Fiesta Restaurant Group, Inc.
Q1 2017 Earnings Call Transcript

Published: 8 May 2017

[Operator:]

Good afternoon and welcome to the Fiesta Restaurant Group, Inc. First Quarter 2017 Earnings Conference Call. Today's conference call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided for you at that time to queue up for questions. I would now like to turn the call over to Raphael Gross, Managing Director at ICR.

[Raphael Gross:]

Good afternoon, everyone. Fiesta Restaurant Group's first quarter 2017 earnings release was issued after the market close today. If you have not already accessed it, it can be found on the company's website, www.frgi.com, under the Investor Relations section. Before we begin, I'd like to inform you that the company, its directors, and certain of its executive officers are participants in the solicitation of proxies from the company's shareholders in connection with the company's 2017 Annual Meeting to be held on June 7, 2017. On May 1, 2017, the company filed its definitive proxy statement and proxy card with the SEC in connection with the solicitation of proxies at the 2017 Annual Meeting. Shareholders of the company are strongly encouraged to read the proxy statement and all other documents filed with the SEC carefully and in their entirety as they contain important information. As you may know, a group of dissident shareholders had launched a proxy contest at the 2017 Annual Meeting. The company will not comment on the proxy contest or take any questions regarding the proxy contest on this call. I must also remind everyone that during the call today, the company will make various statements that are not based on historical information. These forward-looking statements include, without limitation, statements regarding the company's future financial position, and results of operations, business strategy, budget, projected costs and plans, and objectives of management for future operations. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements, and the company can give no assurance that such forward-looking statements will prove to be correct. Important factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements can be found in the company's SEC filings. Please note that during today's conference call, certain non-GAAP financial measures will be discussed which the company believes can be useful in evaluating its performance. Any discussion of such information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and a reconciliation to comparable GAAP measures is available in the company's earnings release. On the call today are Rich Stockinger, President and Chief Executive Officer; Danny Meisenheimer, Senior Vice President and Chief Operating Officer; and Lynn Schweinfurth, Senior Vice President and Chief Financial Officer. After our formal remarks, we'd be happy to answer any questions that you may have. And with that, I'll turn the call over Rich.

[Richard C. Stockinger:]

