Fogo de Chao (NASDAQ:FOGO) Q3 2016 Earnings Conference Call November 7, 2016 5:00 PM ET
Stacy Murphy - Investor Relations
Larry Johnson - Chief Executive Officer
Barry McGowan - President
Tony Laday - Chief Financial Officer
Nicole Miller Regan - Piper Jaffray
John Ivankoe - J.P. Morgan
Jordi Winslow - Credit Suisse
Brett Levy - Deutsche Bank
Greetings and welcome to the Fogo De Chao Third Quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode and a question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference is being recorded.
And Now I’d like turn the conference over to your host Ms. Stacy Murphy, Investor Relations for Fogo De Chao. Thank you. Ms. Murphy, Please go ahead.
Thank you. Welcome to Fogo De Chao third quarter fiscal 2016 earnings call, which is also being broadcast live over the Internet. Before turning the call over, let me quickly remind that certain matters discussed such as statements relating to the company’s strategies, or guidance are not based on historical facts, and are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such statements are subject to risks and uncertainties that are described in our press release in the company’s filings with the SEC. Any forward-looking statements represent our views only as of today and we assume no obligation to update any forward-looking statements.
On the call, we may refer to certain non-GAAP financial measures. Reconciliations are provided in the tables in the press release. On our call today, you will hear from Larry Johnson, Chief Executive Officer; Barry McGowan, President; and Tony Laday, Chief Financial Officer. Following their remarks, we will be happy to take your questions.
Now I will turn the call over to Larry.
Thank you, and welcome to our third quarter earnings call. A few highlights from the quarter include, an EPS of $0.16, positive consolidated comparable sales of 0.6%, and US traffic outpaced the industry by 230 and 220 basis points on the Net Track High-End Steakhouses and Black Box Upscale Fine Dining group.
Another recent highlight we are very proud of that we were recently recognized as the best steakhouse in the US by consumer reports leaders. It marks the first time, a Brazilian steakhouse has been awarded this honor. Since our founding in Brazil, 36 years ago, we have always sought to be the best and the category leader within the Brazilian steakhouse group. So to be recognized by consumers as the leader of the steakhouse category as well is a remarkable complement.
Fogo is a distinctive brand with a compelling value proposition driven by our core attributes of the unique and differentiated service model, authentic Brazilian cuisine and competitive price points. Our strategies are to drive frequency through expansion in restaurant execution of our core experience and our initiatives around daypart, value price optionality and large group sales.
They are proving effective as evidenced by our 0.9% traffic lift and the favorable traffic gap to peers during the quarter as noted earlier. In particular, we were encouraged by our Saturday extended hours initiative, which allows us to further optimize our restaurants’ capacity on our highest volume day, which started as a test in July, it was rolled out to the majority of the US system by the end of the quarter.
Brazilian Brunch and Gaucho Lunch continued to show solid results and help us highlight everyday value while giving guests another opportunity to try the brands. Barry will provide more detail on these traffic driving initiatives. The Olympics were an exciting time for the world and Fogo. As a result of our 36 year history in Brazil and thoughtful strategic positioning of the brands, we were able to capture record-setting increases in traffic in Rio and media coverage globally.
In our flagship Botafogo store, we served over 11,000 guests in one week. This is the brand’s new record high for guest count for a single week. From a global perspective, we reached a high watermark for earned media coverage that stand across the US, Brazil, as well as other countries covering the games.
The media attention included, live cooking segments, our national shows like Good Morning America, as well as multiple appearances on the Today Show and Ryan Seacrest live from Copacabana Beach. We had local on-air cooking segments in approximately 25 US markets and Fogo was mentioned in over 20 US markets as part of informative or Brazil content-driven segments covering our restaurants in Rio and we were honored to help introduce NBC Sports and Tom Brokaw to the Gaucho culture in Southern Brazil. We were part of a four minute video called the Gaucho Way starring Tom Brokaw which aired during the final night of the Olympics.
In the US, we further leveraged the incremental media attention in Brazil Buzz by highlighting our authenticity through our Best of Brazil promotion. This offer invited guests to come in and enjoy up to ten cuts of meat with a focus on Brazilian favorites, like Picanha and Fraldinha along with Market Table and Side Dishes for a value offer of $39.
