addition, we are currently developing simplified product builds, a new, more efficient layout for our center line, streamline point-of-sale entry and enhanced training through a learning management system. We also expect to test a new back-of-house layout later this year. These are all exciting initiatives designed to further enable our employees to more effectively and efficiently deliver great food with great service.

Switching to development, our pipeline continues to be robust, and we are positioned for 8% to 10% unit growth over the long term. Building on the success of our entry into Houston, we've announced significant expansion plans to enter the Dallas market. To ensure continued success in our Texas expansion, we recently added directors of operations and real estate who will be responsible for Company operations and new site selection in Texas.

During the second quarter, we opened one Company restaurant in Humble, Texas and one franchise location opened in Napa, California. We remain on track to open 16 Company-owned restaurants in 2015 representing over 9% growth in Company-owned stores. Our franchisees currently plan to open eight restaurants in 2015. This is down slightly from our previous expectation of 11 as several franchise units expected to open in late 2015 will likely slip into 2016.

Supporting our move to Dallas, we have selected a Dallas-based franchisee to co-develop the market. This new franchisee will open a total of seven restaurants in the area over the next four years. Combined, Company-owned and franchise development is expected to result in a total of 20 to 30 El Pollo Loco restaurants to the Dallas market by 2019.

In addition, we continue to actively pursue Company and franchise development in a number of western markets. As you may have seen, we recently announced a new development agreement with our largest franchise partner, WKS Restaurant Group, expanding their commitment to Utah with plans to open six new restaurants in Salt Lake City. This will bring the total Utah franchise pipeline to 12 restaurants. We continue to hold active dialogue regarding new unit development agreements with current franchisees across multiple markets and have a number of highly qualified franchise candidates looking to develop with us.

In addition to new unit development, we continue to remodel existing restaurant base with our Hacienda design which better reflects our elevated brand promise. Through the end of second quarter, we have completed 243 remodels system-wide and over 270 restaurants are either new or remodeled with Hacienda design representing about 65% of the system.

With that, I'd now like to turn the call over to Larry for a detailed discussion of our second quarter results and 2015 guidance. Larry?

Thanks, Steve. For the second quarter ended July 1, 2015, total revenue increased to $89.5 million from $86.9 million in the second quarter of 2014. The increase was largely driven by growth in Company-operated restaurant sales which rose 2.7% in the second quarter to $83.6 million.

The increase in Company-operated restaurant sales was due to the contribution of 13 new restaurants opened during and subsequent to the second quarter of 2014 partially offset by lost sales from 6 units sold to a franchisee and a comparable restaurant sales decline of 0.5%. The decline in comparable restaurant sales was comprised of a 3.9% decrease in traffic partially offset by an increase in average check size of 3.4%. Franchise revenue increased 6% year-over-year to $5.9 million driven by comparable restaurant sales growth of 2.6% as well as contribution from new restaurants and higher franchise renewal fees.

Turning to expenses, food and paper costs as a percentage of Company restaurant sales increased by 50 basis points year-over-year to 32.4%. The increase was predominant due to higher food costs associated with our shrimp and carne asada promotion. For 2015, we continue to expect overall food and paper inflation to run 2.5% to 3% as higher chicken prices, which we have locked in for 2015, are partially offset by favorability in other commodities.

Labor and related expenses as a percentage of Company restaurant sales increased 50 basis points year-over-year to 25.2%. The increase in labor expenses was driven primarily by higher workers' compensation and medical insurance claims activity. Excluding the higher workers' compensation and medical claims activity, labor costs were approximately flat year-over-year.

Occupancy and other operating expenses as a percentage of Company restaurant sales were flat compared to the prior-year second quarter with both periods coming in at 20.8%. The flat year-on-year performance was driven by lower utility rates offset by higher credit card fees.

General and administrative expenses decreased by $430,000 year-over-year in the second quarter to $6.4 million. As a percentage of total revenue, G&A expenses decreased 70 basis points to 7.2%. The decrease was due primarily to the capitalization of $310,000 in internal development costs related to site selection and construction activities and a decrease in bonus accrual partially offset by an increase in stock option and associated payroll and tax expenses.

