El Pollo Loco Holdings Inc (LOCO) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Fourth Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note that this conference is being recorded today, March 8, 2018.

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 fourth 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-K for 2017 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 would 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.

Before we get started, I wanted to take this opportunity to thank all of you for your continued support. As you know, I am retiring this month in order to spend more time with my wife and family, and this will be my last earnings call. I've had the honor to lead this special brand and team for over the last 7.5 years. During that time, we successfully repositioned the brand targeting the QSR+ niche. We first assembled a formidable team, without whom our many achievements would not have been possible.

Together, we instilled an intense focus on all aspects of the business, which drove meaningful improvement in our company-operated average unit volumes and restaurant-level margins. This heightened focus included involvement from our franchise partners at every level.

Today, our franchise relations have never been stronger. Their insights has supported initiatives, such as our Hacienda design and remodel program, which is now in its second phase with the Vision design. I've truly enjoyed working with this incredibly talented and dedicated team, and I am extremely proud of the successes that we have shared.

I'm thrilled with the board's appointment of Bernard Acoca as president and CEO. He brings years of experience from some of the most well-recognized restaurant companies, like Starbucks and Yum! Brands and has a proven record for driving results. I'm confident that he is the right person to build up on our strong foundation and steer El Pollo Loco in this next chapter. I continue to believe that there is tremendous opportunity for growth ahead for El Pollo Loco, and I look forward to seeing their many successes in the future.

With that, I'll hand it over to Larry.

Thanks, Steve. It's been a pleasure working with you and I wish you and [Judy] all the best. Given our recently announced CEO transition, I will be handling most of today's call. Steve will be available during Q&A, and in case you did not see the recent release, Bernard will start work on Monday, March 12.

I'd like to start our discussion today with a brief review of our fourth quarter results. I'll then provide an update on the first quarter as well as our major strategic initiatives before offering initial guidance for 2018. We will then open the line for questions.

As to our fourth quarter results, we reported revenue growth of 2.9% to $95.2 million and pro forma net income of $0.11 per share. The revenue growth was largely a result of the increase in company-operated restaurant sales, which rose 3.3% in the quarter to $89.3 million. Additionally, franchise revenue was $5.9 million during the quarter.

The increase in company-operated restaurant sales was largely driven by the contribution from 24 new restaurants opened during and subsequent to the fourth quarter of 2016, partially offset by 5 restaurant closures during the same period.

System-wide comparable restaurant sales increased 1.4% during the fourth quarter, including 0.9% growth at company-operated restaurants and 1.9% growth at franchised locations.

Restaurant contribution margin as a percentage of sales was 18.5% of company-operated restaurant revenue. This was flat when compared to the same quarter in 2016 as pricing and lower commodity costs offset higher labor costs driven by minimum wage increases in California.

General and administrative expenses increased by $2 million year-over-year to $10.9 million. As a percentage of total revenue, G&A expense increased 190 basis points versus 2016. The increase was driven by higher securities-related legal costs and bonus accruals, partially offset by lower preopening and stock option costs. Excluding the costs associated with the securities litigation in both periods, G&A expenses in the fourth quarter of 2017 increased by approximately $500,000 or 30 basis points compared to 2016.

During the fourth quarter of 2017, the company recorded a $16.4 million expense net of closed store reserves related to the impairment of the assets of 11 restaurants in Texas and 1 in Arizona. This impairment charge included the entire remaining value of capitalized assets of our company-operated restaurants in Texas.

Overall, we reported a $38,000 net loss for the fourth quarter of 2017 compared to net income of $418,000 in the same period of 2016.

Pro forma net income for the quarter was $4.4 million as compared to $4.6 million in the fourth quarter of last year.

Pro forma diluted earnings per share were $0.11 for the fourth quarter of 2017 compared to $0.12 in the prior year period.

For a reconciliation of pro forma net income and earnings per share to the comparable GAAP figures, please refer to our earnings release.

