El Pollo Loco Holdings Inc (LOCO) 2018 Q3 法說會逐字稿

Greetings and welcome to the El Pollo Loco Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host today, Mr. Larry Roberts, Chief Financial Officer. Please proceed, sir.

Thank you, operator and good afternoon. By now everyone should have access to our third quarter 2018 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 discussions 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 2018 tomorrow. I 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.

I'd now like to turn the call over to President and Chief Executive Officer, Bernard Acoca.

Thanks, Larry. Good afternoon, everyone, and thank you all for joining us today. I'm very pleased to report our results for the third quarter, which we believe are evident that our transformation agenda is sound and is beginning to gain traction.

Systemwide comparable restaurant sales increased 2.6% in the quarter while lapping 1.7% growth in the third quarter of last year for solid 2-year comparable growth of 4.3%, our best 2-year comparable sales trend in over a year. Systemwide comparable restaurant transactions were flat through the quarter. And in terms of cadence, we experienced an uptick in both comparable sales and transactions in September. I'm also pleased to add that this momentum has carried into the fourth quarter, with both system comparable sales and transactions currently positive.

A strong marketing calendar in the quarter, which included our Overstuffed Quesadillas and $5 Craveable Combos promotion, helped to drive our sales momentum. We believe that these promotions demonstrate our ability to drive sales without heavy discounting.

During the quarter, we also reintroduced chips and our handmade guacamole as an option for our guests, which our operators did an excellent job using to drive add-on sale as evidenced by our favorable mix. We're proud of these results and of the strategic progress we made in the quarter. But we believe this is only the beginning of our journey to take the El Pollo Loco brand to new height.

Now let's talk about the progress we've made against the 3 key strategies that underpin our transformation agenda. Our first strategy is creating a people-first culture. As I've discussed previously, culture is the foundation for all great companies, and as part of this, it is critical that we continue to invest in and develop our talent.

All of our support center teams, field leaders and franchisees have completed training on Heart-Centered Leadership, which focuses on leading with authenticity, humility and transparency and is about motivating and inspiring people in the right way. In addition, all of our company area leaders have now been trained on high-impact coaching, one of the 4 essential roles of leadership designed to build the business acumen of our leaders. The balance of company managers will complete the training in the next few months.

We also continued to drive utilization of Workplace by Facebook in all of our company-owned restaurants to increase employee engagement and foster our recognition culture of celebrating employee achievement. It's incredibly exciting to see how our restaurant teams have embraced this dynamic, social media platform to publicize their results, share best practices and deepen their relationships with one another.

Lastly, with regard to our people-first agenda, we recently brought on board a new and our first Chief People Officer, Jennifer Jaffe. Jennifer comes to El Pollo Loco from Estée Lauder, where she led the human resources function for Too Faced Cosmetics and was involved with the company's acquisition by Estée Lauder in 2016. Prior to Estée Lauder, Ms. Jaffe was Vice President of Human Resources at AT&T, where she served on an HR leadership team to support more than 13,000 employees.

It's Jen's top priority to further refine and embed our culture, focusing on employee engagement, recognition, talent selection and development and revamping our people management processes. Overall, we've made a lot of progress on seeding our culture in a fairly short period of time, and it's exciting to think about how much opportunity lays in front of us.

Our second strategy consists of differentiating the El Pollo Loco brand in everything we do. It's paramount for us to focus on those brand equities that we believe not only accentuate our strength, but also deepen the strong emotional connections we have with our customers. We just recently completed codifying our brand architecture in a comprehensive brand book. This is the first time that El Pollo Loco has had such a clear articulation of who we want to be. The book has already started to influence our strategic brand decisions and how we communicate the El Pollo Loco brand to consumers.

Starting in 2019, it will shape everything we do, from advertising and marketing communications to product development and store design. Now that the brand book has been completed, we are planning to make our new brand come to life through a significant brand relaunch that will take place at the start of next year.

Informing the development of our brand work is an expansive customer segmentation study that has just been completed. The study has been instrumental in helping us identify our core customers, how they view and use us and what our biggest opportunities are with them. As discussed on our previous call, while we appeal to a broad variety of consumers, preliminary studies tell us that our Hispanic customers, at almost 50% of our customer base, continue to be both a large source of strength as well as a big opportunity for us.

In addition, the opportunity for El Pollo Loco to own families is immense. Given the fact that we offer high-quality, better-for-you food, freshly prepared in our restaurants at great prices and the fact that almost 30% of what we sell every day are family meals, we believe that families and group occasions are right in our sweet spot.

