El Pollo Loco Holdings, Inc. (NASDAQ:LOCO) Q3 2017 Earnings Conference Call November 2, 2017 5:00 PM ET
Laurance Roberts - CFO
Stephen J. Sather - CEO and President
Alex Chen - Jefferies
Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Third Quarter 2017 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the lines will be open for your questions following the presentation. Please note that this conference is being recorded today, November 2, 2017. On the call today we have Steve Sather, President and Chief Executive Officer of El Pollo Loco, and Larry Roberts, Chief Financial Officer.
And now, I turn the conference over to Larry Roberts. Please begin, sir.
Thank you, operator, and good afternoon. By now, everyone should have access to our third quarter 2017 earnings release. If not, it can be found at www.elpolloloco.com in the Investor Relations section.
Before we begin our formal remarks, I need to remind everyone that our discussion today will include forward-looking statements. These forward-looking statements are not guarantees of future performance and therefore you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect.
We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. We expect to file our 10-Q for the third quarter of 2017 tomorrow and we'd 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'd like to turn the call over to Steve Sather.
Stephen J. Sather
Thanks, Larry, and good afternoon everyone and thank you for joining us on the call today. Third quarter results included revenue growth of 5.6% and pro forma net income of $0.15 per share. While our comparable restaurant sales remained positive during the quarter, our earnings reflected the impact of increased labor costs system-wide, continued investments in our loyalty program and ongoing challenges in our Texas markets.
System-wide comparable store sales grew 1.7% during the quarter, including a 2.4% increase at franchised restaurants and a 0.9% increase at Company-operated restaurants. Sales growth slowed towards the end of the quarter and has remained soft thus far in Q4.
Despite the softness, we remain confident that our efforts to highlight what we believe are our authentic differentiated brand and QSR+ positioning along with initiatives to leverage technology to improve the consumer experience, are the right strategies to drive long-term success of the brand.
During the quarter, our entree promotions were focused on overstuffed quesadillas, taco platters and burritos. Our taco platters performed particularly well, receiving strong customer feedback and addressing an area of opportunity on our menu. These craveable taco platters included the choice of Chicken Avocado Tacos, Chicken Bacon Cheddar Tacos, Avocado Tacos al Carbon, our Shrimp Mango Tacos served with seasoned rice and slow-simmered pinto beans. We believe this differentiated offering, which highlighted our fresh ingredients and unique flavors, could become a permanent menu item in the future.
Our unique family meal offering also continue to resonate with consumers, offsetting some of the softness we saw in entrees. During the quarter, we kept the focus on the $20 price point, which helped drive our strongest family meal growth of the year, up almost 6% compared to last year. For the balance of the year, we will continue emphasizing this price point as we believe it provides good value in this highly value-focused environment.
Our new Loco Rewards loyalty program continued to gain momentum in the quarter. This program, accessible through our new mobile app, offers customers 1 point for every dollar spent at El Pollo Loco and a $10 reward after collecting 100 points. In addition, customers can receive surprise offers, tailored specifically for them based on their purchase history. As of the end of third quarter, we had over 400,000 members, and transactions from loyalty members accounted for 4.7% of sales.
In addition, we are investing in systems to analyze loyalty customer data and create marketing programs that are based on specific customer buying habits. We will continue to invest in our loyalty program, which we believe will drive frequency and in turn drive sales in 2018 and beyond.
I also want to provide a quick update on delivery. While delivery is now available in approximately 28% of our locations across the system, the initial uptake has been modest. We continue to believe that delivery can drive sales growth in the future and we'll continue to optimize this service.
We expect to test a new third-party partner in the Las Vegas market during the fourth quarter. And if successful, we plan to roll out this new service during the first quarter of 2018, which is expected to cover 80% of our system locations. We believe that leveraging technology not only improves the guest experience by bolstering both convenience and value for our guests, but it also allows us to better connect with our customers.
Turning now to development, during the third quarter we opened three new Company-operated restaurants, one in Sacramento, one in Phoenix, and one in Southern California. Additionally, franchisees opened one new restaurant in San Antonio. As for full-year 2017 expectations, we now expect to open 15 to 16 Company-operated restaurants along with seven to nine franchised restaurants this year, as we have lately encountered permitting delays. Due to these delays, two Company-operated restaurants have slipped into early 2018.
Looking ahead to 2018, as we mentioned on our previous earnings call, we expect to build fewer restaurants versus 2017 in both Texas and overall as a result of using more selective development criteria. We will provide more detailed information regarding our 2018 development plans on our fourth quarter earnings call.
