El Pollo Loco Holdings Inc (LOCO) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Second Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note that this conference is being recorded today, August 3, 2017. On the call today, we have Steve Sather, President and Chief Executive Officer of El Pollo Loco; and Larry Roberts, Chief Financial Officer.

And now I would like to turn the conference over to Larry Roberts.

Thank you, operator, and good afternoon. By now, everyone should have access to our second quarter 2017 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 second quarter of 2017 by early next week, and would encourage you to view 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 will like to turn the call over to Steve Sather.

Thanks, Larry, and good afternoon, everyone, and thank you for joining us on the call today. We are pleased to announce second quarter results that included revenue growth of 8.3%, and pro forma net income growth of 8% to $0.21 per share. Systemwide comparable store sales grew 2.9% during the quarter, including a 2.4% increase at company operated restaurants and a 3.2% increase at franchised restaurants.

We are particularly pleased the transaction growth returned to a positive territory in the second quarter and expect the trend to continue in the third quarter. Our results were driven by continued efforts to highlight our authentic brand, differentiated offering and QSR+ positioning. Our entrée promotions during the quarter were focused on our signature avocado tostado salads and our new layered salad LTO. Both of these salad offerings highlighted the freshness of our food and the relative healthiness of our products, which we believe help distinguish us from other QSR concepts. The 4 new layered avocado salads feature fresh ingredients including ripe avocado, and our signature citrus marinated fire-grilled chicken, layered together to create colorful and nutritious menu items. The salads were extremely well received and total salad mix during the promotion hit a record high. We also had continued success with our unique family meal offering.

During the quarter, we kept the focus on the $20 price point, which we believe helped sustain our momentum. Similar to the first quarter, this promotion drove family meal growth over 4% year-over-year, clearly resonating with customers. We will continue to drive this price point for the balance of the year, as we believe it creates an exceptional value option. A key component of our QSR+ positioning is providing a great guest experience.

During the quarter, we put a major focus on enhancing our operations, particularly in the Northern California region. The renewed focus drove improved operating and consumer metrics, and correspondingly drove improved sales and profitability. We expect to take learnings from these efforts and apply them to other markets to continue improving our customer service and delivering higher sales.

During the second quarter, we made significant progress on our technology initiatives designed to drive increased convenience and loyalty. We believe that leveraging technology allows us to better connect with our customers and provide them with a higher quality and differentiated dining experience. During the quarter, we rolled out delivery in partnership with Olo's dispatch delivery service, and it's now available in approximately 40% of our location across the system. While the initial uptake from customers has been modest, we believe that delivery can be a sales driver in the future. We will continue to improve upon this initiative, in addition, to adding delivery service to additional restaurant locations, as we partner with other third-party providers.

Additionally, during the quarter, we launched our all new local reward loyalty program developed by Punchh. This program, accessible through our new mobile app, offers customers 1 point for every dollar spent at El Pollo Loco and a $10 reward after collecting 100 points. In addition to a free entrée reward upon signing up and a birthday reward, customers will also receive surprise offers tailored specifically for them. We believe that our delivery and loyalty programs not only bolster both convenience and value for our guests, but they also allow us to learn more about our customers' behavior and become more targeted into our communications. Over time, we believe that our loyalty program will both attract new customers and increase frequency of our current guests.

Turning now to development. During the second quarter, we opened 4 new company operated restaurants, 2 in Dallas, Fort Worth, and 2 in Phoenix. Additionally, franchisees opened one new restaurants in the Dallas-Fort Worth market. Subsequent to the end of the second quarter, the company and franchisees have each opened one additional restaurant. Looking ahead, we are tightening our new unit opening guidance for 2017, and now expect to open 17 to 19 new company operated restaurants this a year, along with 9 to 11 new franchise restaurants. With regard to our Texas operations, Dallas-Fort Worth and Houston continue to be a challenge and to date we have not been able to maintain the momentum in Taxes that we saw at the end of the first quarter. We currently have 15 restaurants in Houston: 13 company operated and 2 franchised; and 13 in the Dallas-Fort Worth market: 9 company operated and 4 franchise.

