El Pollo Loco Holdings Inc (LOCO) 2016 Q3 法說會逐字稿

Greetings, and welcome to the El Pollo Loco third quarter 2016 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Larry Roberts. Please go ahead, sir.

Thank you, operator, and good afternoon. By now, everyone should have access to our third quarter 2016 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 also 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 third quarter of 2016 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'll turn the call over to Steve Sather.

Thanks, Larry, and good afternoon, everyone. We appreciate your joining us on the call today.

We're pleased to report the third quarter results, which included our 21st consecutive quarter of system-wide comparable restaurant sales growth and pro forma net income of $0.18 per share. Our ongoing focus on our four pillars of our brand -- great food, excellent service, a warm and inviting atmosphere, and a good price -- has enabled us to achieve these results despite the challenging environment.

We believe our steadfast focus on our brand pillars, combined with recent and upcoming initiatives designed to highlight our differentiated brand, sharpen our value, improve our operations and elevate our service, will drive our business today and into the future.

System-wide comparable store sales increased 1.6% during the quarter, including a 1.8% increase at franchise restaurants and a 1.4% increase at company-operated restaurants. While overall transaction growth at company-operated restaurants during the quarter was flat year over year, we started experiencing a softening of sales during the second half of the third quarter, which has continued into the fourth.

We continue to see solid year-over-year growth in our entrees as well as in both lunch and our snack day parts, while the softening being driven largely by our family meals and the dinner day part. As you know, family chicken meals are an important aspect of who we are as a brand, so we are focused on turning these sales around and are currently testing alternative offerings, which we believe will help reinvigorate sales of our family meals.

Highlighted in our differentiated brand identity will be the critical element in an enhanced marketing strategy as we work with our new creative agency. We recently hired Vitro after a competitive review involving over 25 agencies.

Vitro was chosen based on their vision and creative approach to driving brand differentiation. The new campaign is expected to start early next year and will focus on our unique heritage and the lengths we go to in our restaurants to prepare delicious food and deliver a great experience.

At the same time, we've been working with our new media agency, Harmelin Media, to continue diversifying our media spend to include other channels like radio, digital and social media. Combined, we believe we will be able to broaden our reach with a differentiated message.

With regards to service, we continually strive to improve the experience of our customers, and are currently working on a number of initiatives designed to ensure our teams deliver the best dining experience possible. This includes the initial rollout of a new tablet-based learning management system in the fourth quarter. The learning management system is the foundation of a new learning structure that we believe will deliver consistent training to our teams and help enable scalable expansion.

Lastly, we are now testing our mobile app and are on track to roll it out to all stores by the end of the year. Not only will our mobile app give our consumers the ability to order and pay via their mobile phones, it also is a gateway for further innovation, including the loyalty programs, ordering kiosks and delivery, all of which we expect to test and launch during 2017. We believe these initiatives, amongst others, will further enhance our value proposition and drive sales growth.

Turning now to development, during the third quarter we opened five new company-operated restaurants, including our first entry into the Dallas-Fort Worth area in Allen, Texas. Additionally, franchisees opened two new restaurants during the quarter, including one in the Dallas-Fort Worth market.

Subsequent to the end of the quarter we have opened an additional four company restaurants. We are on track to open 17 to 18 new company-operated restaurants this year and expect our franchisees to open 11 to 12 new restaurants.

As we noted on our last call, we have recently undertaken a number of marketing and operational initiatives in Houston to build a deeper relationship with consumers to drive repeat purchases and build frequency. While we have yet to see an improvement in overall sales trends, these initiatives have been in place for only a short time. We are also implementing additional initiatives designed to drive trial in Houston, where we are not as well established as we are in our core markets.

With regards to Dallas, we now have four company and one franchise restaurant open, and we are pleased with the early results. Together with our franchise partner, we expect to open at least seven restaurants in the area this year. We will remain focused on accelerating development and feel good about our development pipeline.

During the quarter we signed a development agreement with a new franchisee, the Listo Way Group, to open two restaurants in Lafayette, Louisiana, and we continue to see high-quality franchisees with the capability to develop new markets.

Lastly, I'd like to touch on our new Vision prototype, which we feel more clearly reflects our brand and our QSR-plus positioning. All five of our current Dallas-Fort Worth locations have opened with the new design. Feedback on the new design has been very favorable, echoing what we heard from our initial remodel in Fullerton, California.

We currently have plans for at least seven additional remodels, which are expected to be completed during the first half of next year. Six of these are located in California and at least one in Houston. While not required to do so, we also have several franchisees committed to completing visionary models early next year.

