El Pollo Loco Holdings, Inc. (LOCO) Q3 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the El Pollo LoCo Third Quarter 2016 Earnings Call. At this time, all participants have are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Larry Roberts. Please go ahead sir.

Thank you operator, and good afternoon. By now everyone should have access to our third quarter 2016 earnings release, if not, it can be found at www.elpolloloco.com in the Investor Relations section. Before we begin our formal remarks, I need to remind everyone that our 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 2016 tomorrow and we encourage you to review that document at your earliest convenience. During today's call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP and reconciliations to comparable GAAP measures are available in our earnings release. With that, I’ll turn the call over to Steve Sather.

Thanks Larry, and good afternoon everyone. We appreciate you joining us on the call today. We’re pleased to report the third quarter results, which included our 21st consecutive quarter of system wide comparable restaurant sales growth and pro forma net income of $0.18 per share. Our ongoing focus on our four pillars of our brand great food, excellent service, a warm and inviting atmosphere, and a good price has enabled us to achieve these results, despite the challenging environment. We believe our steadfast focus on our brand pillars combined with recent and upcoming initiatives designed to highlight our differentiated brand sharpen our value, improve our operations and elevator service will drive our business today and into the future. System-wide comparable store sales increased 1.6% during the quarter, including a 1.8% increase at franchise restaurants, and 1.4% increase at company-operated restaurants. While overall transaction growth at company operated restaurants during the quarter was flat year-over-year, we started experiencing a softening of sales during the second half of the third quarter, which is continued into the fourth. We continue to see solid year-over-year growth in our entrees, as well as in both lunch and our snack day parts, while the softening being driven largely by our family meals and the dinner day part. As you know, family chicken meals are an important aspect of who we are as a brand. So, we are focused on turning these sales around and are currently testing alternative offerings, which we believe will help reinvigorate sales of our family meals. Highlighting our differentiated brand identity will be the critical element and an enhanced marketing strategy as we work with our new creative agency. We recently hired Vitro after a competitive review involving over 25 agencies. Vitro was chosen based on their vision and creative approach to driving brand differentiation. The new campaign is expected to start early next year and will focus on our unique heritage and the lengths we go to in our restaurants to prepare delicious food and deliver a great experience. At the same time, we’ve been working with our new media agency Harmelin media to continue diversifying our media spend to include other channels like radio, digital and social media. Combined, we believe we will be able to broaden our reach with a differentiated message. With regards to service we continually strive to improve the experience of our customers and are currently working on a number of initiatives designed to ensure teams deliver the best dining experience possible. This includes the initial roll-out of a new tablet based learning management system in the fourth quarter. The learning management system is the foundation of a new learning structure, that we believe we will deliver consistent training to our teams and help enable scalable expansion. Lastly, we are now testing our mobile app and are on track to roll it out to all stores by the end of the year. Not only will our mobile app give our consumers the ability to order and pay via their mobile phones, it also is a gateway for further innovation, including loyalty programs, ordering kiosk, and delivery, all of which we expect to test and launch during 2017. We believe these initiatives amongst other will further enhance our value proposition and drive sales growth. Turning now to development, during the third quarter, we opened five new company-operated restaurants included our first entry in to the Dallas-Fort Worth area in Allen, Texas. Additionally, franchises opening two new restaurants during the quarter, including one in the Dallas-Fort Worth market. Subsequent to the end of the quarter, we have opened an additional four company restaurants. We are on track to open 17 to 18 new company-operated restaurants this year and expect our franchisees to open 11 to 12 new restaurants. As we noted on our last call, we have recently undertaken a number of marketing and operational initiatives in Huston to build a deeper relationship with consumers to drive repeat purchases and build frequency. While we have yet to see an improvement in overall sales trends, these initiatives have been in place for only a short time. We are also implementing additional initiatives designed to drive trial in Houston where we are not as well established as we are in our core markets. With regards to Dallas, we now have four company and one franchise restaurant open and we are pleased with the early results. Together with our franchise partner, we expect to open at least seven restaurants in the area this year. We remain focused on accelerating development and feel good about our development pipeline. During the quarter, we signed a development agreement with a new franchisee Listo Way Group to open two restaurants in Lafayette, Louisiana. And we continue to seek high quality franchisees with the capability to develop new markets. Lastly, I’d like to touch on our new vision prototype, which we feel more clearly reflects our brand and our QSR plus positioning. All five of our current Dallas-Fort Worth locations have opened with a new design. Feedback on the new design has been very favorable, echoing what we heard from our initial remodel in Fullerton, California. We currently have plans for at least seven additional remodels, which are expected to be completed during the first half of next year. Six of these are located in California and at least one in Houston, while not required to do so, we also have several franchisees committed to completing visionary models early next year. We will closely measure the reception of the design with the associated sales lift. Going forward, all new company operated restaurants, which have not yet begun the permitting process, will open with the vision design, including substantially all of our openings next year. And now I’d like to turn the call over to Larry, who will go over our third quarter results and our 2016 guidance in detail. Larry?