Based on the success we experienced in August, we have recently reintroduced it as a limited time promotion running prior to our prime holiday season.
In addition to strong Rio results, our recently remodeled Brazilian store is performing well also showing positive comps. During the quarter, we completed our second Brazil remodel at our Moema location in Sao Paulo. Our remodel program generally updates the design to ensure the restaurant décor stays fresh and relevant repositions the bar to create a more approachable productive space and adds dining room capacity where possible. In addition to the Brazil remodels, we will also completed three US remodels by year end.
In Brazil, the exchange rate is stabilizing. The economic forecasts are improving. The political environment is calming and the country navigated a successful summer games. We believe there is reason to be optimistic about the long-term growth and strength of the Brazilian economy, but remain cautious in the short-term.
From a development perspective, we continue to have a strong pipeline of stores. We opened our King of Prussia store during the quarter. This is our second store in the Philadelphia metro area and is consistent with our strategy of penetrating development in key markets.
In October, we opened our second international joint venture location in Mexico City in the Santa Fe area. We currently have five restaurants under construction including four in the US and one in Jeddah, Saudi Arabia. We continued to be on track to open as many as five to six restaurants during 2016 including our Santa Fe Mexico City joint venture restaurant.
And looking beyond 2016, we have five signed leases. Although we are encouraged by our third quarter results, this is still a very challenging consumer environment with a turbulent summer freshen our minds, we understand how easily sales can be impacted by the factors like an uncertain political environment. We believe the strategies we have in place are the key to our long-term growth in EPS and shareholder value.
Now, I’d like to turn the call over to Barry to walk you through the operational strategies in place driving the brands.
Thank you, Larry. Our strategies around daypart expansion, value price optionality and large group sales have been developed to drive awareness, trial and frequency building traffic over time. And the results for the quarter indicate our strategies continue to move the business in the right direction.
As Larry mentioned, our various traffic-driving initiatives continue to gain traction breaking the negative sales momentum that the industry experienced in the summer. In addition, the Olympics were success proving lift to our Brazilian operations and generating significant media impressions across North America.
This resulted in an overall comparable sales result of up 0.6% for the quarter. On a two year stack basis, Fogo’s overall US comparable sales were up 1.8%. The two year US comparable traffic for the quarter is up 4.5% or 740 and 640 basis points higher than our peers at Net Track High-End Steakhouse and Black Box Upscale Fine Dining groups respectively.
Optimizing the highest demand weekend dayparts by expanding Saturday hours and incorporating brunch are key factors in our traffic growth. On daypart expansion, we tested the extended hour strategy by having five stores opened at 2 PM on Saturdays offering dinner price menu. We confirm the demand and utilization of this extra dining time and expand on the test to the majority of our US locations by the end of the quarter.
This dinner hour expansion on Saturday was the largest traffic driver for the quarter. This confirms the pent-up demand for the brand on weekend dinner and have captured this traffic with no noticeable weekend cannibalization at this time.
We also introduced the Saturday Brunch Test starting at six locations and then broadened to 12 locations by the end of the quarter. Opening this unique daypart for Saturday and Sunday lunch gives our guests the opportunity to enjoy Brazilian Brunch dining experience.
Both of these daypart strategies are intended to optimize the restaurants’ capacity on our highest volume day and to optimize revenue on weekends where our overall guest demand is strongest. This is early-stage initiative and we will continue to analyze the results and make refinements as needed to further support our long-term strategy of driving awareness, trial and frequency of the tad.
Like the industry, we are facing a challenging sales environment. The plentiful supply of dining choices, the current gap between food at home deflation, and current food away from home price inflation. An uneasy geopolitical landscape is making consumers more discerning with their dining dollars. However, we believe our traffic-driving initiatives have enabled us to navigate the choppy sales environment and outperform the industry in traffic. This is why our strategy of all day value and price options like Gaucho lunch are important.
The Gaucho lunch initiatives has allowed us to preserve our market share, in fact, the comparable lunch traffic outpaced nap lunch traffic by 840 basis points and lunch sales by 990 basis points. Our operation team continues to preserve our four-wall restaurant margins. Our cost of sales improvement attributed to commodity deflation, positive mix shift from our seasonal initiatives, and a continued focus on minimizing waste.