We will closely measure the reception of the design with the associated sales lift. Going forward, all new company-operated restaurants which have not yet begun the permitting process will open with the Vision design, including substantially all of our openings next year.

And now I'd like to turn the call over to Larry, who will go over our third quarter results and our 2016 guidance in detail. Larry?

Thanks, Steve.

For the third quarter ended September 28, 2016, total revenue increased 7.8%, to $95.8 million, from $88.9 million in the third quarter of 2015. The growth was largely the result of the increased company-operated restaurant sales, which rose 8.1% in the quarter, to $89.7 million. This increase in company-operated restaurant sales was predominantly driven by the contribution from the 22 new restaurants opened during and subsequent to the third quarter of 2015, as well as the 1.4% increase in comparable restaurant sales.

The increase in company-operated comparable restaurant sales was comprised of flat transaction and a 1.4% increased average check. The increased average check was the result of a 1.5% increase in pricing, offset by 10 basis points of unfavorable mix.

Franchise revenue increased 3.3% in the quarter, to $6.1 million, from $5.9 million in the third quarter of 2015. This increase was largely driven by the contribution from 10 new restaurants opened during and subsequent to the third quarter of 2015 and comparable restaurant sales growth of 1.8%.

Turning to expenses, food and paper costs as a percentage of company-operated sales decreased 180 basis points year over year, to 30%. The improvement was predominantly due to lower commodity costs, particularly lower contracted chicken prices.

Labor and related expenses as a percentage of company restaurant sales increased 220 basis points year over year, to 27.3%. The increase in labor expenses was driven by higher wage rates, reflecting the impact of California minimum wage increases and increased labor costs resulting from new restaurants opened in 2015 and 2016.

Occupancy and other operating expenses as a percentage of company restaurant sales increased 50 basis points year over year, to 22.4%. The increase was primarily due to rent expense, a new and renewed restaurant leases and the incremental costs related to opening new restaurants in the fourth quarter of 2015 and the first quarter of 2016.

Included in our third quarter results is a gain on recovery of insurance proceeds for approximately $500,000. This reflects proceeds from business interruption insurance related to a fire at one of our restaurants late last year. While this benefit does have a positive one-time impact on the third quarter, we have not adjusted our pro forma earnings for it as the negative impact of the fire was not adjusted earlier in the year while the restaurant was closed for repair.

General and administrative expenses increased by approximately $1.9 million year over year in the third quarter, to $8.3 million. As a percentage of total revenue, G&A expenses increased 150 basis points, to 8.6%.

G&A expense in the third quarter of 2016 included $519,000 in legal costs related to the securities class action litigation. Excluding costs associated with the securities litigation, G&A expenses in the third quarter of 2016 would've increased approximately $1.4 million, or 100 basis points, as a percentage of total revenue. This increase resulted primarily from increases in headcount, a higher accrual for the Company's annual bonus program, restaurant preopening expenses and travel expenses.

Depreciation and amortization expense increased to $4.1 million from $3.3 million in the third quarter of last year. As a percentage of total revenue, depreciation and amortization increased 60 basis points year over year. The increase was primarily driven by new store development.

During the quarter we recorded a $2.4 million expense related to the impairment of the assets of two restaurants, one in Arizona and the other in Texas. As is our policy, we continue to monitor the recoverability of the carrying value of our assets on a quarterly basis.

Prior to our IPO, we entered into a tax receivable agreement that 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 provide a provision for income taxes of $2.8 million in the third quarter of 2016, reflecting an estimated effective tax rate of 35.2%. This compares to a provision for income taxes of $6.5 million in the prior-year third quarter.

We reported GAAP net income of $5.2 million, or $0.13 per diluted share, in the third quarter, compared to a net income of $4.7 million, or $0.12 per diluted share, in the year-ago period. In addition to our GAAP net income we have calculated pro forma results adjusting for one-time or unusual items.

To arrive at pro forma net income we have made adjustments for expenses and gains on the recovery of insurance proceeds for the reimbursement of property, equipment and other expenses related to a fire in one of our restaurants in 2015; expenses associated with a tax receivable agreement; gains and losses on disposal of assets; asset impairments; closed store costs; gain on disposition of restaurants; and legal expenses associated with a securities class action lawsuit.

We've added back provision for income taxes and have applied a 40% 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 cost structure.

Accordingly, pro forma net income for the quarter was $6.9 million, as compared to $7.2 million in the third quarter of last year. Pro forma diluted earnings per share were $0.18 for the third quarter of 2016, compared to $0.18 in the prior-year period.