Thanks Steve. For the third quarter ended September 28, 2016 total revenue increased 7.8% to $95.8 million from $88.9 million in the third quarter of 2015. The growth was largely the result of the increased company-operated restaurant sales, which was 8.1% in the quarter to $89.7 million. This increase in company operated restaurant sales was predominantly driven by the contribution from the 22 new restaurants opened during and subsequent to the third quarter of 2015, as well as the 1.4% increase in comparable restaurant sales. The increase in company-operated comparable restaurant sales was comprised of flat transactions and a 1.4% increase in average check. The increase in average check was result of 1.5% increase in pricing, offset by 10 basis point of unfavorable mix. Franchise revenue increased 3.3% in the quarter to $6.1 million from $5.9 million in the third quarter of 2015. This increase was largely driven by the contribution from 10 new restaurants opened during and subsequent to the third quarter of 2015, and comparable restaurant sales growth of 1.8%. Turning to expenses. Food and paper cost as a percentage of company-operated sales decreased 180 basis points year-over-year to 30.0%. The improvement was predominantly due to lower commodity cost, particularly lower contracted chicken prices. Labor and related expenses as a percentage of company restaurant sales increased 220 basis points year-over-year to 27.3%. The increase in labor expenses was driven by higher wage rate reflecting the impact of California minimum wage increases and increased labor cost resulting from new restaurants opened in 2015 and 2016. Occupancy and other operating expenses as a percentage of company restaurant sales increased 50 basis points year-over-year to 22.4%. The increase was primarily due to rent expense on new and renewed restaurant leases and an incremental cost related to opening new restaurants in the fourth quarter of 2015 and the first quarter of 2016. Included in our third quarter results is a gain on recovery of insurance proceeds of approximately $500,000. This reflects proceeds from business interruption insurance related to a fire in one of our restaurants late last year. While this benefit does have a positive one-time impact on the third quarter, we have not adjusted pro forma earnings for it. As a negative impact of fire was not adjusted earlier in the year while the restaurant was closed to repair. General and administrative expenses increased by approximately $1.9 million year-over-year in the third to $8.3 million. As a percentage of total revenue, G&A expenses increased 150 basis points to 8.6%. G&A expense in the third quarter of 2016 included $519,000 in legal costs related to the securities transaction litigation. Excluding costs associated with the securities litigation G&A expenses in the third quarter of 2016 would have increased approximately $1.4 million or 100 basis points as a percentage of total revenue. This increase resulted primarily from increases in headcount, a higher accrual for the company's annual bonus program, restaurant pre-opening expenses, and travel expenses. Depreciation and amortization expense increased to $4.1 million or $3.3 million in the third quarter of last year. As a percentage of total revenue, depreciation and amortization increased 60 basis points year-over-year. Increase was primarily driven by new store development. During the quarter, we recorded a $2.4 million expense related to the impairment of the assets of two restaurants, one in Arizona, and the other in Texas. As is our policy, we continue to monitor the recoverability of the carrying value of our assets on a quarterly basis. Prior to our IPO, we entered into a tax receivable agreement that calls for us to pay our pre-IPO shareholders 85% of the tax savings to realize as a result of utilizing our pre-IPO net offering losses and other tax attributes. We provide a provision for income taxes of $2.8 million in the third quarter of 2016, reflecting an estimated effective tax rate of 35.2%. This compares to a provision for income taxes $6.5 million in the prior year third quarter. We reported GAAP net income of $5.2 million or $0.13 per diluted share in the third quarter, compared to a net income of $4.7 million or $0.12 per diluted share in the year ago period. In addition to our GAAP net income, we have calculated pro forma results adjusting for one-time for unusual items. To arrive at pro forma net income we have made adjustments for expenses and gains on the recovery insurance proceeds for the reimbursement of property, equipment, and other expenses related to a fire in one of our restaurants in 2015. Expenses associated with the tax receivable agreement, gains or losses on disposable assets, asset impairments closed store cost, gain on disposition of restaurants, and legal expenses associated with a securities transaction law suit. We have added back provision for income taxes and have applied 40% income tax rate. Included in our earnings release, is a reconciliation of our GAAP results to our pro forma results. We believe that the pro forma results provide a useful view of our business and cost structure. Accordingly, pro forma net income for the quarter was $6.9 million, as compared to $7.2 million in the third quarter of last year. Pro forma diluted earnings per share were $0.18 for the third quarter of 2016, compared to $0.18 in the prior year period. In terms of our liquidity and balance sheet, we had $5 million in cash and equivalents as of September 28, 2016 and $107.5 million in debt outstanding. For the foreseeable future, we expect to finance our operations, including new restaurant development and maintenance capital through cash from operations and borrowings under our credit facility. We expect our capital expenditures to total $37 million to $41 million for the full year of 2016. Turning to our 2016 guidance, based on current information we are updating our guidance of fiscal 2016. We now expect pro forma diluted net income per share of $0.67 to $0.68. This compares to pro forma diluted net income per share of $0.71 in 2015. Our pro forma net income guidance for 2016 is based in part on the following annual assumptions. We expect system-wide comparable restaurant sales growth to be approximately 1%. We expect to open 17 to 18 new company-owned restaurants and expect our franchisees to open 11 to 12 new restaurants. We expect restaurant contribution margin of between 20.6% and 20.8%. We expect G&A expenses of between 8.8% and 9% of total revenue and 8.0% and 8.2% of total revenue when excluding legal expenses related to securities transaction litigation. We expect adjusted EBITDA of between $66 million and $67 million and we are using a pro forma income tax rate of 40%. With that, I’ll turn the call back over to Steve for closing remarks.