In terms of our liquidity and balance sheet, we had $8.6 million in cash and equivalents and $93.3 million in debt outstanding, each as of December 27, 2017.

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 2018, we expect our capital expenditures to total $27 million to $31 million.

I'd like to now provide an update on current trends in the first quarter to date as well as our key strategic initiatives for 2018. We continued to see solid results in our core markets in the fourth quarter of 2017, with December being our strongest month in terms of sales performance. Unfortunately, this momentum has not carried into the first quarter of 2018, and we are experiencing sales decline across our business. To date, system-wide same-store sales were negative, and we expect to finish the quarter down 1 to 2 percentage points as a result of aggressive price competition in the QSR segment and very weak same-store sales performance in several of our noncore markets. We believe that the aggressive discounting being marketed by our competitors is impacting our sales and transactions.

As we've discussed over the past several years, a portion of our customer base is highly motivated by price and we believe that these customers are visiting El Pollo Loco less frequently in response to aggressive discounting by competitors. We are, however, undertaking a number of initiatives in order to reclaim these customers, attract new ones and increase frequency amongst our loyal guests.

First, we will be more aggressive with our promotions and are currently testing a value menu that if successful, will be launched in June. This value menu will be in addition to continuing to advertise our $20 unique family meal, which has resonated well with our customers and drove sales growth throughout 2017.

Second, we will continue with our authenticity media message that drives home our differentiation and fosters a deeper connection with our customers. Third, we are making significant investments in our restaurant training programs in order to improve the customer experience in our restaurants.

And fourth, we will continue to push technology to drive sales.

With regards to technology, our local rewards loyalty program now has 500,000 members and transactions from loyalty members contributed to over 5% of sales over the last 4 weeks. We are currently working with Punchh and Ansira to analyze loyalty customer data in order to improve customer insights and individual customer engagement. Ultimately, we believe these will drive increased sales and profits through better-targeted programs. We expect to begin implementing new marketing programs resulting from this analysis over the next several months.

In addition, we continue to work with Olo to optimize our mobile ordering and delivery platforms and have now successfully integrated them with DoorDash, who we have selected to be our delivery partner. We are in the process of rolling out delivery to our system and expect to complete it by the end of this month, at which point 65% to 70% of our restaurants will fall under DoorDash's service coverage area. This initial rollout will not include the DoorDash marketplace, which we expect to add in Q2.

In addition to loyalty and delivery, we are also developing self-ordering kiosks, which we expect to test in restaurants later this year. We believe kiosks will help increase throughput, order accuracy and average spend while also allowing us to improve labor efficiencies.

I'd like to now talk about our noncore company markets, which include Northern California, Phoenix, Dallas and Houston. Performance of new stores continues to be mixed. And overall, they are not achieving our expectations, especially in Houston and Dallas.

Just to provide a little context, in Q4 2017, our Texas restaurants reduced company same-store sales by 30 basis points and restaurant contribution margin by 240 basis points. In January, we closed 2 restaurants in Texas, leaving us with 13 restaurants in Houston, 11 company-operated and 2 franchised and 10 restaurants in Dallas, 6 company-operated and 4 franchised.

We are continuing to execute our brand relaunch program in both of these markets. However, to date, we've yet to see significant sustained sales growth. Consequently, we decided to fully impair all company restaurants in Dallas and Houston, which when combined with 1 restaurant in Phoenix, resulted in a noncash impairment charge of $16.4 million, net of closed store reserves that I noted earlier.

While we are continuing with our relaunch program in both Texas markets, we have initiated a review of all of our noncore markets to determine the best strategy going forward.

As we have discussed, our challenges in Texas have led to a sharpening of our development criteria and a refocusing on core markets, where new restaurants have a high probability of success.

During the fourth quarter, we opened 4 company restaurants, 1 each in Sacramento and Phoenix and 2 in Southern California. Additionally, our franchisees opened 1 location in Salt Lake City.