In terms of our liquidity and balance sheet, we have $6.5 million in cash and equivalents as of September 28, 2016, and $107.5 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 borrowings under our credit facility. We expect our capital expenditures to total $37 million to $41 million for the full year of 2016.

Turning to our 2016 guidance, based on current information we're updating our guidance for fiscal 2016. We now expect pro forma diluted net income per share of $0.67 to $0.68. This compares to pro forma diluted net income per share of $0.71 in 2015.

Our pro forma net income guidance for 2016 is based in part on the following annual assumptions. We expect system-wide comparable restaurant sales growth to be approximately 1%. We expect to open 17 to 18 new company-owned restaurants and expect our franchises to open 11 to 12 new restaurants. We expect restaurant contribution margin of between 20.6% and 20.8%.

We expect G&A expenses of between 8.8% and 9% of total revenue and 8% and 8.2% of total revenue when excluding legal expenses related to securities class action litigation. We expect adjusted EBITDA of between $66 million and $67 million, and we're using a pro forma income tax rate of 40%.

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

Thanks, Larry.

While the environment remains challenging, we continue to work to drive improvement in our core business by focusing on our four brand pillars: great food, excellent service, a warm and inviting atmosphere, and a good price. We believe that through the focus on these pillars combined with the initiatives such as the value, services and operations initiative that we've put in place during the last year and upcoming initiatives such as our new learning management system and mobile app, we will continue to strengthen our brand and drive improving results.

Our development plans remain on track, and we will continue to work to build the pipeline by partnering with high-quality franchisees.

Thank you again for joining us on the call today. We'd now be happy to answer any questions that you might have. Operator?

Thank you.

(Operator Instructions)

Courtney Yakavonis, Morgan Stanley.

Hi. I just wanted to talk a little bit about the softening you said in the second half of the third quarter and into the fourth quarter. It seems like the 1% same-store sales guidance (inaudible) negative comps in the fourth quarter. So are you currently seeing negative trends, and are you (inaudible) in your guidance?

Yes, hi, Courtney. This is Steve. Let me first say we are seeing some external factors here. Obviously competitive discounting, grocery deflation, and a little bit of the election has impact.

But, that being said, our entree business is performing very well, as is our lunch part. And where we're seeing the softness is in the dinner and the family meals. So we're very focused on developing programs that show better value, variety, and really create that solution to the meal solution.

Right now we're testing a free side promotion. That's currently what we're running. As an alternative meal structure we're also testing in Las Vegas two sides for an additional $3.00. And we're working on a reconfigured meal that'll have a price of $20.00 that'll be advertised on TV in January. So we have high sense focused on that meal solution day part.

And with regards to your question on comps, yes, it implies slightly negative comps, same-store sales, in the fourth quarter.

Okay. And then I think on the last call you had mentioned that you were going to be revising your pricing strategy or reconsidering it again in November. Have you guys made the decision on that?

Yes, we're currently -- in the third quarter we were at about 1.5% effective pricing. If you recall, we took a 0.7% increase last -- I think it was late April. We'll take another 0.7% this November, which is normally when we take a price increase. So effective fourth quarter we'll be at 1.5%.

We'll then go and look at our results from first quarter, analyze it closely and look at doing something potentially in second quarter. But we want to make sure we retain that price/value equation which is so sensitive which we focus on now over the last year.

Okay, and then, just lastly, it seems like historically you guys had a decent spread between the company stores and franchise, and it looks like it's narrowed significantly in the past couple of quarter. So I was just wondering if you have any insight into what's going on there.

Yes, the franchisees have been a little bit more aggressive on their pricing, and that's hitting their transactions slightly. We've been more conservative on the company side. So that spread seems to be getting closer and closer.

Thank you.

Sam Beres, Robert W. Baird & Company, Inc.

Hi. Good afternoon. Thanks for taking the questions.

Steve, you had mentioned in terms of Houston obviously you guys had undertaken some initiatives to drive that relationship with consumers and said you haven't quite seen improvement in the sales trends coming from that yet. So maybe the question is why do you think you haven't seen any impact so far from those initiatives and kind of the strategy for those initiatives going forward?

Yes, we -- first of all, we're still continuing to be bullish on Houston, and, of course, Dallas, the most recent market we entered into. In Houston we opened, gosh, it was seven stores between the late fourth quarter and first quarter this year. And we feel those are really just getting started.