Guided by the segmentation work, we took near-term actions to increase our mix of Hispanic advertising. We also included more 30-second TV ads to allow us to better tell our story and communicate our brand attributes, and we adjusted our marketing calendar to include more relevant and compelling promotions. Along with an operations own-sales mindset at the restaurant level, we believe that these actions are producing improved financial results. There is still a lot of work to do but the exciting news is that we are just getting started and the full execution of these and other initiatives won't be implemented until next year.

Our third strategy, expanding our business profitably and responsibly over the long term is predicated on the first 2. In a moment, Larry will talk about growth in the more traditional sense, or unit growth. But first, I wanted to talk about initiatives we're working on, which should help us focus our growth strategy, thus enhancing its future success.

In September, we began menu simplification tests in Houston, Dallas and Los Angeles to remove a significant number of low-mixing, high-complexity menu items. Not only does this initiative help to highlight what we do best, our fire-grilled chicken on the bone but it also reduces operational complexity, allowing our restaurant teams to further focus on food quality and customer service. We are pleased with the initial results and if they continue to be favorable, we will look to remove additional products in order to free up time for our employees to focus on our customers.

The other key initiative to sharpen our growth strategy revolves around providing frictionless convenience to our customers, which means providing easy access to our brand by increasing the number of channels through which they can engage with and order from us.

As you know, consumers are demanding convenience in the form of mobile ordering, mobile payments and delivery. To address these demands, we continue to add functionality to our mobile app. During the third quarter, we added the ability for customers to pay with their mobile phones, using a stored value component built into our app as well as the capability to e-gift El Pollo Loco to a friend or a family member.

We're also addressing demands for convenience through delivery, which is available through our partnership with DoorDash. All of our restaurants are now served by DoorDash, and we are working to determine the exact delivery fee, which will drive maximum incremental sales.

We continue to believe that success in delivery will be driven by our loyalty program, which currently has over 1.1 million numbers and accounts for approximately 7.5% of our sales. While we will continue to invest in bringing in new members, we have started to reduce the level of discounting required to acquire them. As with delivery, we are now focusing on optimizing our program, which in this case, means determining how to translate the robust purchase history data into personalized communication and incremental sales.

In summary, we're very proud of our third quarter results, which demonstrate increasing business momentum and indicate that our transformation agenda is working. Driven by our strategies of investing in and growing our talent, accentuating our brand strengths and building upon them as well as responsibly and profitably growing our business for the long term, we believe our momentum will continue to accelerate.

I look forward to sharing the progress we are making on future calls, as we continue to grow and elevate the El Pollo Loco brand.

And now I'll hand the call over to Larry to review our third quarter results in detail.

Thanks, Bernard.

Before we get into our third quarter results, I'd first like to touch on our store base. During the third quarter, we opened 3 new company-operated restaurants, 2 in Southern California and 1 in Phoenix. Additionally, franchisees opened 3 new restaurants during the quarter, 1 each in Northern California, Salt Lake City and Dallas. For the year, we expect to open 8 company-operated restaurants along with 9 to 10 franchise restaurants.

As for remodels, the company completed 1 Vision remodel in the third quarter, and franchisees completed an additional 3. We now plan to complete 15 company remodels in 2018, with franchise partners expected to complete 25 to 30, which contemplate some slippage into early 2019.

Now onto our financial results. For the third quarter ended September 26, 2018, total revenue increased 10.9% to $112.2 million from $101.2 million in the third quarter of 2017.

Total revenue in the quarter includes a $5.5 million of advertising revenue related to franchisee advertising fund contributions, required as part of new accounting guidance implementation. Excluding the advertising fund revenue, total revenue would have increased 5.5%, driven by an increase in company-operated restaurant sales.

Company-operated restaurant sales rose 5.3% in the quarter to $100 million from $95 million in the third quarter of last year. This increase in company-operated restaurant sales was driven by the contribution from the 13 new restaurants opened during and subsequent to the third quarter of 2017 as well as by a 2% increase in company-operated comparable restaurant sales, partially offset by 7 restaurant closures during the last year. The increase in company-operated comparable restaurant sales was comprised of a 2.7% increase in average check, partially offset by a 0.7% decrease in transactions.