Looking ahead to 2018, we expect to build 6 to 8 new company-operated restaurants as well as 6 to 8 new franchised locations. All these restaurants will be reflective of the new Vision design, which we believe better showcases our QSR+ positioning.

During the quarter, we completed our 14th Vision remodel, and we continue to be pleased with initial results. Franchisees completed 13 remodels in 2017, including 3 at our Vision design. We are continuing to focus on reducing remodel costs, while preserving the restaurant sales lift. Initial 2018 plans call for 20 company remodels and 3 franchised remodels.

Lastly, with respect to our 2018 outlook, we are providing the following annual guidance: We expect pro forma diluted net income per share of $0.68 to $0.73, which includes an estimated $0.14 benefit from the lower tax rate resulting from the tax reform legislation enacted in 2017.

Our pro forma net income guidance for 2018 is based in part on the following annual assumptions: We expect system-wide comparable restaurant sales growth to be approximately flat. We expect to open 6 to 8 new company-owned restaurants and expect our franchisees to open 6 to 8 new restaurants. We expect restaurant contribution margin of between 18.7% and 19.6%. We expect G&A expenses of between 8.8% and 9% of total revenue, excluding legal fees related to securities class action litigation and CEO transition costs. We expect adjusted EBITDA of between $61 million and $64 million, and we're using a pro forma income tax rate of 26.5%.

Please bear in mind that our guidance may be materially impacted by strategic decisions made during the course of the year as we integrate a new CEO.

That concludes our prepared remarks. We'd like to thank you again for joining us on the call today, and we are now happy to answer any questions that you may have.

(Operator Instructions) Our first question comes from Jake Bartlett of SunTrust.

Larry, this is maybe a bit of a candid question. But looking at the environment around competition in the value-oriented environment, you're seeing the impact of first quarter results. And that was pretty well telegraphed by your competitors now that you're kind of looking to answer it with a midyear change in your strategy? Why didn't you go towards more value in the first quarter kind of anticipating that? Is this something that surprised you? Did you have a value answer that didn't quite work? Maybe just some context around that.

Yes, Jake, thanks. Yes, I mean what we-- all last year, we were talking about the fact that we were seeing the value initiated by competition having an impact. And consistently, we've said we want to be careful about really getting into that game, I'll call it. Just because you start discounting, it hurts your profitability, and it's very hard to come out of. And so -- and what we've seen really in the fourth quarter and then in the first quarter was the intensifying of that discounting. So certainly, as we looked around, a lot more competitors have joined in to competitive discounting that we've seen. The level of discounting has increased, so -- in some way, but I'm not sure we're really surprised. We were trying to stay out of it and to stay with our strategy about differentiating our concept through the authenticity message, being a little more careful, maybe do the things around the menu that bring a little bit more value, but keep driving $20 meals. The one thing we did do in the first quarter was we went to the $5 combos and started advertising $5 combos. But we've really tried to be careful about really jumping into, which we are still doing. I mean, we're going to test the value menu, but we may or may not roll it out depending on what results look like over the next 1 to 2 months because we do want to be careful about getting down that game where you're just discounting -- maybe driving the incremental sales, but you're hurting overall profitability. So again not sure we're really caught by it. We were just trying to stay away from it and be careful about how much we jump into it and even now we're going to be testing some things, but we're going to be cautious about really jumping into the fray where the burger guys have gone, again recognizing that you hurt profitability, and it can be a challenge to get out of that once you start going down that path.

Yes. Got it. That makes a lot of sense. And then another question, it looks like your unit growth is going to be concentrated more in the core markets in '18. Before we think about the growth opportunity in your core markets. What does that look like? You think you can grow this unit kind of low single digits or mid-single digits in your core markets. I know you've done work around and you realize there is greater opportunity in your core markets.

Yes, Jake. That we've looked at it and I think when we -- we've identified somewhere around, I think, 30 to 40 trade areas remaining in our core markets and that doesn't mean we can go out and do 10 units a year in the core markets right away. I think we're going to be in the 4 to 5 -- 3 to 5 in core markets just because how challenge it is to find real estate, get through permitting and all those things. So while we still think there is some pretty good opportunity there, it can be difficult to access the sites, find the site. So I'm expecting 3 to 5, probably in that range in core markets going forward.

