El Pollo Loco Holdings' (LOCO) CEO Bernard Acoca on Q1 2018 Results - Earnings Call Transcript

El Pollo Loco Holdings (NASDAQ:LOCO) Q1 2018 Earnings Conference Call May 3, 2018 5:00 PM ET

Executives

Laurance Roberts - Chief Financial Officer

Bernard Acoca - Chief Executive Officer and President

Analysts

Matthew DiFrisco - Guggenheim Partners

Mary McNellis - Robert W. Baird & Company

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco First Quarter 2018 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, May 3, 2018.

On the call today we have Bernard Acoca, President and Chief Executive Officer of El Pollo Loco; and Larry Roberts, Chief Financial Officer. And now, I would like to turn the conference over to Larry Roberts.

Laurance Roberts

Thank you, operator, and good afternoon. By now, everyone should have access to our first quarter 2018 earnings release. If not, it can be found at www.elpolloloco.com in the Investor Relations section.

Before we begin our formal remarks, I need to remind everyone that our 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 first quarter of 2018 within the next few days 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.

It's now my pleasure to turn the call over to President and Chief Executive Officer, Bernard Acoca.

Bernard Acoca

Thanks, Larry. Good afternoon, everyone, and thank you for joining us today. I'm so excited to be here on my first El Pollo Loco earnings call. And I look forward to sharing our journey with you.

I've now been at El Pollo Loco for seven-plus weeks. And while I'm still immersing myself in the business, I wanted to take this opportunity to share a few of my observations as well as my thoughts on opportunity areas we need to focus on immediately.

When evaluating joining the company, I was first struck with just how special the El Pollo Loco brand is. I instantly fell in love with our signature product, our citrus-marinated chicken, which is freshly prepared right in front of the customer on an open-flame grill. Between the time it takes to marinate and the time it spends on the grill, each chicken takes almost an hour-and-a-half to cook. We simply don't take shortcuts with our chicken, making our product an absolutely delicious, truly differentiated, handcrafted and high quality product.

While other may make claims, we believe that few of our competitors freshly prepare by hand, the amount of food we do every day in our restaurant. Another point of strength is our Los Angeles and Southern California roots, where we have developed a deep cult like connection with our loyal fan-base.

From an operations perspective, I have also been impressed with store-level performance in our core markets, which continues to be very strong as is reflective of the overall quality and commitment of our people. Over the last 50-plus days, I have spent a significant amount of time meeting with each of our teams here at our support center, franchises, as well as with many operators in the field. And I'm very enthusiastic about the quality of our people, the commitment of our franchises and the opportunity I see to further build this brand over the long term.

It is obvious to me that the team has done a lot right to get this brand where it is today. This is evidenced by the recent Market Force survey, in which El Pollo Loco essentially tied with Chipotle as consumers' favorite Mexican restaurant brand, and tied with Zaxby's for third in the chicken category.

Clearly, consumers love our concept, but we are setting our sights on taking El Pollo Loco to higher levels. To that end, we are focusing our work on three key foundational strategies: number one, develop the people-first culture; two, differentiate the brand; and three, grow the business.

Let's quickly review all three. First, because our people are our greatest asset, we need to develop a people-first culture that invests in and grows our talent. This includes implementing a heart-centered leadership program to capitalize on the sense of family that exists throughout the company and foster a culture of courage and compassion to lead others with authenticity, transparency, humility and service with a strong emphasis on impactful coaching and recognition that reinforces the behaviors that we value.

This culture already exists within certain parts of our business, but it needs to live within our entire system, both company and franchise. We've already developed and started training on our heart-centered leadership program and expect to start rolling it out to our franchises at our leadership conference in July.

Second, we must further clarify what our brand stands for, and differentiate it by extenuating and building up on our strengths. This includes establishing El Pollo Loco as the undisputed chicken brand of choice, what we call Pollo Passion, solidifying our better-for-you positioning, celebrating our Hispanic heritage and roots, and consistently delivering service that wows the customer.

Clear articulation of the brand should provide the guardrails for everything we do, from marketing, the product development, the store design. Most importantly, we will become a consumer-driven company.

Third, we will grow the business responsibly and profitably for the long term. This includes developing a customer-centric growth strategy to achieve successful unit growth in new geographies and driving friction-less convenience by making accessing and ordering from us effortless.