Franchise revenue increased 8% in the third quarter to $6.7 million compared to $6.2 million in the prior year period. The increase was primarily driven by a 3% increase in franchise comparable restaurant sales, which included a transaction growth of 0.6% as well as by 9 new franchise restaurants opened during and subsequent to the third quarter of 2017.

Turning to expenses. Food and paper costs as a percentage of company restaurant sales decreased 100 basis points year-over-year to 28.3%. The improvement was predominantly due to price increases, a favorable sales mix and lower commodity cost related to avocados, partially offset by higher packaging cost. During the fourth quarter, we expect a continuation of favorable commodity trends but expect that benefits be offset by higher-cost menu promotion.

Overall, we now expect our commodity basket to be slightly deflationary for the full year. Looking ahead, we have completed our chicken negotiations and anticipate commodity inflation of 1% to 2% in 2019. As a reminder, chicken makes up approximately 36% of our commodity basket.

Labor and related expenses as a percentage of company restaurant sales increased 20 basis points year-over-year to 29.2%. The increase in labor expenses was due primarily to higher wages in California, especially in Los Angeles; the impact of incremental labor required for 6 restaurants opened during or after the first quarter of 2018; and higher workers' compensation expense as a result of higher claims activity. These are partially offset by increased menu prices. We continue to expect labor inflation of about 5% for the full year 2018, accelerating to 5.5% to 6% in 2019.

Occupancy and other operating expenses as a percentage of company restaurant sales increased 80 basis points year-over-year to 24.2%. The increase was primarily due to rent expense, relative to revenue volume generated and other incremental costs related to restaurants built in 2017 and the first 39 weeks of 2018.

In addition, we incurred an unexpected increase in natural gas prices due to supply shortages, resulting from fire damage to a key natural gas processing plant servicing Southern California. We expect continued cost pressures within occupancy and operating expenses through the fourth quarter.

General and administrative expenses increased by $3.9 million year-over-year to $12.2 million. G&A expense in the third quarter of 2018 included $3.7 million in legal cost related to the securities class action litigation as compared to $933,000 in securities litigation cost in the third quarter of 2017. Excluding the cost associated with the securities litigation and executive transition in both periods and adjusting for the impact of franchise advertising revenue on our 2018 revenues, G&A expenses in the third quarter of 2018 increased approximately $1.1 million year-over-year to 8% of total revenues, a 70 basis point increase versus the prior year. This increase resulted primarily from adjustments to our bonus accrual.

Depreciation and amortization expense decreased to $4.5 million from $4.7 million in the third quarter of last year. As a percentage of company revenue, depreciation and amortization decreased 60 basis points year-over-year. The decrease was primarily driven by lower asset value, resulting from the impairment charges taken in 2017 and 2018.

We recorded a provision for income taxes of $2.4 million in the third quarter of 2018 for an effective tax rate of 25.9%. This compared to an income tax benefit of $2.5 million and an effective tax rate of 37.8% in the prior year third quarter.

We reported GAAP net income of $6.8 million or $0.17 per diluted share in the third quarter compared to a net loss of $4 million or $0.11 per diluted share in the prior year period.

Pro forma net income for the quarter was $7.6 million as compared to $6 million in the third quarter of last year. Pro forma diluted earnings per share were $0.19 for the third quarter of 2018 compared to $0.15 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 $8.1 million in cash and equivalents as of September 26, 2018, and $71.2 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 expenditures to total $25 million to $27 million.

As previously announced, our $20 million share repurchase program, which expires on June 26, 2019, will commence on November 6.

Turning to our outlook for 2018. We are updating our guidance for the full year as follows: Excluding the impact of potential share repurchases, we now expect pro forma diluted net income per share of $0.70 to $0.73, which includes an estimated $0.14 benefit from the lower tax rate. This compares to pro forma diluted net income per share of $0.63 in 2017.

Our revised pro forma net income per share guidance for 2018 is based, in part, on the following annual assumptions: we expect systemwide comparable restaurant sales growth to be flat to 1%. As I noted, we expect to open 8 new company-owned restaurants and expect our franchisees to open 9 to 10 new restaurants. We expect restaurant contribution margins of between 18.7% and 19%.

We expect G&A expenses of between 8% and 8.2% of total revenue, excluding CEO transition cost and legal fees related to securities class action litigation and reflecting our change in accounting for franchise advertising fee.

We expect adjusted EBITDA of between $61.5 million and $63 million. And we are using a pro forma income tax rate of 26.5%.

This 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 Mary McNellis with Robert W. Baird.