Performance in both these markets continues to be below our targets and is the primary reason we are lowering our full year earnings guidance, despite the positive momentum in our core markets. We continue to analyze the market in order to help fine-tune our efforts to attract customers, drive sales and improve profitability in these highly competitive markets. To further help focus our Texas efforts, we have decided to close 3 restaurants that are performing poorly, don't meet our more stringent development criteria and are consuming resources that we believe can be better deployed elsewhere in the market. As previously discussed, we are refocusing our development efforts in Houston and Dallas on high-density trade areas.

As a result of this more selective approach, we expect to build fewer restaurants in both Texas and in total in 2018 as compared to 2017. With regard to future development, we continue to seek highly qualified franchisees to partner with us to develop both new and existing markets. Our development incentive program aimed at driving growth in select new markets, along with our new marketing campaign and Vision design continue to generate interest from existing and prospective franchisees. As we continue to build our pipeline, we look forward to working with qualified franchise partners, who are as passionate about the El Pollo Loco brand as we are.

Switching to our new Vision design, we continue to be pleased with the reception of and the initial results from our Vision remodels. The Vision prototype better reflects our authentic brand identity and QSR+ positioning. As we have noted, all new company operated restaurants and the majority of our new franchise operated restaurants will open with the Vision design. We have now completed 7 remodels in California and currently have plans for 7 more by year-end, including 5 in Las Vegas. Additionally, we have several franchisees committed to completing Vision remodels this year. We are continuing to work to value engineer the Vision design in order to reduce cost while still achieving the resultant sales lift.

Before I turn the call over to Larry, I'd like to recognize and Enrique Pulido, the winner of our Grill Master challenge. As we discussed on the first quarter call, our Grill Master challenge is a fun and exciting way for our cooks to refresh their knowledge and test their expert skills against other cooks from around the system, while at the same time reinforcing product quality and service which are key components of our QSR+ positioning. The competition was close, however, Enrique distinguished himself as the top Grill Master. Congratulations to Enrique as well as our other talented competitors in this year's challenge.

With that, I'd like to turn the call over to Larry, who will go over our second quarter results and our 2017 guidance in detail. Larry?

Thanks, Steve. For the second quarter ended June 28, 2017, total revenue increased 8.3% to $105.6 million from $97.5 million in the second quarter of 2016. The growth was largely the result of an increase in company operated restaurant sales, which rose 8.8% in the quarter to $98.9 million. This increase in company operated restaurant sales was driven by the contribution from the 24 new restaurants, opened during and subsequent to the second quarter of 2016 as well as by the 2.4% increase in comparable restaurant sales. The increase in company operated comparable restaurant sales was comprised of a 0.5% increase in transactions and a 1.9% increase in average check.

Franchise revenue increased 1.4% in the quarter to $6.7 million from $6.6 million in the second quarter of 2016. This increase was driven by the contribution from 17 new restaurants opened during and subsequent to the second quarter of 2016 as well as by 3.2% growth in comparable restaurant sales. These were partially offset by lower development and renewal fees and point-of-sale charges passed through to franchisees.

Turning to expenses. Food and paper cost as a percentage of company restaurant sales decreased 27 basis points year-over-year to 29.5%. The improvement was predominantly due to lower commodity costs, particularly lower contracted chicken prices and freight cost. We continue to experience higher produce cost, especially with regard to avocado prices. As a result, we now effect full year commodity deflation of about 2.5%. Labor and related expenses as a percentage of company restaurant sales increased 10 basis points year-over-year to 26.9%. The increase in labor expenses was due primarily to higher workers compensation claims activity, higher minimum wages in California and Los Angeles, and the impact of the incremental labor required for 27 new restaurants opened during or after the prior year quarter. These were partially offset by favorable workers compensation adjustments.