Our next question comes from Mary McNellis of Robert W. Baird.

My question is on performance in Texas. Larry, could you just confirm our math that restaurant margin is negative in your Texas market?

I don't want to get into what the actual margins are. I mean, I'll just stick with what I said earlier, which was -- it's an impact of about 240 basis points in the fourth quarter on margins. I don't want to get into whether it's positive, negative and what -- the degree of how positive or how negative it is.

Okay. Understood. And then any way to talk about maybe when it makes sense to think about closing additional units or possibly even exiting that market altogether.

Yes. So what we've talked about in the past is we do have a relaunch program that we began implementing back in October. And as we highlighted previously, that involved really going back through retraining all the employees in the restaurants, doing some work to the assets, ramping up, doing some more different -- yes, more things in marketing, some different things in marketing. Yes, some of those things really have just kicked off over the last 3 or 4 weeks, including the radio advertising in Dallas. So we've got the relaunch program. We continue to monitor it. As I said in the opening remarks, I mean, there's still -- the results are below expectations, but again, it's still early days in some of the things we've done in the relaunch. So we'll continue reading the relaunch program and then once Bernard gets on board, we'll reevaluate the relaunch, really see where the results are going and then we'll start making some strategic decisions based on the results and what else we are also seeing in the marketplace.

Just last one on that topic. Can you provide what you're expecting for D&A for 2018?

G&A?

D&A, depreciation?

Just give me a second. I'm expecting -- and so they're going to be about 4.5% sales, that range.

Our next question comes from Matthew DiFrisco of Guggenheim Securities.

I have a question, but first just a bookkeeping. I think you said that the quarter-to-date comp -- was the quarter-to-date comp down 2%? Or you guiding to down 2% for the quarter? So I'm wondering, are you seeing those trends right now? Or is it worse?

No, we're seeing those trends right now. And we're guiding to negative 1% to negative 2% for the quarter system comps.

Okay. Anything in the year ago that we should consider. I mean, is this -- a lot of people on the West Coast are lapping some of the very favorable weather comparisons from last year. I mean, is there anything as far as sequentially looking at what you're lapping, changing throughout the quarter in 1Q?

No, I'll just highlight what others have talked about in California is that we are lapping favorable weather from last year really starting late February -- or I guess clearly February -- most of February was where the weather impact was. So we are lapping that. And we highlighted last year, we thought there's going to be 1 point impact on comps last year. So we are lapping that.

So I mean, how much of a variance? If you're doing down 1% to 2% now, how much of a swing factor on your year ago comparisons? What's the difference from what you're lapping now to what you're going to end the quarter with, with lapping?

I'm not sure I fully understand the question, but what I'm saying is last year we had a 1 percentage point impact on system comps. So in fact, I can say down negative 1% to 2% would look a little worse when you take into account that favorable lap that we had this year versus last year.

Okay. And then just if I were to -- can you walk us through some of the economics. I know you're not doing delivery just yet, but when Postmates becomes a bigger factor and your -- 65% of your restaurants are covered, how does those economics look? Can you share with us -- I guess, there is always some concern that the flow-through on the comp might not be as strong as the flow-through of incremental sales coming through the store and there is the risk of cannibalizing your already very strong off-premise business. So I'm just wondering -- or your off-premise business that people come and carry out of the store. So could you walk through the economics on how should we think about that and the level of accretion? Or how that can impact margins?