I, first, just wanted to ask for an update on Texas. I think your commentary in the last call suggested that the improvement that you'd been making in that market may have stalled a bit. But then in this quarter, you introduced the streamlined menu. So I was just wondering if you could comment a little bit on how the performance went in those noncore markets during Q3 and maybe the impact that the menu simplification has had on either operations or guest satisfaction in those markets.

Sure. This is Bernard, I'll take that question. So with our performance in Texas, again, it was really in the middle of that quarter that we implemented our menu simplification test. And what we're seeing right now looks promising. It's still too early to tell. You need a little bit of a longer read when you conduct a menu change of that sort, where we've eliminated 12 to 15 SKUs off of the menu. We're encouraged by what we're seeing. We're not seeing any negativity associated with this test at this juncture. But in regards to just the overall sales trends in Texas, we're continuing to see more of just a plateau effect, if not, a little bit of a softening in the business there. So honestly, I'm not quite sure it's something we could measure within a quarter. We're still looking to play the long game in Texas. And what we've implemented to effect change there, we feel hasn't really fully taken hold. So again, more of a longer-term focus than looking for any meaningful improvement within a given quarter.

Understood. And just one more question on the quarter-to-date turn. I was wondering if you'd be willing to comment directionally on whether the improvement that you saw exiting Q3 and entering Q4 was more so a reflection of the year-ago comparison softening or if you're seeing some evidence that some of these newer initiatives are moving the needle on the underlying trend.

Well, I mean, you can see in the numbers then, and I think we've talked about the fact that our comps last year, in the back half, relative to the first half had softened. But I think what we are seeing in our business we're encouraged by certainly based on the positive transaction trends that I mentioned in my prepared remarks relative to the rest of the industry, where that seems to be somewhat more elusive for many brands. And so we are encouraged by the increasing momentum we are seeing in our business.

Our next question comes from Matthew DiFrisco with Guggenheim.

This is actually Matt Kirschner on for Matt. I just want to start by first discussing the gap between the company stores and the franchise stores. Anything changed there? I see the delta was about 100 basis points this quarter, and it's been roughly at that pace going back the last few quarters. Is that mainly pricing? Or how should we think about that delta going forward?

Yes, Matt. Actually, I would say the delta has actually tightened a little bit. I mean, yes, 100 basis points. But there have been times we have run higher than that in the past. And what we're really seeing right now is a little bit of reverse from where we've been is the fact that we're actually running a higher check on company restaurants. I think part of that is because of the way we've really been driving the guac and chips promotion in our restaurants. And where the franchisees right now are outperforming is on transactions. And so in fact, one of the things we're doing in the fourth quarter is we are running a test in a -- when I call it a test, it's actually across a large number of restaurants, in which we are deploying extra labor at dinner in the drive-through to see if that is one of the drivers of what's causing that transaction gap. And so we've just started that test. It's one of the investments we're making in the fourth quarter, looking to read that. But so right now, what we've seen is a shift where the gap is really around transactions, and we do have a test in place to see if we can close -- further close that gap on transactions in the fourth quarter with this incremental labor.

And that test would only be at the company locations?

That test is only company locations right now, yes.

Okay. I had noted that you would be rolling out a new store design in late September in Dallas. Any key findings or learnings that we should take away since that new store launched?

Well, I think you're referring to the Vision restaurants, which is -- all our restaurants in Dallas are the Vision design. And in fact, what we're doing right now, I can't remember if Bernard talked about it on the previous call a little bit is, we're relooking at that design or some of the elements of design. I mean, they're beautiful-looking buildings, they're fantastic. They work extremely well in California when we built them because California, they know El Pollo Loco. The thing we're questioning is putting them in a new market, as great as they look, do people really understand what El Pollo Loco stands for as a brand by looking at those assets and do we need to make some tweaks to them or changes to them on the outside and the inside to better convey what El Pollo Loco stands for and what you should expect when you go into an El Pollo Loco restaurant. But just to be clear, all of our Dallas restaurants are on that Vision design.

Understood. And the last question, you are opening stores in some and having impairments in store closures. I mean, what's the -- how should we think about the net benefit of opening a store versus maybe closing an offsetting store or underperforming store?