At the beginning of the quarter, we rolled out the butcher’s standard of excellence training platform to the US intended to optimize the front-end kitchen process to improve quality and continue to reduce waste. In labor, we continue to focus on productivity improvements in both the US and Brazil.
In addition, we are improving the new store ramp and we will also – that incremental opportunities to refine our business model, while maintaining our guest experience preserving a strong restaurant level returns.
As discussed last quarter, we have been focused on developing social media strategy to grow our consumer database. Going forward, we will consider cost-effective ways to use layered media such as radio, allophone, and TV over the next few years to further increase the brand awareness, trial and frequency.
Last, as we continue to invest in people and leadership development in all levels of our organization to maintain continuity and succession as we continue to grow at a measured pace. At the beginning of this year, we finalized the investment of the third manager in nearly every US restaurant identifying to promote its several next level leaders to area managers from within and are now investing in additional bench strength in our high volume restaurants.
Our continued investments on developing our leaders and staying focused on enhancing our guest and team member experience is a high priority in maintaining our position as the category leader in churrasco.
Now, I’d like to turn the call over to Tony to discuss our financials. Tony?
Thanks, Barry. GAAP revenue for the quarter increased 13.2% to $0.69. On a constant currency basis, total company revenues increased $7.3 million or 11.8%. The revenue growth is attributable to a 10.4% increase in non-comparable restaurants, a 1.2% foreign exchange benefit, and a 0.6% increase in consolidated comparable sales.
Due to the 53rd week in 2015, comparable sales weeks have shifted one week. The impact of this shift represents a 1% increase in revenue. Specifically, from a US perspective, comparable restaurant sales decreased 1% driven by a 0.7% decrease in check and a comparable traffic decrease of 0.3%.
Although we experienced a slight decline in traffic, as Larry mentioned, this is over 200 basis point above the industry as measured by Net Track High-End Steak Houses and Black Box Upscale Fine Dining. Brazil comparable restaurant sales posted an increase of 9%, which includes the benefit of the increase in tourism generated by the Olympics.
Specifically, traffic increased 5.2% for the quarter, while check improved 3.8% - in our Rio locations were over 25% higher during the Olympics driving the PPA into restaurants up nearly 10%. We are encouraged by the improving currency exchange rate greater clarity on the political front and a positive impact of the Olympics.
We also believe in the long-term growth and strength of the Brazilian economy but remain cautious however in the short-term. Cost of sales decreased 130 basis points to 29.2% due primarily to commodity meat deflation of approximately 100 basis points. Mix shift and waste initiatives also contributed to the decline, but to a lesser extent.
This was slightly offset by new restaurant inefficiencies of about 10 basis points. On a quarter-over-quarter basis, labor increased 200 basis points to $16.3 million. New restaurants accounted for nearly 120 basis point as they continued to ramp. Rising healthcare cost, minimum wage increases, and the addition of a third manager to support growth represented the remainder of the increase.
These collective headwinds were somewhat offset by sales leverage and continued productivity gains in Brazil. Occupancy and other operating cost increased $2.5 million to $13.6 million. As a percentage of revenue, this is a 150 basis point increase to 19.7% primarily driven by higher cost of rent as a percentage of sales in our new restaurants as these stores are early in the maturity curve.
General and administrative expense was $5 million, an increase of $893,000 and 50 basis points to 7.2%. The increase is primarily attributable to an increase in headcount and public company cost as we built the infrastructure to accommodate the needs of a growing public company.
Depreciation expense increased $862,000 to $4 million due to the six restaurants opened in the last twelve months. The effective tax rate for the quarter was 33.8%, slightly above our anticipated normalized rate of between 32% and 33% due to greater than anticipated income taxes on foreign interest income.
Our GAAP net income for the quarter decreased $3.2 million to $4.6 million. Diluted EPS and adjusted diluted EPS were both $0.16 for the third quarter of 2016. The company has generated operating cash flow of $36.7 million thus far in the fiscal 2016.
Additionally, we have $92 million available on our $250 million line of credit, the company’s only debt. We completed a $2 million paydown of debt in the third quarter bringing our total debt pay down for the year to $10 million. At the end of the quarter, the company had cash on the balance sheet of $30 million.
Our healthy cash flows allows us to comfortably fund our paced restaurant development and implement value-creating initiatives to drive the business while maintaining a strong balance sheet.