All our decisions, strategy and tactics will be driven by what consumers want and expect from El Pollo Loco. I'm also in the process of reviewing our non-core markets. Along these lines, I recently visited our restaurants in Houston and Dallas. My number one takeaway was that we have built highly capable, passionate and extremely dedicated teams in both markets.

The biggest challenges are to clearly define the brand for consumers, make restaurants easier to operate, so we can consistently provide great customer service and drive awareness in what are very competitive markets. We are in the midst of our brand re-launch program, but there are more things we can do to enhance the brand and drive sales in these restaurants.

For this reason, we are quickly developing and implementing multiple initiatives to further address the challenges we are facing in both markets. I look forward to updating you on our progress against these strategic priorities in the future, as well as providing more color on the specific initiatives underpinning these strategies.

However, we are not sitting still on the short run as we formulate our long-term strategic plan. I know as do you that comps have been challenged and the industry environment remains highly competitive. We are working hard to regain business momentum in the near term. To that effect, we are continuing to executive our technology initiatives. Delivery and loyalty using our website or new mobile app have been rolled out across the system.

Our goal is to add ever greater functionality to the app over time, to enhance the El Pollo Loco customer experience. In fact, in July customers will be able to effortlessly pay with their mobile phones using a stored value component we have built into the app. In addition, through our partnership with DoorDash, we have delivery capabilities in approximately 65% of our restaurants.

We expect to be added to the DoorDash marketplace, whereby users can order El Pollo Loco for delivery through the DoorDash app as opposed to our own app by the end of the second quarter. We believe success in delivery as well as catering will be tied to the success and growing our loyalty program, which now has 750,000 members. We see enormous potential from more personalized marketing through the rich purchase history data we glean from our loyalty program in the future and are committed to accelerating its growth.

We are also looking to drive business momentum in the back-half of the year, through three key initiatives. They are: one, to determine the best way to deliver everyday value to our customers without compromising or degrading our brand, as well as better communicate the tremendous value we already offer as a result of the superior quality of our food; two, to revisit our media and advertising strategy to ensure we are communicating to our customers as effectively as possible; and three, ensure we have the best possible products and marketing calendar in place to help us win.

In closing, I'm extremely excited to be at El Pollo Loco. Few of any other restaurant concepts offers freshly made high-quality food that's not only craveable, but also fits nicely into consumer trends of healthier eating, while remaining affordable.

We have a strong team in place, and our core market restaurants, which comprises over 80% of our total revenue exhibit very strong unit economics. I believe, we have a tremendous opportunity to build upon past successes of the brand and I look forward to sharing our progress with you going forward.

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

Laurance Roberts

Thanks, Bernard. Before I go over the first quarter financial results, I want to briefly touch on our store base. In the first quarter, we opened two new company-operated restaurants, one in Sacramento and one in Dallas. Franchisees opened three new locations, one in Salt Lake City, one in Sacramento and one in Lafayette, Louisiana. As discussed during our last call, we closed two restaurants during the quarter, one in Dallas and the other in Houston. Additionally, we've closed two more restaurants in Texas, during the second quarter, one in each market.

Our total store count in Houston, Dallas currently stand at 13 and 10, respectively. During the quarter, franchisees completed 10 vision remodels. We remain on track to open six to eight company-operated restaurants along with six to eight franchised restaurants this year and expect to complete 20 company and 30 franchise remodels.

Now onto the results. For the first quarter ended March 28, 2018, total revenue excluding franchise advertising fee revenue increased 0.9% to $100.7 million, compared to $99.8 million in the first quarter of 2017, this was driven by an increasing company-operated restaurant sales. Including $5.1 million advertising revenue related to franchisee advertising fund contributions, required as a part of new accounting guidance implementation, total revenue increased 6% to $105.8 million.

Company-operated restaurant sales rose 1.2% in the quarter, to $94.6 million from $93.4 million in the first quarter of last year. This increase in company-operated restaurant sales was driven by the contribution from 18 new restaurants opened during and subsequent to the first quarter of 2017, partially offset by four restaurant closures and a 2% decline in company-operated comparable restaurant sales. The decrease in company-operated comparable restaurant sales was comprised of a 1.7% decrease in transactions and a 0.3% decrease in average check.