Well, I guess I look at it as we -- I mean, in the past few calls, I think we've highlighted the fact that our development is going to be increasingly focused on core markets. Core being Southern California, Las Vegas, and we'll also be building restaurants up in Sacramento. And we're focusing on those because we know when we build restaurants in those markets, we get very good returns on those. So those are going to be certainly accretive to EBITDA and earnings per share. And of course, as we look around and assess our assets and if we determine that we wanted -- we should close more restaurants, those will also be additive because we'd only be closing those if they were negative EBITDA and negative EPS. So I hope that answers your question. Again, so everything we're going to be building next year. We're very confident in the performance given they're in our core markets. And any closures or anything we did would definitely be accretive to earnings and EBITDA.

Our next question comes from Andy Barish with Jefferies.

This is Alex on for Andy. I just wanted to follow up on Mary's earlier question about Texas and get a sense of what the drag was on comps in restaurant-level margins this quarter. I think, Larry, last quarter, you had shared that was up 50 basis points for the comp. Is that coming down? Where is that trending right now?

Yes. For the comp impact in the third quarter, it was about 30 basis points, so a little better versus Q2.

And is the impact on restaurant-level margins still about 150 basis points or so? Or was that coming down as well?

That actually also improved a little bit in Q3. It was about 130, 135 basis points versus 150, 160. We're spinning with that.

Got it. And then just going back to the comments on the fourth quarter and momentum-to-date, I think in your commentary on cost of goods, you mentioned that there were some higher-cost promotions coming in the fourth quarter. And are those going to be discounting? Or is that a reflection of the efforts to bring down the higher company check and close the traffic gap versus franchisees?

No. What it really reflects is the actual limited-time offer that we have going in, our last module, which would run from roughly Thanksgiving through end of the year. It's not discounting. It's just a fairly high food cost item. I don't want to disclose what it is. But we feel like it's going to be a very strong promotion for us. But it does have a higher food cost associated with it.

Got it. And then just I guess one last question, staying on same-store sales. Where is sort of the delivery mix trending right now? I guess are you open to sharing sort of what percentage of that mix is coming through the El Pollo Loco app versus DoorDash's? I know that was a later add to their marketplace, fairly recently.

So we've been steadily growing digital sales and by digital, I mean mobile, e-commerce and delivery. So right now, it represents 2.6% of our sales in totality. I think where you're really going to see us put a lot more momentum behind delivery is in 2019. Our focus historically as a company -- when I say historically, I mean maybe the past couple of years, few years, has really been around lunch. Where we're going to really pivot in 2019 is put far more effort behind dinner. I think Larry talked about the investment we're making in the quarter, the fourth quarter certainly, around additional labor at the drive-through, particularly at dinner. So that we improve our speed of service times during that day part. But what that will also be coupled by is a real focus on family meals, advertising, targeting dinner as well as in 2019, a greater effort and messaging behind delivery. So I think we've been happy with the steady progress we've been making against delivery in 2018. But we're going to be more ambitious about the growth we're expecting to see from delivery in 2019.

And I guess, will most of that come in the form of the Rewards app and pushing that messaging through the mobile app with rewards?

We think that's the catalyst, the primary catalyst for delivery growth for us, yes. And so you'll see, again, the unlock for delivery for us is a continued growing of our membership base with local rewards or loyalty program. And we're very pleased with our membership acquisition rates there, growing membership to the tune of, let's call it, 10,000 to 12,000 members a week. And so as we continue to grow that program, we see that as being a major catalyst to growing delivery over the long term.

(Operator Instructions) Our next question comes from Jake Bartlett with SunTrust Robinson.

This is Kevin Robinson on for Jake. And my question focuses on primarily like the family meal mix and also the loyalty. If you could give me a sense of what was like the quarter-over-quarter change in terms of the discounting or loyalty discounting, just to get a sense of how that has changed? And also, what was the family meal mix percent of sales this quarter?

So the discounting associated with the loyalty program, if anything, has slowly started to ramp downward. We're holding at about 1%. We've done a few things that have actually helped kind of -- halted this -- or I should say, keep the discounting steady, if anything, there, which is reducing the discounting associated with acquiring a new member, which doesn't seem to have hurt us too significantly, quite honestly. In regards to the family -- in regards to the mix around family dinner, family meals, that has historically been anywhere between 28% to 30% of our business. And what we are trying to do certainly in 2019 is meaningfully grow that as we start to pivot and put more of our attention and focus around dinner, as I mentioned just a moment ago.

Thank you. There are no further questions in queue at this time. I would like to turn the call back over to Mr. Bernard Acoca for closing comments.

Well, I just want to thank everyone for attending this evening's call, and we look forward to touching base with all of you in our next quarter. Thank you for attending today.

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