Depreciation and amortization expense increased to $3.2 million from $2.8 million in the second quarter last year. As a percentage of total revenue, depreciation and amortization increased 40 basis points year-over-year. The increase was primarily due to our new store development as well as our remodeling program. For the full year, we continue to expect depreciation and amortization expense to be between 3.7% and 3.9% of Company revenue.

Interest expense decreased by $4.7 million year-over-year to $1 million from $5.7 million in the second quarter of 2015. The decrease is largely due to payoff off our second lien credit facility and the proceeds of IPO in July of 2014, lower interest rates associated with our December 2014 refinancing of our credit facility, and to $30 million of payments on the revolver in the first half of 2015.

During the second quarter, we incurred a charge of $200,000 related to the present value of expected payment under our income tax receivable agreement which calls for us to pay our pre-IPO shareholders 85% of the tax savings realized as a result of utilizing our pre-IPO net operating losses and other tax attributes. We recorded a provision for income taxes of $5.1 million in the second quarter of 2015, reflecting an estimated effective tax rate of 41%. This compares to a provision of $570,000 in the prior-year second quarter.

We reported net income of $7.2 million, or $0.18 per diluted share, in the second quarter compared to net income of $6.6 million, or $0.22 per diluted share, in the year-ago period. Weighted average diluted shares outstanding were approximately 39.1 million shares for the second quarter of 2015 and 30.4 million shares for the year-ago period.

To account for our 2014 IPO and change it to our capital structure, we have calculated pro forma results including net income and basic and diluted share count as if the IPO had occurred at the beginning of FY13. To arrive at pro forma net income, we have made adjustments for IPO and secondary offering expenses, credit facility interest expense, expenses associated with a tax receivable agreement, losses on disposable assets, asset impairments, and closed store costs. We have added back provision for income taxes and have applied a 41% income tax rate.

Included in our earnings release is a reconciliation of our GAAP results to our pro forma results. We believe that the pro forma results provide a useful view of our business and our post-IPO capital and cost structure. Accordingly, pro forma net income for the quarter was $7.4 million as compared to $6.1 million in the second quarter of last year.

Pro forma diluted earnings per share were $0.19 for the second quarter this year compared to $0.16 in the prior-year period. We have used a diluted weighted average share count of 39.1 million shares for the second quarter of 2015 and 38.6 million shares for the year-ago period which we reflects our shares post-IPO.

In terms of our liquidity and balance sheet, we have $6.4 million in cash and equivalents as of July 1, 2015, and $135.7 million in debt outstanding. For the foreseeable future, we expect to finance our operations including new restaurant development and maintenance capital through cash from operations and borrowing under our credit facility. We still expect our capital expenditures to total $34 million to $37 million for the full-year 2015.

Turning to our 2015 guidance. We are maintaining our 2015 pro forma diluted net income per share expectation of $0.67 to $0.71, which now includes a $0.02 per share benefit resulting from capitalizing development costs directly attributable to remodels and building new restaurants. This compares to pro forma diluted net income per share of $0.55 in 2014, which included an estimated $0.01 per share positive impact due to a 53rd week.

Our pro forma net income guidance for 2015 is based in part on the following updated annual assumptions. System-wide comparable restaurant sales growth of approximately 3%.

We expect to open 16 new Company-owned restaurants and expect our franchisees to open 8 new restaurants. We expect restaurant contribution margin of between 21.2% and 21.5%. We expect G&A expenses of between 7.8% and 8% of total revenue. We expect adjusted EBITDA of between $65 million and $67 million, and we are using a pro forma income tax rate of 41%.

With that, I'll turn the call back over to Steve for closing remarks.

Thank you, Larry. We continue to be excited about the long term opportunities to grow the El Pollo Loco brand. Our success to date has been driven by our focus on delivering high quality food, compelling value, excellent service, and a warm and inviting atmosphere. We believe our efforts to reengage the value customer along with our steadfast focus on these four pillars position the brand for continued growth through increasing comparable restaurant sales, expanding the restaurant base, and enhancing restaurant operations.

Thank you for joining us today. We appreciate your interest in El Pollo Loco, and we would now be happy to answer any questions that you might have. Operator?

(Operator Instructions)

David Tarantino, Robert W. Baird.

First question is about the comp trends that you saw in Q2, and perhaps if there is a comment on what you're seeing in Q3. Steve, could you elaborate on the factors you think are weighing on the trend line? And then, I know you mentioned removing the $5 panel, and now bringing it back. Is that one of the factors that's giving you confidence that you could see better trends going forward? And then, I have a follow-up. Thanks.