Franchise revenue decreased 3.4% in the quarter to $6.1 million from $6.3 million in the prior year period. The decrease was driven by a decline in franchise and development agreement fees and lower fees received from franchised restaurants related to their use of our point-of-sales system, as well as a 0.4% decline in comparable restaurant sales. The decrease was partially offset by 10 new franchised restaurants opened during and subsequent to the first quarter of 2017.

Turning to expenses. Food and paper costs as a percentage of company restaurant sales decreased 20 basis points year-over-year to 28.8%. The improvement was predominately due to lower commodity costs related to chicken, partially offset by higher packaging costs. We continue to expect modest commodity basket inflation for the full year of approximately 1%.

Labor and related expenses, as a percentage of company restaurant sales increased 60 basis points year-over-year to 29.3%. The increase in labor expenses was due primarily to higher wages in California, especially in Los Angeles, and impacted incremental labor required for 18 new restaurants opened during or after the prior year quarter, partially offset by lower workers' compensation expense. For the full year, we now expect labor inflation to be about 5% as we are experiencing increase wage pressures.

Occupancy and other operating expenses as a percentage of company restaurant sales increased 120 basis points year-over-year to 23.2%. The increase was primarily due to rent expense, relative to revenue volume generated and other incremental costs related to restaurants built in 2017 and the first 13 weeks of 2018.

General and administrative expenses increased by $3.5 million year-over-year to $13.2 million from $9.7 million in the prior year period. As a percentage of total revenue, G&A expense increased 270 basis points versus the prior year period. G&A expense in the first quarter of 2018 included $3.7 million in legal costs related to the securities class action litigation as compared to $351,000 in securities litigation cost in the first quarter of 2017.

Additionally, G&A expense in the first quarter of 2018, included $646,000 in executive transition costs compared to $92,000 in the prior year period. Excluding the cost associated with the securities litigation and executive transition of both periods. And adjusting for the impact of the change in accounting for franchise advertising fees on our 2018 revenues. G&A expense in the first quarter of 2018 decreased approximately $438,000 year-over-year and were 50 basis points lower year-over-year as a percentage of total revenue. This decrease resulted, primarily from a lower bonus accrual.

Depreciation and amortization expense decreased to $4.2 million from $4.3 million in the first quarter of last year. As a percentage of company revenue, depreciation and amortization decreased 30 basis points year-over-year. The decrease was primarily driven by lower asset value resulting from impairment charges taken in 2017.

As mentioned earlier, during the quarter we closed two restaurants in Texas, one in Houston, and one in Dallas. We recorded a closed store reserve expense of approximately $2.8 million. We recorded a provision for income taxes of $1.9 million in the first quarter of 2018 for an effective tax rate of 43.5%. This compares to a provision for income taxes of $3.5 million and an effective tax rate of 41.6% in the prior year first quarter.

We reported GAAP net income of $2.5 million or $0.06 per diluted share in the first quarter compared to a net income of $4.9 million or $0.12 per diluted share in the prior year period. Pro forma net income for the quarter was $6.7 million, as compared to $6.1 million in the first quarter of last year. Pro forma diluted earnings per share were $0.17 for the first quarter of 2018 compared to $0.16 in the prior year period. Our reconciliation pro forma net income and earnings per share to the comparable GAAP figures, please refer to our earnings release.

In terms of our liquidity and balance sheet, we have $6.2 million in cash and cash equivalents as of March 28, 2018 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 expect our capital expenditures to total $27 million to $31 million.

Turning to our outlook for 2018, we are reiterating our guidance for the full year. We expect pro forma diluted net income per share of $0.68 to $0.73, which includes an estimated $0.14 benefit from the lower tax rate. This compares to pro forma diluted net income per share of $0.63 in 2017. Our pro forma net income guidance for 2018 is based in part on the following annual assumption.

We expect system wide comparable restaurant sales growth to be approximately flat. We expect to open six to eight new company-owned restaurants and expect our franchisees to open six to eight new restaurants. We expect restaurant contribution margin of between 18.7% and 19.3%, which reflects continued investment in our Texas market.

We expect G&A expenses of between 8.2% and 8.4% of total revenue, excluding legal fees related to the securities class action litigation and CEO transition costs and reflecting our change in accounting for franchise advertising fee.