For 2017, we expect labor inflation of about 4%, as a result of minimum wage laws and tighter labor markets. Occupancy and other operating expenses as a percentage of company restaurant sales increased 30 basis points year-over-year to 21.8%. The increase was primarily due to rent expense relative to revenue, volume generated and other incremental costs related to restaurant built in 2016 and the first 26 weeks of 2017. General and administrative expenses increased by approximately $1.3 million year-over-year in the second quarter to $9.6 million.

As a percentage of total revenue, G&A expenses increased 60 basis points year-over-year. G&A expense in the second quarter of 2017 included $1.1 million in legal costs related to the securities class action litigation, as compared to $340,000 of securities-related litigation costs in the second quarter of 2016. G&A during the second quarter of 2017 also included $179,000 of executive transition costs related to our previously announced CEO search.

Excluding the costs associated with the securities litigation in both periods and executive transition expenses, G&A expenses in the second quarter of 2017 increased approximately $400,000 year-over-year and were 30 basis points lower year-over-year as a percentage of total revenue. This dollar increase resulted primarily from higher payroll expense due to an increased number of corporate employees and higher accrual related to the company's annual bonus program. Depreciation and amortization expense increased to $4.6 million from $4 million in the second quarter of last year. As a percentage of total revenue, depreciation and amortization increased 30 basis points year-over-year. The increase was primarily due to our new store development. During the quarter, we recorded approximately $400,000 of expense related to the impairment of assets at one restaurant in Texas. We recorded a provision for income taxes of $4.2 million in the second quarter of 2017, reflecting an estimated effective tax rate of 35.2%. This compares to a provision for income taxes of $5.3 million, and an effective tax rate of 42.4% in the prior year second quarter. We reported GAAP net income of $7.8 million or $0.20 per diluted share in the second quarter compared to a net income of $7.3 million or $0.19 per diluted share in the year-ago period. In addition to our GAAP net income, we've calculated pro forma results adjusting for onetime or unusual items.

To arrive at pro forma net income, we have made adjustments for income expenses associated with our tax receivable agreement, gains or losses on disposal assets, asset impairment and store closure costs, gains and losses related to a fire in one of our restaurants and recovery and insurance proceeds, legal expenses associated with the securities class action lawsuit, and expenses associated with executive transition. We've added back provision for income taxes and have applied a 39.5% 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 $8.2 million as compared to $7.6 million in the second quarter of last year. Pro forma diluted earnings per share were $0.21 for the second quarter of 2017, compared to $0.19 in the prior year period. In terms of our liquidity and balance sheet, we had $4.4 million in cash and equivalents as of June 28, 2017, and $94.9 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. For the full year, we now expect our capital expenditure to total $42 million to $44 million.

Turning to our outlook for 2017. We are revising our guidance for the full year. We now expect pro forma diluted net income per share of $0.64 to $0.67. This compares to a previous range of $0.65 to $0.69 and pro forma diluted net income per share of $0.66 in 2016. Our revised pro forma net income guidance for 2017 is based in part on the following annual assumptions: We expect systemwide comparable restaurant sales growth to be approximately 1% to 2%. We now expect to open 17 to 19 new company owned restaurants and expect our franchisees to open 9 to 11 new restaurants. We now expect restaurant contribution margin of between 20.3% and 20.7%. We continue to expect G&A expenses of between 8.5% and 8.7% of total revenue, excluding legal fees related to securities class action litigation. We now expect adjusted EBITDA of between $66.5 million and $68.5 million. And we continue to use a pro forma income tax rate of 39.5%, which reflects our successful program to obtain [warranty] credits.

Now I'll turn the call back over to Steve for closing remarks.