Now I would like to turn the call back over to Larry.
Thank you, Tony. In closing, I just want to reiterate, we are excited about the long-term growth opportunity for Fogo. We believe the fundamentals of Fogo’s business model are sound. We have a distinctive value proposition supported by our core attributes of a unique and differentiated service model, authentic Brazilian cuisine, competitive price points and customization to drive the top-line.
Our operating model is efficient and generates significant cash flow and high returns on capital and our development strategy capitalizes on the significant white space to grow domestically through capital light joint ventures in international markets beyond Brazil.
Now, I would like to turn the call over to the operator to open the lines for questions.
Thank you. [Operator Instructions] And our first question comes from the line of Nicole Miller with Piper Jaffray. Please go ahead.
Nicole Miller Regan
Thank you for taking my question. I want to ask two questions quickly. First on the grocery deflation side, does that limit your pricing power? Or do you think you really are hosting an experiential diner where that’s not a factor?
Nicole, this is Barry. I think the pricing power if you would, the deflation right now our people are driving traffic with discounting, the way we’d like to see it is we have an experiential diner but we are also investing in a mix shift with Gaucho lunch and brunch initiatives. So that value creation. We are also adding, if you would, we’ve added products to our daypart special guest Brazilian Brunch. So I’d like to say, we are balancing that deflation with offer to the guests. So that’s how we see that obviously, how we are competing for traffic.
Nicole Miller Regan
Okay, that’s helpful. And then, just given the big picture commentary that you offered, what do you think is a reasonable, just big picture holiday outlook? Like, how do you expect bookings to come in? And how do you expect people big parties to spend more or less? What are you thinking for holiday?
You bet. I think it’s a great question. We believe our larger groups right now are on track on what we anticipated for Q4. I think what everybody in our industry is asking or special guests or restaurants that take reservations we are hopefully optimistic we are just uncertain about walk-in traffic. So, we are being aggressive around capturing revenue to large group and we feel like, right now reservations are on pace to do well. But without overguiding, I think we feel optimistic. I think the biggest thing that everybody is waiting for is, what’s going to happen tomorrow and post that just to get it behind us.
This is Tony as well and obviously there is a lot of uncertainty out there from a political perspective. But some of the things that we do know, one is obviously, we were also hit from a hurricane perspective, which we were able to – we had to close our Miami restaurant, our Orlando restaurant and we were also affected in the Southeast with just the hurricane going at that direction. So, we are cautious about the outlook for Q4. We know that just given some of the things we’ve already seen from a natural event perspective that that’s created some additional headwinds for us. And then, the other pieces at Rio were the New Year’s Eve’s shift, which will be a negative guy for us.
Nicole Miller Regan
Very helpful. Alright. Thank you for the time.
And our next question comes from the line of Mr. John Ivankoe with J.P. Morgan. Please go ahead.
Thank you. In your remarks, I think you said that the same-store traffic was down 30 basis points in the US and you stressed the lot of the success that you are having with lunch overall and Brazilian Brunch and extended hours and Saturday lunch, what have you, so that kind of leads open the question, how your core dinner business is doing in terms of – are you seeing material pockets of weakness either during a mid-week dinner, weekend dinner and if you can elaborate a little bit more, because I may have missed that, in terms of the best of Brazil was $39 is obviously kind of a mid-price offering that you haven’t really had before relative to like a $50 or $60 full Gaucho experience if you can maybe talk about whether that makes sense to permanently layer that into your dinner business? And then I have a follow-up as well.
Good question, John. I would say, in terms of overall, kind of, would you say industry, if you look at us get snap, obviously, we are maintaining and obviously picking up market share. We are focusing on weekend capacity that’s where we lacked. So we are picking that up, but like, I would say this through all consumer soft environments and consumer usually gives up the first part of the day, the week usually dinner. So the demand is all weekend-driven. So we are picking that up. We feel good about that. Overall check, like the $39 Best of Brazil, we feel great about it, because just for an additional $9 - $8 to $9 I can have the full Fogo experience. So, that is a great driver we are able to leverage the awareness that Larry spoke to through the Olympics, through that media and we see that as definitely something that will continue to draw on because of its success.
But your point of view is that people are going to trade up from $39 to Fogo experience not trade down from the Fogo experience to the $39?