We expect adjusted EBITDA of between $61 million and $64 million, and we're using a pro forma income tax rate of 26.5%. Please bear in mind, that our guidance may be materially impacted by strategic decisions made during the course of the year as we integrate a new CEO.

That concludes our prepared remarks. I'd like to thank you for joining us on the call today. And we're now happy to answer any questions that you may have.

Question-and-Answer Session

Operator

At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Matthew DiFrisco, Guggenheim Securities. Please proceed with your question.

Matthew DiFrisco

Thank you. I know it might be a little bit early but, Bernard, I guess, could you talk a little bit about some of the potential marketing strategies or at least the cadence of the pace of when we might see different marketing strategies or significant difference in waiting or something of that nature? How that might change over the next couple of quarters or over the next couple of years? What sort of a cadence and pace we should expect?

Bernard Acoca

Well, I think I would categorize them in two buckets. And per my opening remarks, I think we're very, very focused in the near term in terms of optimizing our marketing calendar and our marketing message to regain momentum in the back-half of the year. So I think what you can expect to see there is us taking the hard look and revisiting our marketing calendar, our advertising and how we're allocating our media weight to best optimize those things to have maximum impact for the balance of the year.

Concurrently, we're taking a hard look at our brand architecture to ensure that we are clarifying and differentiating what our brand stands for and really leveraging what our key differentiators are in the marketplace. So in the short-term, I think you could expect to see some incremental changes to what we're doing in the back half of the calendar year with more to come medium to longer term as we start to further differentiate and clarify what our brand stands for.

Matthew DiFrisco

Excellent. Okay. Thank you.

Operator

As a reminder, we are now conducting a question-and-answer session. [Operator Instructions] Our next question comes from Mary McNellis, Robert W. Baird & Company. Please proceed with your question.

Mary McNellis

Good afternoon. Thanks for taking the question. Bernard, you noted an opportunity in your remarks about focusing on continually delivering a good guest experience. So I was wondering if you could talk a little bit how operations improvements might play a role in this strategy going forward and what your consumer feedback scores or what your initial experience has told you about what might need to improve there.

Bernard Acoca

Sure. Well, I would say, first off, that the culture that we had at the company is something that I have been very, very impressed by coming into the company. There is a word here that I've heard repeated quite often, both in this building, at our support center and then our restaurants, and that's family. And that's evidenced by the very long tenure we have in many, many of our employees both here at the support center and in our restaurants.

I think it's something that's somewhat of an anomaly in the QSR business, for the restaurant business in general I should say. That is a very strong foundation, off of which to build a very dynamic culture, which really focuses on our employees, unleashes their potential and frees them up to do the right things on behalf of our customers.

So culture and really investing in our people and growing our talent is going to be of paramount focus for us in the coming weeks and months ahead. To answer your question more specifically, we are working with our operations team and looking to see what we need to do to deliver a superior customer experience.

I think if we take a look at lot of the metrics that we have in our markets today, we're pleased with a lot of the customer KPIs that we measure. But we see an opportunity to further elevate them and we'll be looking to do so through a variety of different initiatives over the coming weeks and months.

Mary McNellis

Thank you. That's helpful perspective. And then with the strategy going forward expected to include greater focus on communicating the differentiated factors of the brand, do you think at this stage that there is a step-up in the marketing spend needed to execute that plan or do you think of it as more of a reallocation of the spend?

Bernard Acoca

Right now, I see it as more of a reallocation of the spend in making sure that we are spending what is in our budgets as efficiently as possible right now, and then secondly, ensuring that the creative that we developed to communicate that or to leverage that spend is as impactful and is compelling and as relevant as possible. So I don't see it as being an increase in the spend, no.

Mary McNellis

Okay. Thank you very much. That's it for me.

Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Bernard Acoca for closing remarks.

Bernard Acoca

Well, thank you. I appreciate. Like I said earlier, I'm very much looking forward to sharing with you in the coming weeks and months ahead the journey that we're on. I'm extremely excited to be here. I see tremendous opportunity in taking El Pollo Loco to new heights. And looking forward to sharing with you our progress as we make some headway with some of the initiatives I referenced on today's call. We look forward to talking to you soon. Thank you.

Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.