Thank you, Raph. Today, we will focus our comments on our strategic Renewal Plan that we believe will drive long-term value creation. To begin, I want to share the roadmap we followed to develop the plan. I have used this process at other brands with consistent successful results, most recently with Benihana, where we generated industry-leading comparable restaurant sales and margins for several years following the implementation. The process starts with extensive research by rolling up your sleeves, getting into the heart and soul of the company, its restaurant operations. At Fiesta, our research included a review of previously commissioned research, spending a substantial amount of time in our Pollo Tropical and Taco Cabana restaurants, assessing all aspects of the guest experience. I sat down with the founders of each brand and the brand operations and management teams to understand the origin and brand evolution that had taken place over the years. We reviewed financial, operational and guest metrics including guest feedback and social media scores. With the assistance of a culinary expert that I have worked with in the past, we reviewed each ingredient, product specification and recipe across the entire menu at both brands. Finally, among other things, the operations and facilities teams did an exhaustive assessment of deferred maintenance needs in every restaurant in our portfolio. The next step was the development of the strategic and comprehensive Renewal Plan, which currently has more than 170 action items underway. The strategic framework includes three key priorities. Our first priority initiative is to revitalize our brands in core markets. Investments in core markets have suffered over the past few years as a result of the expansion of Pollo Tropical into other markets. Therefore, it is imperative that we revitalize both our brands in their core markets first with the goal of establishing our brands as best-in-class within our segment and providing the best quality and value to our loyal guests. We plan to relaunch the Pollo Tropical brand in our core markets in September and the Taco Cabana brand later in the year. Based on the Renewal Plan strategy, we made the recent decision to close 30 Pollo Tropical locations in Atlanta, Nashville and Texas to focus our resources and revitalization efforts initially on core markets. A culture change is underway in operations and across the company, with ignited passion to deliver an exceptional guest experience at a high standard. The process will be led by dedicated brand presidents, where Pollo Tropical and Taco Cabana will continue to be managed separately by their operating teams, with operations-driven support staff on site. Enhancing the quality and freshness of our food and increasing the use of natural ingredients are paramount to our plans. We are in the process of revising product specifications and recipes to include more natural, fresh, and higher-quality ingredients than recently used. Delivering exceptional hospitality for a best-in-class experience is also essential. We will train all team members to consistently meet new and improved quality standards. These include improved food quality, kitchen procedures, and enhanced front-of-the-house hospitality and service systems. Managers will manage, and labor schedules are being optimized to ensure staffing levels are appropriate. Other restaurant-level programs are being refined, including dress attire, music, health and sanitation, pest control, line checks, and receiving procedures and other initiatives to drive an exceptional customer experience and improve restaurant operations. We plan to implement high-quality systems that improve our guest experience and operational efficiency, utilizing state-of-the-art digital platforms, enhanced online, delivery, and catering systems capability, digital menu boards and video monitors. We are also evaluating production systems, kiosks, and point-of-sale enhancements that will be considered in the future. Enhanced guest service tools, including call centers, social media programs and guest feedback systems are being reviewed to optimize quality of interaction, efficiency and effectiveness. We will revamp marketing, advertising and social media programs including resuming Spanish television and outdoor billboards in core markets to complement the balance of our advertising initiatives going forward. Until the relaunch, we are scaling back on broadcast media wherever possible while we implement the Renewal Plan. Finally, we revised and prioritized our 2017 capital plan to address deferred repair and maintenance items across both brands and to enhance restaurant visibility with better exterior lightning and signage. Although we have reimaged some Pollo Tropical restaurants over the past few years and completed a remodeling program at Taco Cabana about two years ago, these previous upgrades primarily address the front of the house. Work still needs to be done in both the front of the house and back of the house. The revised capital plan will consider all aspects of every restaurant. Our second priority initiative involves improved management of capital and a commitment to ongoing financial discipline. Cost will be reduced throughout the organization to mitigate investments being made to enhance our guest experience. All non-operating expenses and high cost areas like benefits and insurance programs are under review. We are updating key performance indicators based on our new strategy and cost structures for both concepts, including new theoretical food, labor and other costs to drive organizational focus on improving operating and financial results. Incentive plans have been modified being driven by financial results with other qualitative factors and include guest complaints and health and sanitation scores. In addition to corporate support and capital expenditures, our commitment to financial discipline will include product pricing. We will test and analyze our menu pricing elasticity by geography. This will help us to determine the right balance of pricing while retaining a strong value proposition in the eyes of our guests. Our third priority is to establish platforms for long-term growth. This third priority entails a number of separate but related steps, beginning with refining our brand positioning across each of our markets. We will do quantitative and qualitative research, menu pricing, menu design and menu offerings by geographies to complement our core products at each brand, such as fire-grilled marinated chicken at Pollo Tropical. As I previously expressed, we're in the process of engaging technology partners that provide state-of-the-art digital platforms and processes to improve our catering, delivery and loyalty programs. We believe these programs will be the key growth drivers in the future. We also intend on refining our building prototypes to be more appealing to our guests, more efficient operationally, and lower in cost. We will update our site selection criteria, sales forecasting and market potential tools for both brands so that we can better analyze and target future opportunities at a measured pace. These steps are anticipated to deliver a cash-on-cash return for new restaurants of 30% or better. When we are confident that these new prototypes can meet our investment return requirements, we will restart organic growth to renew restaurant development. Over the long term, we believe there is an opportunity to expand our brand outside of core markets. We plan to utilize 19 company-owned Pollo Tropical restaurants outside of Florida, including 13 in Atlanta and 6 in South Texas, to refine and test our long-term growth potential for future expansion beyond Florida. In closing, our opportunity is huge, our objectives are clear, and our passion is great. We strongly believe that the many initiatives, including our strategic Renewal Plan, will revitalize and rebuild our brand equity for Pollo Tropical and Taco Cabana. With that, let me turn the call over to Lynn to discuss our financial results.

[Lynn S. Schweinfurth:]

