El Pollo Loco Holdings, Inc. (LOCO) Q2 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the El Pollo Loco Second Quarter 2014 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded today, September 4, 2014. On the call today, we have Steve Sather, President and Chief Executive Officer of the company; Larry Roberts, Chief Financial Officer; and Ed Valle, Chief Marketing Officer. And now, I will turn the call over to Larry Roberts.

Thank you, operator, and good afternoon. By now, everyone should have access to our second quarter 2014 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 risk 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 are also filing our 10-Q for the second quarter of 2014 today, and we encourage you to review that document at your earliest convenience. Lastly, during today's call, we discuss non-GAAP measures which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and reconciliations to comparable GAAP measures are available in our earnings release. With that, I'd like to turn the call over to Steve Sather.

Thank you, Larry. Good afternoon, everyone, and welcome to our inaugural quarterly earnings conference call. I'd like to welcome you and express my appreciation for your interest in learning more about El Pollo Loco. The format for today's call will be as follows: I'll begin with an overview of El Pollo Loco. Larry will then review our second quarter financial results and provide our guidance for the balance of 2014. Then I'll conclude with some comments about our growth plans before turning the call over to Q&A. For those of you who may be newer to our company, El Pollo Loco is a differentiated, value-oriented, faster fast casual restaurant concept. We have a distinct menu that features our authentic, freshly made, fire-grilled citrus-marinated chicken, and we pride ourselves on providing great food at a great value. Since our founding in Los Angeles, California, in 1980, El Pollo Loco has grown to over 400 restaurants today. It all starts with our signature hero product, our chicken. We handcraft our entrées using fresh ingredients and recipes inspired by authentic Mexican cuisine. Our grill masters fire-grill our chicken on real grills in our open kitchens, showcasing what we refer to as our theater of chicken. Our Mexican-inspired cooking process allows our customers to watch our grill masters and team members in action as they fire-grill and hand-cut our signature chicken, which we also use to create our handmade burritos, salads, tostadas, stuffed quesadillas and chicken entrées. We believe that we are uniquely positioned in the restaurant sector by offering the high-quality food and dining experience you would expect from fast-casual restaurants, while providing the speed, convenience and value typically of traditional quick-service restaurants, the combination of which we refer to as QSR plus. The majority of our menu items are priced between $5 and $7 with an average per-person spend of just $5.83, well below those in the fast casual space and only modestly above the QSR segment. We cater to time-pressured, value-conscious, mainstream food enthusiasts. Our broad customer base crosses over traditional age, ethnic and income demographics, and we think we are well positioned to benefit from consumer trends favoring healthier eating and bolder flavor profiles, including families who are trying to solve the dinner time dilemma of combining health, convenience and value. In fact, approximately 28% of our sales are generated from family-size meals. We take a strategic approach to our menu designed to allow for broad appeal with customers. Also, our balanced day-part mix sets us apart from our competition. Our customers use the restaurants in a variety of different ways with 42% utilizing the drive-through, 25% dining inside our restaurants, and the remainder ordering inside the restaurant or for takeout in order to take advantage of our fresh salsa bar, where they can customize their food. Our individual and family-sized chicken meals appeal to customers looking to dine in at the restaurant or take out during the dinnertime, while our more portable Mexican-inspired entrées draw traffic from customers at lunchtime or for afternoon snack, enabling us to generate sales that are equally split between lunch and dinner. We are excited to satisfy the needs of a growing consumer base that is seeking real food, real fast and reasonable prices with our authentic, distinct menu of fresh-made, Crazy You Can Taste, fire-grilled chicken and entrées. We believe that we are well positioned for the future and plan to grow our brand by expanding our restaurant base, increasing our comparable restaurant sales and enhancing our restaurant operations to leverage our infrastructure. With that summary, I'd like to turn the call back over to Larry to discuss our second quarter financial results.