Sure, David, glad to. Let me give you an overview, and then I'll have Ed talk specifically on some of the things we've done in Q3. First of all, I think -- kind of referred to it. We lost the value focus on the first half of 2015. As you know, we employ a balance of a high/low-pricing strategy, and what I think happened is we temporarily overweighted this to the higher-priced items. To be more specific, we increased the prices on our $5 combo meal. We actually removed that panel from the rest -- from the menu board, and because that was in February -- because of the higher pricing.

Also, we increased the prices on our value menu, and specifically, on another entree line, which was important, the 5 under 500. We believe that really impacted our value customer. When you then take on top of that that we layered in the premium proteins, we first did shrimp and then carne asada. While we were happy with their performance, we think that they really further drove that perception of higher prices with the non-focus of value. And, I'll add comment on what we've done in the start of third quarter to really counter that. But, good question, David.

I think that is exactly right. We launched the $5 combos, David, or relaunched them. To make -- first of all, to put that panel back up on the menu board and make it more prominent, and we're seeing strong results from that. That $5 combo panel will remain for the balance of 2015. We also relaunched the under 500 line, which we spoke about briefly in the last call, that we have. Giving customers more value in terms of, not just variety, but also in terms of price range as well. It's not back to its original level, but it is showing very solid growth as we're looking at it. So, we feel pretty good about moving to trying to stabilize the business and reengage our value customer.

And then -- .

David, you had another question?

Yes, the follow-up to that was -- it sounds like you alluded to it. But, you're starting to see the business respond to the changes you're making, and in your history, have you dealt with this issue before in terms of losing that value customer and then winning them back? Some historical context there would be helpful.

Yes, this is Steve.

I think in period seven, first period of Q3, we actually had the $5 pollo bowls to launch there, and then the next period the $5 combos and the chicken and shrimp, and we saw the stabilization certainly of bringing that very popular $5 pollo bowl item and now the $5 combos on that. So, we're seeing that stabilization.

Quite frankly, we had never taken something like that off the menu board before. They've been on -- we've had a very -- there has always been a value portion. Either in $5 loco menu or a number of what we call our snack items, and we had taken some price on those. So, we think we've got the menu back in line, seeing improvement, and that will transition through Q3 and then build in Q4.

Great. Thank you.

All right. Thanks, David.

Andy Barish, Jefferies.

Yes. Wondering why you didn't get -- assuming menu pricing was about 3% in the 2Q or so -- wondering why you didn't get more menu mix from promoting premium items? And then, in the back half you're implying about a 3% system-wide comp, I think. What gives you confidence in that number for the back half of the year?

Well, Andy, as we mentioned we've seen the immediate stabilization and return of the transactions with the launch of the $5 pollo bowls and now the 5 under 500 calorie line. We have got a revamped menu on that. As well as -- I just want to say that shrimp and steak also performed well on the consumer attribute. We just thought we lost that whole aspect of the value. So, we're seeing it come back. Ed, you want to add anything?

I think people, Andy, are managing check, and I think that we're seeing some trade-down. For example, on drinks, and those types of things.

Okay. Thank you.

Operator?

John Glass, Morgan Stanley.

Hi, this is Courtney on for John.

Just a quick question on G&A. It seems like aside from the $310,000 that you capitalized, it was still down year-over-year. So, if you can just give us a sense on how to model that going forward?

Yes, Courtney, the other big thing we did in the quarter was we adjusted our bonus. We call it the ICP bonus, and that was adjusted downward given our year-to-date results. So, that was actually the bigger driver of the upside than even the capitalization. And then, for the balance of the year based on our forecast, we're also projecting G&A savings from that bonus adjustment.

Okay. Got you. And then, just quickly can you just comment on how the minimum wage hikes in California and in LA, specifically, have impacted the store-level margins in those areas? And then, in aggregate?

Sure. As of now, again, just to repeat what we said before is, the minimum wage hike in California, the initial one was last July of basically 50 basis points or 0.5%. And, we did not really see much impact from that. We took some pricing and offset that. No other minimum wage increases will take place until January 1. That's when the state of California goes from $9 to $10. And, we're working here to mitigate the impact of that through a number of initiatives.