We've put some additional effort in FSIs, direct mail, things like that. We've also looked at doing things where we're coming up now and adding -- we've kept our additional labor in Houston because we want to make sure that customer experience is correct. And we've seen very good actual performance over the summer and early fall on our market force metrics.

So we think what we want to do now is focus on getting more people into the restaurant so they can experience that great food. If you know our equation it's great food with service and environment over a competitive price. And we think when Houston people experience that we'll drive sales.

We're looking at some additional things, some expanded FSIs, taking the rings around the stores from a two- to a three-mile radius to drive that trial. We've taken our media and we've focused a little bit more doing the enhanced direct mail. We're also looking at adding some mobile billboards there. But we really think it's early in the Houston cycle, given that 7 of our 11 stores opened up really late last year and first this year.

On our other entry, in Dallas, we feel good, again, five stores opened, four company, one franchise. That's our Vision design. And we've seen -- very early, but good results so far with the -- we think the Vision design will be a big part of our entry in the Dallas market.

That's helpful. And in terms of the comment in being pleased with Dallas, is that being pleased in relation to the initial sales trends or consumer feedback to the brand, or maybe both?

I would -- first of all, it's too early to comment on sales trends, because we have tremendous honeymoon periods when we enter a new market. That being said, as you recall, both our -- we opened a franchise store and the four company stores at the -- right around since the middle of this summer. So all of them seem to be initially doing well.

What I'm very pleased at, too, is our operational execution. We've taken some learnings that we had in Houston. Our market force scores in Dallas seem to be very strong for the market entry. We feel good about that.

And our Vision design, we really feel, if you remember on the last all we've talked about our Vision design we think reflects the image of our -- the image reflects now the high quality of our food. And we think that's really that equation where we had the great food, now we're bringing the service up, and clearly the Vision design is a fast casual plus design, and then over reasonable prices, we think that that's resonating with the Dallas consumer.

Hey, Sam, the only thing I would add -- this is Larry -- is that, I mean, we are happy with the sales volumes where they've opened. As Steve said, you've got to see the honeymoon period, but certainly the volumes they've opened, we're happy with the volumes.

Great. Thanks. And then, Larry, maybe just one quick one, in terms of chicken for 2017, any visibility or update on the contracting for that and then where maybe commodities could shake out for 2017 for the entire basket?

Sure, yes, we are basically wrapping up our chicken negotiations. We feel very good about how those negotiations have gone. And overall right now we're looking at probably a 1% commodity deflation in 2017. And, again, our contracts on these chickens will be fixed for next year, so we'll be locked in at that.

Great. Thanks, guys.

Sharon Zackfia, William Blair.

Hi, this is Aaron Murphy on for Sharon. Just a quick question in terms of regional differences you're seeing. Can you comment on California versus Texas during the quarter?

In terms of what, Aaron? In terms of comped sales, profitability?

Yes, in terms of comps or traffic.

Well, the challenge on comps and traffic is in Texas is these are all new restaurants, right? So we have very limited comp data on Houston. There's only about three or four that have comp. They're lapping at very -- kind of a longer opening curve, so those comps are certainly negative.

And in California, LA, especially, comps in the third quarter were positive. And, again, as Steve highlighted earlier, we are seeing softening.

And when we talk about comps, I mean, for the most part, I mean, that's California. I mean, that's the bulk of our restaurants. So for the quarter if we say we're going to be soft in terms of comps or slightly negative in comp sales, the implication is that California we're looking at probably slightly negative also.

Okay, great. And then can you just update us on hourly labor inflation for the third quarter, and then do you expect similar inflation levels next year?

Yes, so, I kind of look at what kind of impact -- well, in the third quarter what we saw, and I'll give it to you in terms of percent of sales, the impact, and what we're seeing is California, LA, minimum wage in the third quarter was probably about 0.8% impact on our labor cost. And then we're also seeing additional wage inflation on top of that of about 0.4%. So that's obviously a fairly significant impact.

As we look forward to next year, as you may be aware, California will go up an additional $0.50 to $10.50 on January 1, and LA will go to $12.00 on July 1, from $10.50. Overall we kind of have taken an initial stab at what we think that cost would be. We've still got some work to do around compression and those things. But it's probably going to be in about the $3 million area.

Okay, great. Thanks.

(Operator Instructions)

Gentlemen, there are no further questions at this time. I would like to turn the floor back over to Steve Sather for closing comments.

Great. Thank you, operator, and thanks again, everyone, for your continued interest in El Pollo Loco, and have a good evening.

This concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.