Thanks, Steve. Before we discuss our financials, I'd like to briefly recap our recent IPO. On July 30, we completed Initial Public Offering of our common stock by issuing approximately 8.2 million shares, including approximately 1.1 million shares as part of the underwriters overallotment option. We received net proceeds of approximately $112.8 million net of offering fees and expenses, which we used primarily to repay in whole a $100 million second lien term loan. Now turning to the results of our 13-week second quarter ended June 25. Total revenue increased 6.3% to $86.9 million in the second quarter of 2014 from $81.7 million in the comparable quarter last year. The majority of our revenues are made up of company-owned restaurant sales, which increased 6.3% to $81.4 million during the quarter, compared to $76.5 million in the year-ago period. The increase was primarily due to a 5% increase in company-operated comparable restaurant sales consisting of a 2.2% increase in traffic and a 2.8% increase in average check. Franchise revenue increased 6.5% to $5.5 million year-over-year for the quarter, largely due to franchise comparable restaurant sales growth of 5.9%. While we do not intend to provide partial quarter comparable restaurant sales on an ongoing basis since we are 3 weeks from the end of our third quarter, we are providing a comparable restaurant sales outlook. For the third quarter, we expect system comparable restaurant sales to increase 6.5% to 7% and company-operated comparable restaurant sales to increase 5% to 5.5%. Now turning to expenses. Food and paper costs as a percentage of company revenue increased 30 basis points compared to last year to 31.9%, driven largely by higher commodity cost related to cheese, avocados and beef, which was featured in our highly successful carne asada promotion. These were basically offset by menu price increases -- increases taken at fourth quarter of 2013. Labor and related expenses as a percentage of company revenue sales decreased 40 basis points to 24.7%. This decrease was primarily due to the leveraging of labor cost as a result of our company-operated comparable restaurant sales growth. Occupancy and other operating expenses as a percentage of company revenue increased 10 basis points to 20.8% due to an increase in utility costs related primarily to higher gas and electric costs as well as higher average rising costs, increased general liability costs resulting for higher claims activity. Turning to general and administrative expenses, our reported G&A increased $0.5 million, or 8.5%, to $6.8 million during the second quarter of 2014 from $6.3 million in the quarter last year. As a percentage of total revenue, general and administrative expenses increased 20 basis points to 7.9%. The second quarter 2014 included a $0.2 million increase in stock option expense primarily due to the issuance of new stock options and a reversal of stock option expense in the prior-year quarter as a result of the departure of a management team member as well as higher professional fees incurred in the preparation for our IPO. On a pro forma basis, general and administrative expenses were $6.9 million compared to $6.5 million last year and, as a percentage of total revenue, remains flat at 8%. Depreciation and amortization expense increased to $2.2 million from $2.5 million last year, as a percentage of total revenue, increased 10 basis points to 3.2%, primarily due to the -- our remodeling program. Interest expense decreased approximately $4.1 million to $5.7 million due to lower interest rates on our debt bond on our October 2013 refinancing. Included in interest expense is a $0.3 million writeoff related to an interest rate hedge that we put in place late last year. As I mentioned previously, we used the majority of the net proceeds from our IPO to repay our $100 million second lien term loan. On a pro forma basis, after considering the debt paydown and adding back amounts paid in debt service, quarterly interest expense would have been approximately $3.1 million. We recorded an income tax provision of $570,000 for the second quarter of 2014 compared to $2 million last year. The provision for income tax related primarily to changes in our deferred taxes and the related effects of maintaining a full valuation allowance against certain deferred tax assets. We reported quarterly net income of $6.6 million, or $0.21 per diluted share, compared to net income last year of $0.4 million or $0.01 per diluted share. Weighted average diluted shares outstanding were approximately $30.6 million for the second quarter of 2014 and approximately $29 million for the prior period. Please also note that neither share count reflects our IPO, which closed in July. To account for the IPO and exchanges to our capital structure, we have calculated pro forma results, including net income and basic and diluted share count as if the IPO had occurred at the beginning of fiscal 2013. To arrive at pro forma net income, we have made adjustments to our management and consultant fees from our sponsor, credit facility interest expense, IPO-related expenses that were not capitalized, estimated ongoing public company costs, losses on the disposal of assets, asset impairment and closed store costs. We have added back provision for income taxes and have applied a 40.5% income tax rate. Included in our earnings release is a reconciliation of our GAAP results to our pro forma results. We believe that our pro forma results provide a useful view of our business given our post-IPO capital and cost structures. Pro forma net income for the quarter was approximately $6.1 million compared to $5.5 million last year. Diluted pro forma earnings per share were $0.16 for this year compared to $0.15 for last year. We have used a diluted weighted average share count of 38.8 million shares for the second quarter of 2014 and have 37.2 million for the second quarter of 2013, which reflect our shares post-IPO. In terms of our liquidity and balance sheet as of June 25, 2014, we had cash and cash equivalents of approximately $27.1 million and outstanding debt of $288.3 million. Based on application of IPO proceeds, our current total debt is approximately $189 million. Related to our debt payment, we will write off approximately $850,000 unamortized debt issuance costs in the third quarter. 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 $26 million to $30 million during the full year of fiscal 2014. With regards to fiscal 2014, we are providing the following full year guidance: first, we expect systemwide comparable restaurant sales to grow 5.5% to 6%, including company-operated comparable restaurant sales growth of 5% to 5.5%; second, we expect to open 9 to 11 new company-owned restaurants and 4 new franchise restaurants; and third, we anticipate restaurant contribution margin of between 21.4% and 21.6%. With that, I will turn the call back to Steve for a discussion of our growth strategy and closing remarks.