Thank you, Rich. Let me begin by congratulating Rich and welcoming Nick Shepherd to our board of directors. Nick is a proven business leader with extensive experience in restaurant and multi-unit retail businesses. We believe the addition of Rich and Nick to our board of directors of the company will further enhance the composition of the board. Industry weakness continues to impact our Florida and Texas markets. Pollo Tropical's comparable restaurant sales decreased 6.7%, which included an 8.9% decrease in comparable restaurant transactions, partially offset by a 2.2% increase in average check. Sales cannibalization from new restaurants on existing restaurants negatively impacted system comparable restaurant transaction growth by approximately 0.7%. Average check was primarily driven by menu price increases that positively impacted restaurant sales by 2%. As noted in our press release, Black Box reported declining comparable restaurant transactions of 6.8% for the fast casual segment in Florida. Pollo's comparable restaurant transactions were approximately 100 basis points below this benchmark. However, we believe that our Florida comparable restaurant transactions were negatively impacted by sales cannibalization from new restaurants by approximately 70 basis points. April comparable restaurant sales and transactions through April 30 declined by 7.6% and 10.7% respectively. We suspended traditional television advertising on March 26 and were up against television advertising last year during the last two weeks of the month which we believe negatively impacted current-year results compared to the prior-year period. We anticipate being on television by September when we relaunch the Pollo brand in our core markets. Turning to Taco Cabana, comparable restaurant sales in the first quarter decreased 4.5% as a result of a 4% decrease in comparable restaurant transactions and a 0.5% decrease in average check. The average check was negatively impacted by higher discounts and promotions, partially offset by menu price increases that positively impacted restaurant sales by 2.2%. Higher discounts and promotions were the result of offering multiple meal deals that negatively impacted sales mix that we do not currently plan on continuing. In fact, we are in the process of pulling back on discounting, not only at Taco Cabana but at Pollo Tropical as well. Black Box reported declining comparable restaurant transactions of 6.5% for the fast casual segment in Texas. Comparable restaurant transactions at Taco were approximately 250 basis points better than this benchmark. April comparable restaurant sales and transactions through April 30 declined by 1.9% and 1.7%, respectively. Houston results have been trending better and in April, turned positive, with comparable restaurant sales growth of 1.6%. Taco advertised on televisions both this year and last year for three weeks during the month. The brand suspended television media at the beginning of May and, as Rich mentioned, we anticipate the brand will be back on television later in the year. Now, let me spend some time on our significant charges. For the first quarter, we recognized impairment and other lease charges of $32.4 million primarily related to the closure of 30 Pollo Tropical restaurants. For the second quarter, we estimate lease and other charges of approximately $9 million to $12 million based on actual timing of restaurant closures. We currently estimate that the cash impacts of these lease and other charges in 2017 will be approximately $3 million to $4 million assuming ongoing lease, tax, utility and other obligations. The 30 closed restaurants contributed approximately $27 million of restaurant sales and $14.6 million of pre-tax restaurant-level operating losses including $4.9 million of depreciation expense and $1.8 million of pre-opening cost to results in 2016. For the first quarter of 2017, these restaurants contributed approximately $6.2 million of restaurant sales and $3.8 million of pre-tax restaurant-level operating losses including $1.2 million of depreciation expense. The restaurants negatively impacted Pollo consolidated comparable restaurant sales growth by 60 basis points and restaurant-level EBITDA margins by 430 basis points. All in, we estimate our annualized general and administrative expense savings associated with the restaurant closures to be $2.5 million to $2.7 million, of which we currently expect approximately $0.9 million in savings net of cost in 2017. And as Rich indicated, all non-operating costs are under review to help pay for the investments we are making in the restaurants and to enhance the guest experience. In 2017, we are now expecting to open eight Pollo Tropical restaurants and seven Taco Cabana restaurants. Two of the Taco Cabana restaurants will be conversions of closed Pollo Tropical restaurants. 2017 capital expenditures are now estimated to be $60 million to $70 million including $22 million to $25 million for development of new restaurants, $21 million to $25 million for ongoing and deferred capital maintenance; $14 million to $16 million for other corporate projects; and approximately $3 million to $4 million for remodeling costs. To conclude, our strategic Renewal Plan is now in place to reestablish Fiesta as a best-in-class restaurant operator and in doing so, create long-term value for our shareholders. We appreciate your time, and now Rich, Danny and I would be happy to answer any of your questions.

[Operator:]

At this time, we will be conducting a question-and-answer session. Our first question comes from Joshua Long of Piper Jaffray. Please proceed with your question.

[Joshua C. Long:]

Great. Thank you for taking my question. It sounds like there's a lot of initiatives on tap and I can appreciate that it's still early on in the process, but wanted to see if you might be able to just provide some context in terms of how this process, at least as you understand it now compares to prior processes that you've gone through. You referenced the work you've done at Benihana and so maybe for some of us who are not as familiar with all that went in there, just curious if you might be able to set up how this kind of entire process across the two brands might compare to prior turnarounds that you've worked on, Rich. .

[Richard C. Stockinger:]

Sure. Very similar in every aspect and we're going through the same process in every aspect here at Fiesta as we've done in the past and most recently at Benihana. I will tell you that the Renewal Plan at Benihana was implemented in September of 2009. We started getting comparable sales increases in January of 2010, and we were number one in Knapp-Track comparable sales increases for 2011, 2012 and 2013. So, again, it's all about getting the restaurant systems and brands back to where we need to get them with quality food and we're expecting to be as successful here as we were in the past.