I think it’s both. I think there, we have a lot of trial. Our brand is still relatively new with a small footprint. So we see that as a drive trial. So as we talk about our media strategies and those price points, if you think about three years ago, we only had one price point which was pretty high. And so we kind of discounted at lunch. So putting in these other price options allow different consumers to try Fogo and also during times that I would say this, price concern – or sensitivity, that value and price options give those guests an opportunity to try us in different ways but also long-term to drive frequency.
Okay it was in your prepared remarks, Barry, that you mentioned, refining the business model. What did you mean by that? What kind of opportunities do you have?
We are all facing pressure on the headwinds labor. Obviously, we get some benefit from deflation. So we are looking to again, add value back to the consumer equation. We are doing that in some of our pricing models through price options if you would. Also looking at the ways to innovate around food to give even further value and new experience leveraging our churrasco platform, but also really productivity as a big part of what we still believe we’ve got some more room to continue to improve on. Obviously, still challenged, but we still see continued room to manage a middle P&L, that’s middle, and then of course, large group sales we are innovating around other areas as we open up brunch on Saturday, Sunday. We are focusing on social group sales which are big opportunity for us. And then obviously, our LFM continue to go after check and other avenues. So we are focusing on top and bottom if you would, for this model.
[Operator Instructions] Now our next question comes from the line of Jordi Winslow with Credit Suisse. Please go ahead.
Hi guys. Thanks for taking the question. Just one on the industry and then one on labor. It looks like the overall steakhouse category seems to improve quite a bit through the quarter. Any take on what drove that improvement you think just that, that at the segment level?
We really can’t speak from an industry perspective. I mean, one of the things we did see from an entire industry perspective is that, in July, there was a tremendous amount of, I guess, anxiety from a guest perspective and I think, we are really trying to figure out exactly what that was, but over time, throughout the quarter, what you did see from an industry perspective is, once the convention has got behind this and those kinds of things were able to settle, and we did see ourselves as well as the industry begin to pick up throughout the quarter.
Got it. Okay, thanks and then on labor, what exactly is the role of the third manager? What kind of benefits are you seeing the restaurant where, I guess they’ve all been implemented and do you think, little further down the line, there are other investments that you may need to make to retain and attract the kind of talent that makes the Fogo experience what it is?
You bet and a great question. So we – the third manager obviously is a build up to growth and then, so really as we grow, we just want to backfill in how really the competency level where we needed. We are training at every level of organization for kind of that next level leadership. So, as we grow, we are being very thoughtful and investing ahead of time. So that we maintain execution levels and we also see it as key driver to obviously the guest experience and productivity overall.
[Operator Instructions] And our next question comes from the line ….
If there are -
We do have one question come from the line of Mr. Brett Levy with Deutsche Bank. Please go ahead sir.
Good afternoon. First question. Just a technical one. You said no change to the guidance, the guidance items should – does that mean we should assume a 366 real for the full year? Or should we assume something different?
Obviously, it would be slightly below the 366, just given the average for the third quarter, we had 325.
Right. That’s I just wanted to make sure on that.
And second, can you spell out a little bit more on what you are seeing in terms of the remodels? Are you seeing anything changing in perception? Are you seeing anything changing in the way customers are using it or is it just all capacity?
Brett, the ones that we have finished this year are the two in Brazil, with one in Brasília and then our Moema store in Sao Paulo. We are seeing high single-digit sales lifts in those stores and I think it is certainly, we have additional capacity now with those remodels. But I think the most important thing is that, the remodels are consistent with the look in field that we are doing in our new stores now. The other one, most significantly is, we will be having enhanced bar venue now in those stores and we are getting a very good reaction and response from our traditional guests and we think now, we have the opportunity to attract a wider range of guests in Brazil. We are finishing three of our remodels in the US. We will have visibility on that as those stores – as that remodel work is completed.
Thank you very much.
There are no further questions at this time. I will turn the call back over to management for any final remarks.
Very good. We appreciate everybody taking the time to join us on the Q&A today. Once again, we want to reiterate that we are excited about our Q3 results and we continue to be cautiously optimistic as we go forward. Thank you.
Ladies and gentlemen, this does conclude our teleconference for today. We thank you for your time and participation and you may disconnect your lines at this time. Enjoy the rest of the day.