Thanks Larry. While the environment remains challenging, we continue to work to drive improvement on our core business by focusing on our four brand pillars; great food, excellent service, a warm and inviting atmosphere, and a good price. We believe that through the focus on these pillars combined with the initiatives such as the value of service and operations and issues that we put in place during the last year and upcoming initiatives such as our new learning management system and mobile app. We will continue to strengthen our brand in driving improving results. Our development plans remain on track and we will continue to work to build a pipeline by partnering with high quality franchisees. Thank you again for joining us on the call today. We’d now be happy to answer any questions that you might have. Operator?

Thank you. [Operator Instructions] Our first question comes from Courtney Yakavonis with Morgan Stanley.

Hi. I just wanted to talk a little bit about the softening you said in the second of the third quarter and into the fourth quarter, it seems like the 1% same-store sales side is giving its inclined negative comps in the fourth quarter, so are you currently seeing negative trends and are you making an improvement in your guidance?

Yes. Hi, Courtney, this is Steve. Firstly, we are seeing some external factors here, obviously competitive discounting, grocery deflation, and a little bit of the election has impacted, but that being said, our entree business is performing very well, as is our lunch part, and we are seeing this softness is in the dinner and the family meals. So, we are very focused on developing programs that show better value, variety, and really create that solution to the meal solution. Right now we are adjusting a free side promotion; that’s currently what we’re running as an alternative. Meal structure, we are also testing in Las Vegas, two sides for an additional $3. And we're working on a reconfigured meal that will have a price of $20 that will be advertised on TV in January. So, we have a high sense focused on that meal solution day part. And with regards to your question on comps, yes it implies a slightly negative comps same-store sales in the fourth quarter.

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

Yes, we are currently, in third quarter we had about 1.5% effective pricing, if you recall we took 0.7% increase last, I think it was late April. We’ll take another 0.7% this November, which is normally when we take a price increase. So effective fourth quarter, we will be at 1.5%. We will then go and look at our results from first quarter analyze it closely and look at doing something potentially in second quarter, but we want to make sure we retain that price value equation, which is so sensitive, which we focus on over the last year.