Thank, Larry. Our core business is performing well driven by our strategy of highlighting our QSR+ position through our new marketing campaign, LTOs, and efforts to improve operations as well as by initiatives designed to enhance convenience and loyalty. We are working hard in Texas to drive trial and repeat visits and in turn, improving sales and profitability. We believe that our authentic brand, differentiated product and strong value equation will drive positive financial results and create long-term value for our shareholders. Again, I'd like to thank you all for joining us on the call today.

We're now happy to answer any questions that you may have. Operator?

(Operator Instructions) Our first question comes from the line of Matt DiFrisco with Guggenheim Securities.

This is [Jay Dunn] for...

Actually sorry about that guys. My headset was coming in and out there. The question was with respect to your average check in the quarter. I jumped on a little late there and I was just curious if you can give us some color on what were the drivers of that?

Yes, you have to clarify because you were kind of coming in and out. You're asking about what was driving our average check during the quarter. I think there are couple of things number one, was again the increased mix and growth of our family meals. As we highlighted, we had 4% growth in family meals again, during the quarter. That was a driver of check. I think, the other one contributing probably to a smaller amount was the increased usage of our mobile app. We do see that as a check driver. We're seeing higher average check among our mobile users. So I think those were the 2 big factors driving our average check during the quarter.

And did you disclose how much is being done on the mobile?

I think now we're running somewhere around 1.3% -- 1.2%, 1.3% transactions, in that range.

And then how would you rollout the -- or what are you looking at to sort of test delivery and how would you implement that with the third-party -- the choice of the third-parties, what are you going to be looking at [when it's time] to select those?

On the delivery, we've got the -- through the Olo dispatch, we've rolled that out to about 40% of our stores. Right now, as you know deliveries are kind of a rapid changing industry. We think, we're not fully satisfied yet with the service we are receiving on that. And we are also, we are not participating with any of the delivery marketplace providers that many consumers are using right now. So as a response, we are looking to add those delivery services that operated in marketplaces. But we also want the ones that deliver direct orders for a reasonable fee. So we think this will significantly increase the number of restaurants that we're doing again, about 40% or 180 of our restaurants have delivery right now. Could increase it into the mid-350s. And we are looking at various providers right now to assist us with that in delivery.

Can you share with us what you've seen with delivery in those stores? Those 40% that do have it at that store level, what delivery represents as percent of sales?

Yes, I mean, it is a very small amount right now. I mean again, it's a fairly new launch. We expect it to build over time. And I think, Steve took you through a number of the initiatives we are doing to grow that side of the business. But I will say initially it has been a fairly small amount of mix transactions.

Our next question is from the line of David Tarantino with Baird.

My question is based on -- my question is about what you're seeing in Texas. It sounded like coming out of the last call, that you were very confident in some of the initiatives that you had put in place on the marketing and operations side. But it seems like maybe the impact of those has faded. So can you talk about sort of what you're seeing there? And maybe, provide some perspective on what the new game plan might be to get the sales going in those markets?

Sure, David. This is Steve. Let me give you a little overview on that. We did see a lot of some variability in the results in Texas. And as we previously discussed on our call in the first quarter, we had a positive response to some of the initiatives that we implemented in the first quarter and we really felt good about the momentum we were headed to into Q2. But that, those sales didn't sustain. And we are really digging into a lot of the data to better understand that, what that sales drop off was right now. At the same time, we have already implemented a number of initiatives to help drive awareness and communicate the brand, and increase frequency of -- currently this is the increase in social media advertising. We just introduced in Texas our Taco platters, Tacos, as you know in Texas are very popular. We are seeing a better uptick on those and even in our current markets. So we think that will continue to stay on the menu there. We're continuing with the successful things we did in Q1. The fundraisers were very -- fundraising activities were very strong. And we are pushing really our -- aggressively our loyalty program in Texas this quarter as well. Also we are looking at some initiatives to simplify our concept so consumers can make it easier to understand and also for our operators to execute. To help our efforts and as we focused on or commented on the call, we did close 3 stores that weren't performing well and didn't meet our current development criteria on the density or the consumer aspect. And we think we can better deploy those assets. As you know, the market is very competitive. But we think we have a unique concept there, a very differentiated product in our flame-grilled chicken. We also think that we are well in line with what consumers want today. So we feel positive about and confident on the Texas market. We think these changes will help us focus better on that. And we think, we'll ultimately be successful in Texas as well as other new markets. So that gives a little overview. Larry any comments to add on that?