[Joshua C. Long:]

Great. Thanks for that. And then as we think about some of the discrete items you mentioned, in terms of talking to the customers, going back to the core brand DNA and maybe making some – or accentuating some of those items, you mentioned the place that natural and fresh kind of ingredients or improvements in the ingredients would play. Just curious if you might be able to talk about what the customers and what your research uncovered in terms of what was working and kind of how that helps you determine where to start?

[Richard C. Stockinger:]

Sure. I'll speak at Pollo. It's the chicken, the chicken, the chicken, the chicken. And that's what we're concentrating on is the chicken. There were some decisions made to replace certain quality parts of the chicken with maybe some thigh meat that the guests told us, loud and clear, didn't like. We immediately changed that back, back to the breast and it's proving to be successful already. So frankly for Pollo and that's what we're concentrating on right now and rolling out, it's all about the chicken and more to come and some of the things we're doing with the chicken.

[Joshua C. Long:]

Great. Thank you. And then last one for me in terms of just thinking about how to best attack all of these changes and opportunities you have for the brand, it seems like it might be even easier to just maybe curtail development altogether now and focus on the core markets and then relaunch brand building a little bit further down the road. Are the 8% to 9% at Pollo and 6% to 7% at Taco Cabana a function of just leases that were already kind of in the process or should we expect that to maybe tail down or turn down over time? How do you think about kind of balancing new development with all of the work you have in terms of just getting the brands back to where they need to be?

[Richard C. Stockinger:]

Sure. The ones we're working on right now and we've eliminated some that were in the pipeline are those that had been signed and not only signed, but pretty far along the development process. In terms of the next year, I don't anticipate doing a lot of growth. We'll do similar type growth in our core markets, kind of filling in certain areas. But you're right, we want to get the core markets first done, get the rebranding done outside the core markets before we really turn the growth machine back on as well as doing and bringing in some outside experts and research regarding what should be the menu items around the chicken portfolio. But this year, these are those – the ones we're doing are the ones that were in the pipeline signed, cost approvals done and the rest have been slowed down.

[Joshua C. Long:]

Thank you.

[Operator:]

Our next question comes from Brian Vaccaro of Raymond James. Please proceed with your question.

[Brian M. Vaccaro:]

Good afternoon. Thank you. Rich, I just wanted to circle back to Pollo Tropical and the learnings from the brand research and maybe we could take a step back and high level things. But as you look at it, what areas of the guest experience, I know you mentioned just chicken, chicken, chicken, which makes sense in the food quality. But as you kind of holistically look at the brand and your guest satisfaction scores across many metrics, what are some of the greatest opportunities or where have you slipped the most in your view? How would you categorize those or prioritize those?

[Richard C. Stockinger:]

Sure. And I think the biggest opportunity for us is to regain the number one, our strength in the core markets. And I think we said it early on that money had been taken out of core to both brands. But let's talk about Pollo. Money had been taken out of core, such things as advertising, management talent, repair and maintenance to further along the growth of Pollo in the non-core markets. And that hurt us. We lost some market share by doing that. And it's now going back, refocusing on the core markets and what's made us so positive in core, and that is going back to the Spanish TV which we moved away from, going back to even little things like billboards in certain parts of the country may work and may not work, has worked in the past. And getting back to our roots in that core market and taking back the leadership role that Pollo Tropical has had and will have in the future. That was the number one item, was that people from core telling us kind of you forgot about us a little.

[Brian M. Vaccaro:]

Okay. And in terms of growth next year, it sounds like you still plan to open some units in the core, which I assume is South Florida. But I was wondering, could you comment on the new unit performance that you're seeing in the core, maybe from an average unit volume and store-level profitability perspective?

[Lynn S. Schweinfurth:]

Yeah. Brian, it's Lynn. Store returns in the core markets are at that 30%-plus level. So those restaurants still perform incredibly well. Right now, South Florida is running over $3 million in terms of average unit volume. And then margins can be anywhere northward of 25% depending on the average unit volume.

[Brian M. Vaccaro:]

All right. That's helpful. Thank you. I'll pass it along.

[Operator:]

Our next question comes from Nick Setyan, Wedbush Securities. Please proceed with your question.

[Nick Setyan:]

Thank you. Lynn, how should we think about the unit-level margin benefit for the rest of 2017 from the 30 closures?

[Lynn S. Schweinfurth:]

Well, I think we've provided some data in our opening comments and also in the press release. You've got your restaurant-level operating losses for those restaurants clarified. The margin drag for the 30 restaurants that we closed was about 430 basis points for the first quarter. And so I think those numbers can help you arrive at the impact depending on what your model provides for the balance of the system.