We currently have 12 Company-operated and two franchised restaurants in Houston and seven Company-operated and four franchised restaurants in the Dallas-Fort Worth market. Performance in these restaurants continues to be below our expectations, and as such we will be implementing a brand relaunch in both of these markets.
The brand relaunch is planned to encompass everything from operations to facilities to marketing, with a goal of driving brand awareness, bringing guests into our restaurants, and delivering a wow experience. Highlights of the relaunch include; a re-training of all employees from area leaders to cashiers; the restructuring of our menu, which we believe will make it easier for customers to understand and customize their orders while also making it easier for operators to execute; and an enhanced marketing strategy, incorporating social and digital media, a PR program centered on the one-year anniversary in Dallas, as well as improved and additional signage.
The full Dallas relaunch kicked off this week, while Houston, which was delayed due to Hurricane Harvey, will hold off on some of the marketing related initiatives until January. The incremental cost of the program incurred during the fourth quarter will be approximately $300,000. We will continue to analyze our efforts in order to fine-tune our strategy to attract customers, drive sales and improve profitability in these competitive markets.
Our Vision remodels, which we believe better showcase our QSR+ positioning, are continuing to drive positive results. We have completed eight Company remodels in total and have six more in the pipeline which are currently scheduled to be completed by the end of the year. Additionally, our franchisees have completed three Vision remodels this year as well as 10 remodels in the Hacienda style. We are continuing to work to value-engineer the Vision design in order to reduce cost while still achieving the intended sales lift. Looking ahead to 2018, we expect to complete 20 Company and 30 franchised remodels next year, all of which will use the Vision design.
Before I turn the call back over to Larry, I'd like to commend our entire team for the way they handled the challenges delivered by Hurricane Harvey. Our priorities in the days following the storm were taking care of our employees and reopening our affected restaurants. To support our employees during this time, we continued to pay them while the restaurants were closed. In addition, we established funds to aid distressed employees and to support charitable relief efforts.
We also believe that a reopening of these restaurants quickly was important in order to provide our employees with some stability in the face of such disruption and tragedy. Through the hard work of our teams in Houston and the support center, we were able to reopen all affected stores within three weeks, and I'd like to thank all of our team members for making this possible.
With that, I'd like to turn the call over to Larry who will go over our third quarter results and 2017 guidance in detail. Larry?
Thanks Steve. For the third quarter ended September 27, 2017, total revenue increased 5.6% to $101.2 million from $95.8 million in the third quarter of 2016. The growth was largely the result of the increase in Company-operated restaurant sales which rose 5.8% in the quarter to $95 million. We estimate approximately $450,000 of lost sales as a result of Hurricane Harvey in our Houston market.
This increase in Company-operated restaurant sales was driven by the contribution from the 25 new restaurants opened during and subsequent to the third quarter of 2016 as well as by the 0.9% increase in comparable restaurant sales. The increase in Company-operated comparable restaurant sales was comprised of a 1.7% increase in average check, partially offset by a 0.8% decrease in transactions.
Franchise revenue increased 1.6% in the quarter to $6.2 million from $6.1 million in the third quarter of 2016. This increase was driven by the contribution from 15 new restaurants opened during and subsequent to the third quarter of 2016, as well as by 2.4% growth in comparable restaurant sales, partially offset by a decline in franchise and development agreement fees and fees received from franchised restaurants related to their use of our point-of-sale system.
Turning to expenses, food and paper cost as a percentage of Company-restaurant sales decreased 70 basis points year-over-year to 29.3%. The improvement was predominantly due to lower commodity costs, particularly lower contracted chicken prices, partially offset by higher food waste and loyalty program incentives. While we experienced higher avocado prices during the third quarter, they have since come down and as a result we continue to expect full-year commodity deflation of about 2.5%.
Labor and related expenses as a percentage of Company-restaurant sales increased 170 basis points year-over-year to 29%. The increase in labor expenses was due primarily to higher workers' compensation expense, higher minimum wages in California, specifically Los Angeles, and the impact of incremental labor required for 25 new restaurants opened during or after the prior year quarter. While we have recently seen an acceleration in wage rate increases, for 2017 we continue to expect labor inflation of about 4%.