No, I think you hit the main points. I think, the one thing we see and add a little bit Steve is just -- David you clearly -- 2 things that come out of the research are convenience and top of mind awareness are what we call the barriers right now. So and I think convenience comes from just you don't have a lot of restaurants in those markets. But the one we really want to focus on is the top of mind awareness is to get people in the restaurant and then drive that frequency, because that top of mind awareness is what drives people into the restaurants consistently. So that is why, as Steve highlighted, we are really going after some of these initiatives around loyalty, around social media. We think those are things that will really drive that top of mind awareness, and as we launch those we are optimistic that we're going to see these volumes start to move up.

Great. That's helpful. I guess in the interim how are you thinking about putting new capital to work in those markets? Is it sort of time to rethink whether you should be growing in those markets until you start to see better performance around the units you have already opened?

Well, as we have mentioned, we've slowed down our growth in Texas but we're still deploying capital to the sites that hit the Tier-1 to high-density with a new demographic research that we have done. So we will still continue to develop in Texas. In fact, we are starting construction on a store this coming Monday there, but it is one that meets that criteria. And that is what we meant about refocusing our resources on those where we know they are going to be strong.

(Operator Instructions) Our next question is coming from the line of Jake Bartlett with SunTrust.

This is Kevin Robinson on for Jake Bartlett. My question is you've talked a lot about slowing growth in new markets in 2018. Could you give us an idea of what you mean for the overall unit growth rate in 2018?

Sure, yes. As we highlighted in our opening comments as Steve just highlighted, we're going to slow down development in Texas, focused on just those sites that hit our criteria. Really that will result in an overall reduction in our expected development in 2018 relative to 2017. I'm not ready to give a number or a range on that right now. The one thing I would highlight is that when you look at the core markets, we actually expect development to accelerate in the core markets, core being Southern California. Because we do feel like, we've got actually a lot of opportunities in Southern California still. So that will increase year-over-year rather significantly versus '17. So bottom line is total development will decline but we will see higher development in what we call core markets.

And one follow-up. Can you give us a sense of how much you expect the sales initiative like mobile ordering, loyalty, and delivery to be in 2017, or is this -- is this something we will see more meaningful impact in the 2018 type of story?

Well, just on the loyalty program, we are seeing very good -- I mean, first of all, it is very early for us. We just launched it 7 weeks ago. But there has been a great adoption there. We've got almost 200 (sic) [200,000] members as we speak today and we're adding about 3,000 a day. So we feel very good about the loyalty. But this will be a long-term driver because it will increase frequency and also bring in new people. But probably more importantly it gives us great consumer data. That will enable us to better understand our customers and drive even more effective promotions with it. So we are excited about the loyalty aspect of that.

And let me just add to what Steve said, just to give you a little more framework around why we feel like the loyalty program has gotten off to a great start. As Steve said, we have been doing it for 7 weeks. We have already got around 200,000 people on our loyalty program which we feel like is a strong number. We are adding 3,000 to 4,000 new loyalty members every day. So we feel good about the program, the launch is on. And as Steve highlighted, long-term, we expect to see it be a frequently and sales driver. And I'll say, I'm cautiously optimistic that we will get some benefit this year from that program from a sales standpoint.

At this time, I will turn the floor back to Steve Sather for closing remarks.

We would like to thank everybody for joining us on the call today, and thank you for your continued support of El Pollo Loco.

Thank you. This will conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.