[Nick Setyan:]

I guess, let me ask that a little differently. So for the balance of the system, I guess, down 10% comps. To what extent do you kind of expect – what kind of de-leverage do you expect for the balance of the system?

[Lynn S. Schweinfurth:]

Well, that's a difficult question to really refer to the balance of the year, this year, with all the moving pieces around the Renewal Plan, and we'll certainly share more information as we move forward and decisions are made and financial implications are understood.

[Nick Setyan:]

Got it. And then in terms of just kind of where the comp is, down 10%, down 7% in Q1, I mean, it can't all just be moving marketing around, et cetera. I mean, what are some specific things that you think is causing the pressure on the comps?

[Lynn S. Schweinfurth:]

Well, I think we did highlight what the casual segment industry was experiencing in our Texas and Florida markets. Our performance at Taco is better, and we've talked a lot and other restaurant companies have talked a lot about the state of Texas. You've got a lot of other occasions with which people can choose to select a meal, whether it's delivery services, whether it's grab and go, whether it's other competitors out there in the marketplace because there has been a lot of growth, particularly in Texas. And then Florida, you're seeing very similar impacts. There are additional considerations, we believe, in Southern Florida around tourism trends being down, immigration concerns in terms of certain folks going into the restaurants. So I think those are certainly having an impact in South Florida. The Pollo results were about 100 basis points worse than the fast casual segment. Now, we did quantify the cannibalization we're experiencing in that market on an estimated basis and it really explains a lot of that differential.

[Nick Setyan:]

Got it. Thank you.

[Operator:]

Our next question comes from Will Slabaugh of Stephens Inc. Please proceed with your question.

[William E. Slabaugh:]

Yeah. Thank you. I had a question on the refocusing on core markets and what that might involve. So I'm curious, you've actually been moving some of those staff and it sounds like were moved away from the core back to where they were initially? And then, what else should we be thinking about in terms of changing what has happened in the past?

[Richard C. Stockinger:]

Sure. The amount of people that actually have to move back from Texas or the positions added back to Miami is like four or five. It's not that much, but we're going to have a division president there. We're talking about Pollo. Plus, we'll have a division president in Taco. And they'll have the support that they need. I'll give you an example. It could be a financial analyst that will help them through various tests regarding labor schedules and flow-through that they'll have right there at their sites rather than having to go through Texas. It will be positions like that that will be there. We'll have shared services here at the corporate locations. That will include our legal, our finance and accounting, our HR, things that you frankly could be in Dallas or can be in Phoenix. It doesn't matter where the banks recs are done as long as they're done. But the key is to give the operators the sophisticated tools and support right where the heartbeat of the concepts are, and that is in Miami for Pollo and in San Antonio for Taco. So from an overhead structure perspective, it's just giving the tools where it needs to be, where decisions are made on an hourly basis. And, really, the corporate function, shared functions will be centralized. Right now, it will be right here in Dallas.

[William E. Slabaugh:]

Got it. And on pricing, in the past, both brands had at times priced above peers, given either bone-in chicken inflation or other reasons. After taking a fresh look at the menu and I'm assuming some customer reaction or research, how would you assess the pricing at both brands, and does there need to be any sort of significant adjustment there?

[Richard C. Stockinger:]

We're looking at not just the pricing, of course, the quality of everything including the ingredients. And the portion size to really come up with the value and value scores. So I'd say it's a little early in the game because we're looking at all three of those. From my background, I hate pricing and I don't like discounting. And we are, as we said earlier, that we're stopping the coupons. I don't believe in coupons if you offer a value product, a high-value product. So that's all being looked at right now. But it's not just pricing, it's also quality and portion size.

[William E. Slabaugh:]

Got it. And lastly, can you address the rent expense on those closed stores? I know you gave us some margin guidance in terms of what those may end up costing, but I'm curious, were there many you were able to get out of or sublet, and is there any chance of that happening down the road which could be a positive versus what we know today?

[Lynn S. Schweinfurth:]

Yeah. I think the majority of the cash rent anyway is represented in the lease and other charges in the P&L. And we are actually seeing a lot of activity around interest in terms of the excess properties. Some of which have been sublet, but most of which are still in process. But we're optimistic that we should be able to either sublet – maybe in some cases get out but for the most part sublet the properties based on the demand we're receiving.

[William E. Slabaugh:]

Thank you.

[Operator:]

Ladies and gentlemen, we have reached the end of our question-and-answer session. This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.