Occupancy and other operating expenses as a percentage of Company-restaurant sales increased 100 basis points year-over-year to 23.4%. The increase was primarily due to rent expense relative to revenue, volume generated, and other incremental costs related to restaurants built in 2016 and the first 39 weeks of 2017.
General and administrative expenses were essentially flat year-over-year in the quarter at $8.3 million. As a percentage of total revenue, G&A expenses decreased 40 basis points year-over-year. G&A expense in the third quarter of 2017 included $933,000 in legal costs related to the securities class action litigation, as compared to $519,000 in securities litigation cost in the third quarter of 2016.
Excluding the costs associated with the securities litigation in both periods, G&A expenses in the third quarter of 2017 decreased approximately $380,000 year-over-year, and we're 80 basis points lower year-over-year as a percentage of total revenue. The decrease resulted primarily from an increase in revenue, a decrease in preopening costs, and a reduced accrual for our annual bonus program.
Depreciation and amortization expense increased to $4.7 million from $4.1 million in the third quarter of last year. As a percentage of total revenue, depreciation and amortization increased 30 basis points year-over-year. The increase was primarily driven by our new store development.
During the quarter, we recorded approximately $15 million of expenses related to the impairment of assets of eight restaurants in Texas and two units in Northern California. Additionally, we closed three restaurants in Texas, resulting in a closed-store reserve expense of approximately $1 million.
We recorded an income tax benefit of $2.5 million in the third quarter of 2017, and an effective tax rate of 37.8%. This compares to a provision for income taxes of $2.8 million and an effective tax rate of 35.2% in the prior-year third quarter.
We reported GAAP net loss of $4 million or $0.11 per diluted share in the third quarter, compared to a net income of $5.2 million or $0.13 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 or unusual items.
To arrive at pro forma net income, we have made adjustments for income and expenses associated with our income tax receivable agreement, gains or losses on disposal of assets, gains and losses on disposition of restaurants, asset impairment and store closure costs, gains and losses related to a fire in one of our restaurants and recovery of insurance proceeds, legal expenses associated with securities related lawsuits, insurance proceeds related to the reimbursement of legal expenses paid in prior years for the defense of securities related lawsuits, and expenses associated with executive transition. We've added back provision for income taxes and have applied a 39.5% 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 million, as compared to $6.9 million in the third quarter of last year. Pro forma diluted earnings per share were $0.15 for the third quarter of 2017, compared to $0.18 in the prior year period. We estimate that the negative impact of third quarter earnings as a result of Hurricane Harvey was approximately $300,000 before tax.
In terms of our liquidity and balance sheet, we had $7.1 million in cash and equivalent as of September 27, 2017 and $85.3 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 $39 million to $41 million.
Turning to our outlook for 2017, we have revised our guidance for the full-year 2017. We now expect pro forma diluted net income per share of $0.61 to $0.63. This compares to a previous range of $0.54 to $0.57 and pro forma diluted net income per share of $0.66 in 2016. Our revised pro forma net income guidance for 2017 is based in part on the following annual assumption.
We expect system-wide comparable restaurant sales growth to be 1% to 1.5%. We now expect to open 15 to 16 new Company-owned restaurants and expect our franchisees to open seven to nine new restaurants. We now expect restaurant contribution margin of between 19.3% and 19.6%. We expect G&A expenses of between 8.1% and 8.3% of total revenue excluding CEO transition costs and legal fees relating to securities class action litigation. We now expect adjusted EBITDA of between $64 million and $65.5 million, and we continue to use a pro forma income tax rate of 39.5%, which reflects our successful program to obtain WOTC credit.
Now I'll turn the call back over to Steve for closing remarks.
Stephen J. Sather
Thanks, Larry. In summary, we continue to believe that we will drive sales and profitability through our efforts to highlight what we believe are authentic brand, are differentiated offerings, and are QSR+ positioning. Our loyalty program is gaining momentum and we are getting ready to test a revamped delivery platform that we believe will drive incremental sales.
We will continue to invest in technology to bolster convenience and value, and improve the guest experience. We are implementing a comprehensive brand relaunch in Texas, planned to encompass everything from operations to facilities to marketing, designed to drive brand awareness, bring guests into the restaurants, and deliver a wow experience.
We believe that our authentic brand, differentiated product, and strong value equation, position us well to drive positive financial results and create long-term value for our shareholders. Again, I'd like to thank you all for your continued interest in El Pollo Loco. We are now happy to answer any questions that you may have. Operator?
[Operator Instructions] Our first question comes from Andy Barish with Jeffrey. Please proceed with your question.