Thank you, Larry. As we look ahead, we are very encouraged by our second quarter's strong financial performance. And we believe that we are well positioned over both the near and long term. Before moving to Q&A, I want to briefly share what we believe are our significant long-term opportunities to grow our business, build our competitive position and enhance our brand. First, we believe we have significant whitespace development opportunities with an estimated long-term total restaurant potential of about 2,300 restaurants nationwide. Our in-house development team has over 95 years of combined experience in hospitality, commercial development and in analytics. Our long-term systemwide unit growth is targeted at 8% to 10% and will be balanced between growth in existing and new markets using a rigorous site selection process. In addition to building density in our existing markets, we plan to expand our footprint in select new markets to a disciplined hub-and-spoke strategy in contiguous states. Our first new market is Houston, which we will enter this fall. We also plan to grow our franchise base through existing franchisees and the recruitment of new franchisees. To that point, we recently signed agreements with Anil Yadav, a large independent franchisee, to develop 8 restaurants in the San Antonio -- in San Antonio and 12 in the Houston markets. Second, we have a consistent track record of strong, comparable restaurant sales growth, and we are confident that the initiatives we have in place can drive long-term comparable restaurant sales growth of 2.5% to 3.5% annually. We will continue to adapt our menu to create entrées that complement our signature fire-grilled chicken and that reinforce our differentiated QSR plus positioning. We're able to provide our customers with even more choices through customization and successful limited-time alternative proteins such as carne asada, shrimp and carnitas. In addition, we continue to meet the demands of the increasingly health-conscious consumers through our signature salads and our recently launched 5 Under 500 calorie menu, which has been an overwhelming hit with our customers. We'll continue to engage customers and drive brand awareness through our 10-module product calendar, which feature seasonal favorites. Our advertising campaign, Crazy You Can Taste, highlights the great lengths we go to, to deliver real food throughout the year. We tailor our message across television and direct mail, which garners broad exposure, and also through our cost-effective email marketing program, My Loco Rewards. In addition, using our social media platform, we can engage in one-on-one conversations to solicit new ideas and deepen the relationship between our customers and our brand. And we will continue to utilize our Hacienda remodeling program, which offers a more modern feel and inviting dining experience. This program has resulted in an incremental 3% comparable restaurant sales lift on average for our remodeled restaurants. We expect roughly half of our system to be remodeled by the end of this year with the entire system on track to be completely remodeled by 2018. Finally, in addition to growing our restaurant base and our comparable restaurant sales, we expect to enhance our restaurant operations and leverage our infrastructure. We believe that we have additional opportunities to further improve our margins by maintaining fiscal discipline, increasing fixed cost leverage and enhancing our purchasing efforts. Our state-of-the-art operations dashboard aggregates realtime restaurant-level information from nearly every aspect of our business, allowing us and our franchise partners to grow and manage the productivity of each restaurant. Additionally, we believe through the growth of AUVs and as our restaurant base matures, we will be able to leverage corporate cost and improve margins. In closing, I'm extremely proud of what we've accomplished at El Pollo Loco and look forward to our future as a public company. We have spent the past 3 years repositioning our brand, improving operational efficiencies, strengthening our management team and refinancing our indebtedness in preparation for future growth. We have a compelling value proposition and broad appeal that's clearly resonating with our customers. It's demonstrated by consistency of our comparable restaurant sales, which now includes 12 consecutive quarters of growth. We believe that we have significant potential to grow our restaurant base, including substantial opportunity within our existing markets as well as new markets. And finally, we have a number of initiatives in place that we believe can support consistent, comparable restaurant sales growth and also improve our restaurant-level profitability. Thank you, again, for joining us this afternoon. We appreciate your interest in El Pollo Loco. We'd be happy to answer any questions that you might have. Operator, open the lines for questions please.

[Operator Instructions] Our first question comes from John Glass from Morgan Stanley.