Yes. So we're using DoorDash, and there's really 2 types of delivery that we're implementing with DoorDash. The one that's been rolled out currently is really what we call Dispatch. So these are customers who are going on to our website or using the mobile app and ordering delivery directly through us. So those transactions, for us, the economics are, I think it is about $1 delivery fee plus $0.50 additional fee. The consumer is paying for the delivery of the, call it, $5.99 or depending on what that rate is. So for that -- those should be -- if they're incremental, they're highly profitable, because again they're going directly to us and the transaction fees are fairly low. The second phase, which we will be looking to launch in Q2, will be introducing ourselves on the DoorDash marketplace, in which case we'll incur what others are incurring, which is a 20% off the call it ticket, which is paid to DoorDash. So on a $20 ticket, that would basically be $4 going to DoorDash. So that's where we really have to drive incrementality to make it work because obviously, that's a pretty big haircut off a ticket, and we'll be covering that cost versus the consumer.

(Operator Instructions) Our next question comes from Andy Barish of Jefferies.

This is [Alexa] on for Andy. Larry, would you mind going into a little more detail on that same-store sales gap between the core and the noncore? Just thinking about where the quarter-to-date is and then obviously, the challenges in Texas. Trying to understand how much of that drag is coming from Texas and other markets.

Yes, I'm not going to get in too much detail -- more detail about the quarter. We've given the guidance. As I said, in the Q4 of last year of the fourth quarter, we saw about a 30 basis point drag from Texas. It's been running between 30 and, say, 50 basis points-a-quarter drag through last year. So that's kind of the range what we're talking about in terms of looking at the comp drag we're incurring because of Texas.

Got it. And then I guess, thinking about the relaunch and a couple of months now in the rear-view mirror, what are the kind of metrics that you're looking at that are going to tell you that this is working or not with respect to either labor or awareness.

Yes. So really the big things we're looking at in the relaunch we always planned to was, one looking at the consumer responses. And so we have our measures that we use, last visit, excellence that we get from customers, mystery shops we're looking at. And what we have seen throughout Texas is a nice improvement in those scores. So we know that operationally, we've seen a nice move that we are providing even better service to consumers as they are coming in. And of course, then the obvious one is just watching sales and transactions and looking to start moving them up fairly significantly. And so that's -- though we feel good about where we are operationally, we did have people go in and do some blind shops of the market. They're coming back saying, "Hey, the operations look very good." We're seeing that in the operations metrics we're measuring. And now we're just continuing to push. Like I said, we've go on radio now in Dallas and really trying to move the needle on, getting people on the restaurants, get them using us and ultimately, getting them to come back. So clearly right now, we're really just watching sales and looking to drive sales and get them up fairly significantly from where they are today.

Got it. I guess, to circle back to the comment on competitive discounting from peers, I mean, are you seeing fairly -- do you think that impact is fairly broad-based across, say, the core and noncore markets? Or do you think that hurts more in a place like Texas?

No. It actually seems to be fairly broad-based. Again, obviously, our cores outperforming the new markets. But overall, we've seen it impact across our business, across our markets.

Got it. Just one last one, if I may. For Jake's question, he had asked about growth in the core and you had said 3 to 5. Just to confirm, was that 3 to 5 units or 3% to 5% annual growth?

3 to 5 units, I'm sorry.

Our next question comes from Sharon Zackfia of William Blair.

I guess, I have a question on the comp trend. If I recall correctly, you had a really challenging February in the year-ago time frame. I don't know if you talked about whether you've seen any improvement in February relative to January. And then just trying to kind of break down the flat comp guidance for the year given the negative trend in the first quarter. Obviously, comparisons are getting tougher. So I guess, could you kind of quantify how much you're counting on delivery or value menu or marketing initiatives to get back to flat?