It's Alex Chen on for Andy. I was hoping that you could dig a little bit more into maybe the monthly cadence of the comp, and I know that the family meals have been helping out in the mix, what did that look like in the quarter, and you talked a lot about loyalty, was that offsetting some of the benefit of family meals? Any color would be helpful.
Stephen J. Sather
Sure. This is Steve. We started off really in July and August pretty strong. We were at a 2.9% system-wide in July and 2.8% in August. We saw some softening begin in mid-September and that continued so far into Q4, although we are positive as we sit here today in Q4.
So, we believe the primary reasons for that softness was there are some heavy competitive discounting that began early in September, and we think some of the customers that were attracted to that and the deep discounting.
Also, the biggest impact was in our entree business that we saw. Although we have a very good burrito business, our burrito LTO in September didn't perform quite the expectations that we thought. So, overall a little tough competition in the end of September and that competitive aspect continued on.
If you talk about the loyalty aspect, we feel very good on our loyalty program. We talked about that on the last call. In fact, Alex, if you look, right now we've got about over 450,000 members as of today and we continue to add new members on a daily basis. It's a little over 4.7% of sales. We think this is really a long-term sales driver as it increases frequency.
Additionally, new to this, and the great part about loyalty is you get great consumer data, and it will help us better understand the customers and drive even more effective promotions. We hired a company called [indiscernible] to help us do this data analysis. So we think that's a long-term driver, especially as we get into the 2018 end of sales.
Alex, just to add to Steve's comments, you were asking a question regarding mix, and I think you were getting at the loyalty incentive impact [indiscernible].
I think you called that out precisely because if you look at it, [indiscernible], mix came in roughly flat to maybe down a 10th, and you certainly saw favorable mix with our family meals, but that was offset by the incentives of our loyalty program. If you look at the average check on loyalty program, it's somewhere around $4 to $5 as a result of those incentives. So you can see when you are driving that program, that mix in the loyalty program is offsetting your favorable mix on your family meals.
And then I just also want to, [indiscernible] Steve, it was right around the numbers. We saw some softness in September, and then we have seen that, certainly the start of Q4 has been softer than we expected and hoped for. But as Steve highlighted, we are running positive and we are really positive over 1% so far this quarter.
Got it. Thank you. And then if I might just ask one more, you talked about testing out a third-party delivery, and if I recall, at one point you were working with Olo Dispatch. I'm just curious about whether this is a thing separate from that and were you finding a reason to kind of switch between them and what kind of incremental sales you might have been seeing?
Stephen J. Sather
I'll give you a little bit of color on it. We were working with Olo Dispatch and that's really in about 28% of our system right now. What we weren't participating in with that so far was the delivery marketplaces, which many consumers are using. And what we are doing is we are going to test in fourth quarter here with DoorDash to become a delivery service provider. We're going to test that in our Las Vegas market. And they can not only do that, they operate in the marketplace, but also can do our direct orders, which is what we are doing now at a very reasonable fee.
So we are very excited about that test, because if it's successful in fourth quarter, we'll roll it into the system next year and we think that will take us from about – currently about 28% of our stores are participating in delivery, we think that will take us to 80%-plus. So we are excited about that test in Las Vegas.
And Alex, just to clarify, I mean Olo, we are still using Olo. Olo is our mobile ordering mobile app provider. And so, whereas previously we were using them along with UberRUSH, we are now looking to test them in conjunction with DoorDash. So, Olo is still a very good partner, we are working with them. So it's really just a delivery service provider what we are looking at, not a mobile app provider.
Stephen J. Sather
Yes, we think that DoorDash has a real focus on the large orders and especially catering orders. They have got a very good performance on the catering side, which is a big potential for us with both our family meals and then large office caterings.
Actually that makes me curious, with the mobile so far, are you seeing orders tend toward that higher-ticket kind of larger order or the smaller more maybe loyalty promotional items?
Stephen J. Sather
No, so far when we look at the average check per mobile ordering in the mobile app, it's running higher, and certainly a chunk of that is catering orders coming through mobile. So it is running higher, and right now I think it's running, was it 1.4% or 1.5% of sales, is being done via mobile ordering.
[Operator Instructions] At this time, I would like to turn the call back over to Mr. Sather for closing comment.
Stephen J. Sather
Thank you, operator. We want to thank everybody for joining us today. We appreciate your time and your interest in our brand. Have a good evening.
This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.