Can you maybe just provide us a little update on the development activity? Steve or Larry, in the back half, you talked about 9 to 11 units, maybe the third versus the fourth quarter, how the Houston market, in particular, is shaping up, and when you expect that first unit to open.

Yes. Let me just -- thanks, John. Let me give you just a quick overview. We have currently 4 company restaurants, and this is on the company side, 4 company restaurants open today. We've got another 5 that are under construction -- already under construction, and 3 that have the potential for this year to still go under construction and potentially finish. So that's why we increased to 9 to 11 units there. Our first -- on Houston, our first Houston company store will open in first part of October this year. We'll open 1 additional, possibly 2, so that would be 2 to 3 company stores in Houston. And we have a very robust pipeline of RESAC approved sites for Houston and the rest of the company for 2015. I might also comment, we did sign a franchise agreement with Anil Yadav, both for our San Antonio markets and our Houston markets. San Antonio, he'll add 8 stores to our base there. And in Houston, he has a 12-unit agreement.

And then, Larry, you gave some color in the third quarter, I appreciate that. The system sales, to get to 6.5 to 7, would presume the franchise comps, I think, would have to accelerate pretty meaningfully given what you said about company. Can you just flesh that out a little bit, why would they accelerate much more than company? Was that a difference in pricing, or what else -- what other dynamic is going on there?

Yes John, I think there's a couple of things. I think one element that we're digging to is potentially pricing. They may be a little bit more aggressive on pricing than we have been. The other one is that, as we've seen, as franchisees are a little bit more heavily invested in markets outside L.A., traditionally, those have grown a little faster than L.A. So the fact that they have a little more waiting in those markets outside L.A. also contributes to that growth. So those are the elements that are probably driving their growth slightly better than the company's growth.

Great. And I'm sorry, just one last one. How did the minimum wage go over -- increase go over in L.A? Was that as expected in the P&L behaving as you'd expect given that plus the price increase you took?

Yes, John. Yes, we took the half-point pricing first week of July. That has gone to P&L just as we thought it would, and we're not hearing any consumer pushback on the price increase, so we're very happy with the performance of that price increase.

Our next question comes from Andy Barish from Jefferies.

On the commodity side of things in the 2Q bumping up against 32%, do you think that's kind of peaking for the year? And I guess, how much of that was driven by the choice to promote steak during the quarter?

Yes, Andy. That's a -- I mean, a significant portion was driven by the steak. We had always planned to have a higher food cost with the steak promotion. We actually have -- it was so successful and mixed so high that we actually had to go out and procure more steak at even higher prices. But obviously, it was a great sales driver and don't want to disappoint customers, so that contributed a big portion to that. We've got a little bit of that because that promotion kind of also went into Q3. So Q3 will probably be in the same range around food cost, and then we expect that after that, it will fall back in line to where we traditionally have our food cost.

And is it -- where do you guys stand on chicken negotiations? When will you have a little bit more color on the 2015 chicken contracting? And then, maybe for Ed, any decisions on adding a new protein for next year or is that still to be determined?

So I'll take the chicken question, and I will turn it over to Ed on the protein. So we are just now kicking off our chicken negotiations, so we've gone out -- we've gone contacting suppliers, getting ready for 2015. Our approach is as usual, to find the multiple suppliers that we believe can play a part or play a role in our chicken supply. And so then we will be working through that over the next couple months. Honestly, it's probably going to be mid to late October until we have a real good sense for where those are coming out. Right now, 2015, we don't anticipate any major issues around chicken. The overall economics are favorable. It's just, there is a little supply and demand pressure. But overall, we're kicking off negotiations, and we don't foresee any big issues going in 2015.

And as Larry said, the carne asada was incredibly successful module for it, as you guys know, we actually test these live on the menu. It's our second-highest mixing promotion that we had. So it's certainly, going to get very, very strong consideration in 2015. And as we've discussed before, we have the option of using that as an LTO, as a seasonal LTO or as a permanent item. So more to come on that.

Our next question comes from start to from David Tarantino from Robert W. Baird.

My question relates to the entry into Houston market and just wondering if you could elaborate on some of your plans as you enter that market to market the brand and build the brand awareness and, I guess, set the stage, for all of the unit growth that you're planning there over the next several quarters.

David, this is Steve. Let me first start that off that we're very excited about the entry into the Houston market. As I think we mentioned in our roadshow, we're staffing that with existing management that's transferring for the first 3 stores, both the AM and the GMs from seasoned restaurant management from L.A. and our Las Vegas markets. So we'll operationally be ready to hit the ground running with the first 3 stores. In fact, the area leader also is already in Houston as we've finished the construction on the first store. And I'll turn it over to Ed because we've got a lot of exciting things on the brand. We've been researching the Houston market for a couple of years now, so we're all very familiar with...