Yes. So I think -- Sharon, I'm not going to give specific numbers, but we are looking to delivery and loyalty to really kick in and start delivering some comp growth. Loyalty, we've now had in place for roughly 6 months or so. We're still in investment phase, but we're kind of getting to the point now where we've made the investment. I've said on the opening remarks that we had 500,000 loyalty customers -- or actually over 640,000 as of today. So it continues to grow. We've made that investment. We're using -- Ansira and Punchh have been helping us with the analysis on our loyalty program and coming up with how best to utilize that customer data that we are collecting and really start targeting that. So we're really looking for loyalty, I'd say loyalty especially and then ultimately, delivery will start kicking in and driving comp growth in this business. Obviously starting fairly shortly as we get that data on loyalty and really start utilizing it to target our customers. And then on the other comp drivers that we're really looking at is we get a little bit from remodels as we do them throughout the year. And then also as I said, reading results and testing some value initiatives, especially the value menu, and we'll put that in test -- is going to test very shortly. We'll read the results and that's something also we see as we can implement that to be a comp driver. But clearly, technology is something that we made the investments in really over the last year, especially the last 6 months on loyalty, and we expect them to start kicking in and delivering comps over the next several months.

Okay. I guess, another question. I don't know if you gave us. If you did, I missed it. Did you give an outlook for commodity and labor inflation for '18?

No, I didn't, but I can give it to you now. It's -- we expect commodity inflation of around 1% and labor inflation around 4.5%.

Our next question is a follow-up from Jake Bartlett of SunTrust.

Just a real kind of a bookkeeping question. But what were the system-wide sales in the fourth quarter?

System-wide sales of fourth quarter were $198.5 million.

Great. And then for the unit growth for the franchise, it sounds like your company is going to be in the core markets in 2018. But what about the franchised stores? Are those going to be in the newer markets in the 6 to 8?

Yes, there will be some in the newer markets. So I know we have a few in Texas that are slotted. Salt Lake City is another market we expect to see a couple of openings. I have to go back and look at the rest of the detail, but certainly some out in the outer markets are expected.

Okay. And then lastly, what was your menu pricing in the fourth quarter? And what are your expectations for 2018?

And so pricing in the fourth quarter was 1.9% gross pricing, and it's about the same for this year. Now the break down this year will be somewhere around 1.5%, I will say, in the core market, while say core -- but it's 1.5% generally and then there's going to be incremental pricing in LA and San Francisco in response to the minimum wage increases in those markets.

Got it. So if I had to describe for you, about 1.5% for the first 3 quarters and you went to 1.9% in the fourth.

Well, Q3 last year was 1.8%. So it last year went 1.4%, 1.2%, 1.8%, 1.9%.

Our next question is a follow-up from Matthew DiFrisco of Guggenheim Securities.

Larry, I guess, can you also give a little bit of intel on who you think the -- have you been able to tell who the competition is that sort of turned it on in the last couple of months -- or I guess, in the last couple of months to start 2018? Is it broad QSR and including Burger guys? Or are there a couple of chicken guys that have changed their messaging in response to the broader arena that sort of affected you? Because, I mean, certainly, value hasn't really changed much. It's been pretty strong in the last 18 months or so.

Yes. But like I said, we haven't really seen -- I haven't seen KFC and Popeyes and other chicken guys really change their tune. They're still doing kind of the $5 meals and the $20 family meals. That really haven't changed. Certainly, we've seen the McDonald's and the Burger King's get aggressive. I also think there is just -- over time, more and more people become aware of these things and you see more people start to use the discounts to get their food at McDonald's and Burger King and those guys. But I have seen out here, I see Carl's out there now being more aggressive in California. Jack in the Box is now pushing it. So you start to -- and then Taco Bell has kind of jumped in, and they are starting to now be more aggressive along with Del Taco. So you'll see a lot of these value players in response to, I think, McDonald's and Burger King and some of the others. They are stepping up their games and being more aggressive and they're promoting their discounting. I mean, Taco Bell used to not really push it that hard because they just thought themselves as the natural discounter, but even they've been more aggressive in terms of talking about it. So I think there is just an over time effect that more and more people just start using it more and more, but I also do think that we've seen a higher share of voice from a lot of the QSR competitors really pushing these value menus and these deals for $2, $3, $4 in that range.

Ladies and gentlemen, we've reached the end of our question-and-answer session. This does conclude today's conference, you may disconnect your lines at this time. Thank you for your participation and have a wonderful day.