Okay. And then just lastly, it seems like historically you guys had a decent spread between the company's tourist and franchise and it looks it’s narrowed significantly in the past couple of quarters, I just want to see if you have any insights into what’s going on there?

The franchisees have been a little bit more aggressive on their pricing and that’s hitting their transaction slightly. We've been more conservative on the company side so that spread seems to be getting closer and closer.

Thank you.

Thank you. Our next question comes from with Sam Beres with Robert W. Baird. Please proceed.

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

We think - first of all we are still continuing to be bullish on Houston and of course Dallas of the most recent most market we entered into. In Houston, we opened, I guess it was seven stores between the late fourth quarter and first quarter this year and we feel those are really just getting started. We put some additional effort in FSI’s direct mail and things like that. We’ve also looked at doing things where we are coming up now and adding. We’ve kept our additional labor in Houston because we want to make sure that customer experience is correct. And we have seen very actual performance over the summer and early fall on our market force the metrics. So, we think what we wanted to do now is focus on getting more people into the restaurant. So they can experience the great food. If you know our equation it is great food with service and environment over a competitive price and we think when Houston people experience that we will drive sales. We are looking at some things, some expanded FSIs taking the rings around the stores from a 2 mile to 3 mile radius to drive that trial. We’ve taken our media and we’ve focused a little bit more doing the enhanced direct mail. We are also looking at adding some mobile billboards there. But we really think it is early in the Houston cycle. Given that 7 of our 11 stores opened up really last year and first this year. On our other entry in Dallas, we feel good again, five stores opened, four company, one franchise. That’s our vision design and we’ve seen a – very early, but good results so far. We think the vision design will be a big part of our entry in the Dallas market.

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

First of all it is too early to comment on sales trends because we have a tremendous honeymoon periods when we enter a new market. That being said, as you recall both our - we opened a franchise store and the four company stores at the right around, since the middle of this summer. So, all of them seem to be initially doing well. What I'm very pleased to is our operational execution, we've taken some learnings that we’ve had in Houston on our market four scores in Dallas seem to be very strong for the market entry. We feel good about that. And our vision design, we really feel, if you remember on the last call we've talked about our vision design. We think reflects the image of our - the image reflects now the high quality of our food. And we think that's really that equation where we had the great food. Now we're bringing the service up and clearly the vision design is a fast casual plus design, and then over reasonable prices we think that's resonating with the Dallas consumer.

Hey Sam, the only thing I would add – Larry, is that, I mean we are happy with the sales volumes. Steve said you guys see the honeymoon period, but certainly the volumes have opened, we're happy with the volumes.

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

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

Great, thanks guys.

Thank you. Our next question comes from Sharon Zackfia with William Blair. Please proceed.

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

In terms of what, Aaron. In terms of comp sales, profitability.

Yes, in terms of comps or traffic.

Well the challenge on comps and traffic in Texas is these are all new restaurants right so, we have very limited comp data on Houston. There is only that three or four that have comps. They are lasting a very, kind of a longer opening curve. So those comps are showing negative. And in California, LA especially comps in the third quarter were positive and again as Steve highlighted earlier we are seeing softening, and when we talk about comps, I mean for the most part, I mean that’s California that’s the bulk of our restaurant. So for the quarter, we are going to be soft in terms of comps or playing negative in comp sales implication as a California we are looking at probably slightly negative also.

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

We kind of impact - in the third quarter what we saw and I do it looking in terms of - I get to in terms of percent of sales, the impact and what we are seeing is California, LA in the third quarter was probably that eight tenth of a percent impact on our labor cost, and we are also seeing additional wage inflation on top of that of about four tenths of a percent. So that is obviously, fairly significant impact and as we look forward to next year as you may be aware, California will go up an additional $0.50 to $10.50 on January 1; and L.A. will go to $12 on July 1 from $10.50. Overall, we kind of have taken initial stab of what we think that would be, we still are desperate to what we can do around to impression [ph] those things, but it’s probably going to be in that $3 million area.

Okay, great. Thanks.

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

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

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