Yes, and we went through all of that research that we did over the last couple of years here. We're going into Houston very strong. We're going into Sugar Land. We're going to actually open up with cable TV starting on 9/15, and we're going to be running that for 12 weeks in Houston. And we're going to continue to support our openings with cable TV. We'll also have direct marketing, some market-level event as well. And we're in the process of extending an offer to local field marketing person in that market to -- and this is the first time we're really engaging in field marketing and hope to have that person on board within the next 2 to 3 weeks. So just a lot of events there, including, and I forgot to mention, including out of homes. So we're going in strong. We want to go in solidly and leave no stone unturned.

Great, that's helpful. And then maybe a second question on the franchising. It sounds like you got the deal done with the one in Texas. I'm just wondering kind of what the pipeline is or the level of discussions you're having with potential future franchisees? And do you think that, that signing of the first franchisee is a catalyst to sign more in the coming quarters?

Yes. This is Steve, David. We've definitely seen increased responses or inquiries with the announcement of Anil -- signing of Anil. I think we have 3 solid ones that we're looking at for the markets that -- in the Southwest that we're considering. We're very pleased with that. But like with Anil, we're going to be very selective and make sure we have the right partners there. I can also add that our existing franchisees have been very active in ramping up on development, not only in their markets, but other markets as we look at Sacramento and Phoenix area, the Salt Lake. Our existing franchisees are becoming very active too because, of course, their business has done very well over the past 3 years.

Great, that's helpful. One last one for Larry. The tax rate in the quarter on a pro forma basis was a little higher than what we were using. What's the right number to use as we look forward?

Yes. So the long term, what we did is we went and had our tax advisers go back and recalculate determination based on our growth plans and things. And so they came back with a rate of about 40.5%. So on a pro forma basis, that's the right rate to use.

[Operator Instructions] Our next question comes from Paul Westra from Stifel.

Just a couple follow-ups. Just to make sure on the third quarter here, anything to be -- maybe bring to light about the transaction with the franchisee in San Antonio? I know you talked about the transaction itself, and then the transition went smoothly. Anything onetime of nature on the cost side as far as any potential friction costs hitting the third quarter?

On the, specifically to the San Antonio transaction, the sale?

Correct. Correct.

No abnormal cost or anything. We're on schedule to close late in the third quarter. So we are moving forward on that. And things are going smoothly right now, and there's been no incremental cost associated with that.

So for the company, it will be -- those stores will be carried as company-owned stores, obviously, until the day that -- official close at the end of the quarter?

Correct.

Okay, that's helpful. And then just a quick follow-up, I mean, given the numbers -- I'm calculating this a little bit on the fly, but it's -- obviously, your third quarter performances are very strong across the board and especially at the franchisee side. And then as I'm trying to deduce what the fourth quarter potential implied guidance is. It seems as though on the franchisee side, it may imply a little bit of a slowdown. Is that intentional? Or is that just a function of some rounding on midpoint assumptions?

Yes. I don't think it's -- basically, what we're doing is we're holding the fourth quarter where we originally had it. We're looking at the calendar and things, and we just think that's a good estimate for now in terms of what we think the fourth quarter outlook is.

Our next question comes from Sharon Zackfia from William Blair.

This is actually Matt Curtis on for Sharon. I just got a question on marketing costs. First of all, what were your marketing costs in second quarter? And how is that likely to trend going into 2015 as Houston development ramps up?

What you're saying -- to be more specific, are you focusing on the incremental marketing spend on Houston or...

No, I mean, on the second quarter, just what was your total marketing spend here as a percentage of sales or in dollars? And then...

Yes. So it was 4.3% in the second quarter.

Okay. And then is that likely to rise next year, given that Houston is going to see more of an ad spend?

Yes. I'm sorry, it was 4% in the second quarter.

Okay, then just another one. What was your systemwide revenue for the quarter?

Systemwide revenue for the third quarter?

For the second quarter.

The second quarter, it was 86 --

$86.9 million.

$86.9 million.

At this time, we have no further questions. I will turn the call back over to management for closing comments.

Okay. Thank you, operator, and thank you, everybody. We appreciate your time and certainly your interest today. We thank you for joining us, and we look forward to speaking with you again soon. Good evening.

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