Starting -- first of all, really going through all of the other costs in the organization. Really scrub and look for cost savings to mitigate that impact. We'll also look through and see what things we can do to drive efficiencies in our back of house. A number of the things that we're doing operationally which Steve talked about in the call will hopefully drive efficiencies.

And then, the third element will be, then -- okay, let's take a look at where we are and then we'll look and see whether we need to take additional pricing. And, we'll be much more sophisticated about how we take that pricing. Get very focused on where those minimum wage impacts are impacting our margins and look at [taking] pricing there. And also, we'd hire an outside company to help us look through -- what items are elastic, which ones are inelastic, and we'll have a much more sophisticated approach to pricing that we'll take if necessary toward the end of this year.

Okay. Thank you.

(Operator Instructions)

Sharon Zackfia, William Blair.

Hi, good afternoon. I have a few questions. If I'm not mistaken, trends must have worsened as the second quarter went on since you slightly missed your guidance. Can you talk about what you saw with trends worsening in June? And then, I think it would be really helpful to know what the quarter-to-date trends are through the middle of August? I know you said things have improved. Steve, you said the return of the transactions. I don't know if that means traffic is back to positive or not, but I think it is important for all of us to understand where the business is now relative to the guidance.

Sure, Sharon, the trends -- Larry, we can give the trends in the quarter in Q2?

Yes. The trend in Q2 was -- it did weaken during the quarter as carne asada and hand-carved salads came on again, tying into the fact that those are high-priced items. And, again, we hadn't changed out the value menu and the value panel until really end of the quarter, early third quarter.

And, we saw those reverse almost immediately when we did the -- on the transactions trends. When we brought in the $5 pollo bowls in period seven and then the $5 combos on the menu permanently in period eight now.

So, you are back to positive transactions?

Well, no, we are not yet back to positive, Sharon.

Okay.

We are improving from where we were during Q2 in the Company restaurants. And, as we've said, this value equation will fix itself over time. It will take a little bit, so we think Q3 will probably be a little softer than Q4 as this relaunch of value and those initiatives take hold, get traction, and then lead us into a decent Q4.

Okay. Maybe asking a different question along these lines. Just trying to get clarity, again, on the guidance. You still have a range for the full year, but you have a pinpoint approximately 3% guidance range, instead of the comp? Is that a plus- or minus-50 basis points that you're thinking about for the approximately 3%?

Yes. I think it would be something like 50 basis points. Yes. (multiple speakers)

Another question on the franchise development side. So, just thinking through -- understandable, restaurants move into the next year. Are you still pretty comfortable on getting the 8% development growth as early as next year? Or, should we think about ratcheting that down a little bit in our models?

Yes, we're very comfortable on the Company side, and we've got good, improving -- good and improving on the franchise pipeline. As you know, we just mentioned on the call that the -- in Utah, we signed Roland Spongberg, WKS along with United Lerone which is the other franchisee which we announced earlier this year. That is 12 units there. And, we're going into Dallas. We have that franchise agreement is signed. In fact, that franchisee is in training right now with us here in Southern California. So, that will augment our Dallas.

And, we have other existing franchisees looking to develop in the balance of the west as well as Kay Bogeajis and her group in the franchise side have generated a number of interests from larger franchisees that are outside of our current system. So, we feel good about -- very good in Texas, both in Houston and in Dallas. Utah now, those units will start to open up next year. We see probably five to six units opening up in Dallas full year. First units opening up in the first half.

Okay. And then, last question. When you're talking about getting more sophisticated if you need to take price again for the minimum wages, particularly in California Are you doing that work on the price studies now so that if you need to take price in order to combat or protect the margins, you'll be in a position to do that?

Yes, we started, and I'll turn it over to Ed here. But, we brought in a company called Czar Metrics and working with us, and we have been working about -- just on a month right now analyzing all of our price aspects. Ed, you can give more specifics.

I've worked with them in the past. We brought them in. We're actually working on the data right now. Plan to have that all completed over the next couple of months here in time for our next price increase. They'll really give us the science that we're looking for here.

Thank you.

Thank you, Sharon. Operator, next question?

There are no other questions in the queue at this time. I'd like to hand it back over to management for closing comments.

Thank you very much everybody for joining us today, and we look forward to next quarter. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.